Rio Tinto Scraps Plans To Sell Diamond Business After Strategic Review

by Trefis Team
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Rio Tinto
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After conducting a strategic review in which all possible options were considered, Rio Tinto (NYSE:RIO) has decided to retain its diamond business. The company feels that this is the best way to generate maximum value for its shareholders. [1]

Rio claimed that the diamond business was well-positioned to capitalize on medium and long term growth opportunities in Asia and North America, even though these markets are sluggish at the moment. It made it clear that it would not sell its assets in a hurry at low prices.

Rio’s diamond unit has mines in Canada, Australia and Zimbabwe and is said to be worth about $2.2 billion. The business includes Rio Tinto’s 100% interests in the Argyle Diamond Mine in Australia and the Bunder Diamond Mine in India, a 60% interest in the Diavik Diamond Mine in Canada and a 78% interest in the Murowa Diamond Mine in Zimbabwe. It also operates a niche cutting and polishing factory in Perth for rare pink diamonds from its Argyle mine. [2]

See Full Analysis for Rio Tinto Here

Why A Sale Was On Anvil In The First Place

Rio’s performance in 2012 was very weak. It reported a net loss of $3 billion down from a profit of $5.8 billion in 2011. This was largely due to the hefty $14 billion impairments it had to take on account of writedowns in the aluminum and Mozambican coal businesses. Underlying earnings in 2012 stood at $9.3 billion compared to $15.5 billion in 2011. This was due to a combination of lower prices of iron ore, aluminum and copper and a net negative effect from the variance in volumes.

At the time of announcing the results, the management had said that key priorities going ahead will be to achieve cost savings of $5 billion over the next two years and generate significant cash from the sale of non-core assets and businesses. At the same time, Rio is likely to go ahead with its major expansion plans in the Pilbara iron ore region of Australia. Also, it is keen to maintain its single-A credit rating and reduce its $19 billion debt. [3]

Why Selling The Diamond Business Has Been Difficult

The natural resources sector is sluggish at the moment with economic growth in key emerging markets slowing down. The diamond business generated a loss of $43 million for Rio in 2012 compared to a net profit of $10 million in 2011. This was due to lower prices, which in turn was a function of lower demand from key Asian and North American markets. In such circumstances, it would be difficult to find a buyer willing to pay Rio’s asking price. Also, according to an unnamed banker, debt costs have risen by 200 basis points (1 basis point=0.01 percent) in the last couple of weeks. This would make it costly to finance any acquisitions. [4]

Some blame can also be laid upon the nature of the diamond business. Most of it is controlled by a few big players such as Anglo American, Alrosa and Rio. A bid by a large player for assets could attract regulatory scrutiny, while smaller players may not be able to afford the price. [5]

Our View On Rio’s Decision

We think that while Rio may be correct about medium and long term market opportunities for diamonds, it still doesn’t make much sense for the business to be owned by the company. While the business is intrinsically a good one, it makes little sense for a company of Rio’s scale and nature. It is too small to be of strategic significance to the company and provides little by way of diversification to its bread-and-butter iron-ore business. Since good quality diamond mines are very difficult to come by these days and the development involves a long gestation period, the scope for scaling up the business is also limited. Also, it eats into management time and company resources would be better channeled elsewhere in light of the tough times Rio is facing right now.

Indeed, the company had reportedly been toying with the idea of going for a public listing of the diamond business on the London Stock Exchange, which could have been worth up to $5 billion. We are not sure why it eventually didn’t opt for this route, and no explanation from the management have been offered either. In our view, this would have been the best option under the circumstances. ((Rio Tinto To Seek IPO For Diamond Business As It Fails To Find Buyer: Bloomberg, NASDAQ))

We have a Trefis price estimate of $56 for Rio Tinto.

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Notes:
  1. Rio Tinto opts to retain diamonds businesses, Rio Tinto Press Release []
  2. Rio Tinto ‘seeks to list gem division’, Business Report []
  3. Rio Tinto 2012 Earnings Report, Rio Tinto Media Release []
  4. Rio Tinto overhaul plans dented as diamond sale scrapped, Reuters []
  5. Rio Tinto Drops Sale of Diamond Business, WSJ []
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