BHP looks to exit diamond business

BHP Billiton (BHP-N, BLT-L, BHP-A) is considering leaving the diamonds business, because it may no longer fit its modus operandi of owning only “large, long-life, upstream and expandable assets.” 

The world’s largest miner by market cap said on Nov. 29 that it is reviewing whether it should sell all or part of its diamond interests, which comprise a non-core division of the company.

BHP holds 80% of the Ekati diamond mine located near Yellowknife in the Northwest Territories, and 51% of the grassroots Chidliak diamond project on Baffin Island. Ekati’s co-discovers Stewart Blusson and Charles Fipke each hold 10% of the producing mine, while Eric Friedland’s Peregrine Diamonds (PGD-T) holds the remainder of Chidliak.

“Ekati is a world-class operation and Chidliak is a promising exploration opportunity, but many years of extensive exploration suggest there are few options to develop new diamond mines that are consistent with [our] approach,” BHP stated in a press release.

“We are examining a variety of options, including keeping the business, or a possible sale of our interests in Ekati and Chidliak to one or more purchasers,” Ruban Yogarajah, BHP’s media relations representative, added in an email.

During the process, the company will also calculate how much bang for its buck it will be getting down the road. Given that Canada’s first surface and underground mine has been in production since 1998, it has another eight years of production
left. 

If it does put its assets on the auction block, it may consider selling Ekati soon, says Edward Sterck, a London-based analyst with BMO Capital Markets.

“Ekati still has a reasonable mine life left and a fairly large residual value,” Sterck commented over the telephone. “If they do want to move on, perhaps it is better to sell while there is still some residual value there.”

BMO Capital Markets values the asset at US$1.8 billion with a 10% discount rate, which is down from its previous estimate of US$2.7 billion. 

Sterck says potential buyers of BHP’s interest in Ekati include Russia’s Alrosa, Rio Tinto (rio-n, rio-l, rio-a) and Harry Winston Diamond (hw-t, hdw-n).

In early October, Russia’s Interfax news agency reported that the Russian state-owned diamond producer was eyeing a piece of Ekati.

But Alrosa will likely need to go public to raise the cash it needs to make the purchase, Sterck says. The move may not be politically applauded or welcomed by Alrosa’s largest shareholder, the Sakha republic, which would likely want the money invested locally.

Rio may have a better shot at Ekati, Sterck reasons, noting that Harry Winston may not have enough cash to buy Ekati on its own. Rio and Harry Winston are 60-40 joint-venture partners at the nearby Diavik diamond mine.

Diavik, Canada’s second diamond mine, started production in 2003 and is expected to operate for 16 years to 22 years.

Sterck suggests that since Diavik and Ekati are beside each other, they could generate cost reductions under a single operator and potentially be mined as one operation.

Another possibility is for Rio and Harry Winston to partner at Ekati. 

“Rio Tinto is unlikely to be interested in directly buying Ekati because it is a mine with a short life, but a long reclamation liability,” newsletter writer John Kaiser penned in a Nov. 29 note. “But it might be an opportunity for Harry Winston’s Bob Gannicott to acquire a bigger role on the Canadian diamond scene if, with Rio Tinto’s support, he emerges as the primary driver of a deal where Harry Winston and Rio Tinto split ownership of Ekati through their stakes in Diavik.”

Kaiser also suggests that Anglo American (AAUKY-Q, AL-L) may take a go at Ekati, despite agreeing to pay US$5.1 billion in cash for a 40% stake in De Beers.

On the contrary, Sterck of BMO Capital rules out Anglo American, saying he doesn’t see the company bidding for Ekati after snapping up the Oppenheimer family’s stake in De Beers. 

De Beers, a prominent player in Canada’s diamond scene, has been operating the Snap Lake mine near Yellowknife and the Victor mine in northern Ontario since 2008, and has another project nearing construction. It will start building its Gahcho Kué diamond project near Yellowknife once the ongoing environmental impact review is completed and approved. Considering De Beers has a lot on its plate, it may pass over the old Ekati mine. 

BHP says it should complete its diamonds review by late January 2012.

“Potential transactions arising from the review will be subject to detailed analysis before a final decision is made,” BHP says, noting that if it is unable to find suitable bidders, it will keep its
assets. 

While there’s much speculation about Ekati, Peregrine shareholders may be more acutely concerned about BHP’s interest in Chidliak.

Kaiser says the timing of BHP’s review is unfortunate, given that the junior’s $11.8 million unit rights offering at 85¢ expires on Dec. 6.

He adds that news of BHP eyeing the exit door implies that it’s unlikely the major would fund more exploration work at Chidliak, leaving Peregrine scrambling to fund its upcoming $25-million, bulk-sampling program. 

Kaiser suggests that Peregrine could buy BHP’s stake. But the price may be too steep  if a deep-pocketed Ekati buyer also wants Chidliak. 

On the news, Peregrine shareholders pushed the stock down 14% to close Nov. 29 at 70¢, and the following day during presstime Peregrine lost another 14%, sinking to 60¢.