Why Rio Tinto Might Favor A Flotation Over Outright Sale Of Diamond Business

RIO: Rio Tinto logo
Rio Tinto

After mining giant BHP Billiton announced the sale of its diamond operations for $500 million last week, all eyes are now on Rio Tinto. The latter had followed BHP Billiton in putting its diamond business on the block for sale in March this year. However, due to an unsatisfactory valuation of the business by potential buyers, Rio has chosen not to make a sale thus far. Now speculation is mounting that Rio intends to float its diamond business as an independent company rather than opting for a straight sell-off. The company has kept both options open since announcing its intention to sell the diamond business and hasn’t commented on the flotation speculation thus far. [1]

Why Flotation Over An Outright Sale?

It is possible that it may opt for this route in order to unlock greater value for its diamond business. Unlike BHP Billiton, Rio has developed significant in-house capabilities for diamond processing and marketing which are not very easy to value. In addition, Rio has made a major discovery at Bunder in India which has been described as the largest discovery in the country in the last fifty years. A flotation might be able to do a better job of putting a higher value on these assets.

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There is also speculation that Rio will retain a 40% stake in the new listed company which will have Argyle mine and the Diavik mine in Canada as its major producing assets. Secondary assets might include the small Murowa mine in Zimbabwe in which Rio owns a 78% stake and the undeveloped Bunder mine in India. Rio Tinto owns all of Argyle which started production in 1983, and 60% of Diavik which started in 2003. These mines produce very rare pink diamonds and are the only large scale mines producing these.

Why Rio Might Retain A Substantial Stake In The New Company?

Based on information currently available we can only speculate why Rio is likely to retain a significant stake in the business. It is possible that Rio may have had a change of heart in looking at the potential of the Bunder mine which is expected to produce 2-3 million carats annually starting  2016-17. At this point it is difficult for Rio to ascribe a value to this asset. However, there is something else we find puzzling. The stated reason for exiting the diamond business was Rio’s contention that it wants to invest scarce capital into businesses with long term growth potential. If Rio continues to own a major stake in the company after the flotation, it will likely be the operator of the new company which will still require labor and capital resources to the business. How does that tie out with what Rio claimed earlier?

We think that it doesn’t. It is possible that Rio has decided to continue investing in the business and will likely sell its stake once it receives what it views as a justified valuation for the assets. We admit that we are on relatively weak ground here about the strategy behind Rio’s sale, but then Rio has not offered any explanation thus far so it’s difficult to claim anything with certainty.

The diamond business constitutes only 4% of Rio’s Trefis price estimate.

We have a Trefis price estimate for Rio of $45 which is nearly 5% below its market price.

Understand How a Company’s Products Impact its Stock at Trefis

  1. Rio Tinto buffing diamond float to take on De Beers, Mining.com []