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"The company needs fresh blood at all levels"

12 february 2018

Sergey Ivanov, CEO of ALROSA, speaks about the company’s strategy and development plans, the Mir mine, current market conditions and synthetics issue.

sergey_ivanov_x.jpg(kommersant.ru) – Sergey Ivanov, Chief Executive Officer of ALROSA tells the Kommersant Daily about how the accident at the Mir mine will affect business and why the diamond mining company does not want to buy the Grib mine.

You turned to be the head of ALROSA not long ago, in 2017. Who offered you this post?

It was offered by Anton Siluanov [Russia’s Minister of Finance. – Kommersant.], Chairman of the Supervisory Board of ALROSA. When we met, I asked about the tasks facing the company and he outlined them. I am interested in real production with a longer planning perspective. It is a fascinating task to turn ALROSA into a world leader not only in terms of production, but also in terms of operating efficiency, into a company with stable long-term advantages, but mobile and flexible.

You said that you had changed about 70% of the ALROSA team in Moscow. What were the main reasons for this rotation? Do you plan any further personnel changes?

My immersion into this business – I have been with ALROSA for ten months - showed that many things stay hidden behind the company’s remarkable EBITDA. This implies the opacity of procurement purchases and that of the investment program involving billions of rubles, decentralized budgetary control, non-automated processes and hence, among other things, the lack of proper analytics and economic security services, degraded personnel management and development, as well as duplication of functionality. There are loopholes in the industrial safety system - I would even say, the lack of this system, because the company has always decently invested in safety measures, and there is no end-to-end systemic control over its compliance. All these changes require a substantial restructuring from within and a change in the internal culture. The company needs fresh blood at all levels, as well as experience in building systems acquired in other industries.

The second important point is volatility. When the market grows, the company has good performance, but when the market feels bad, its performance at once goes down. I see the task in making us much more stable even in a storm wind. This requires a long-term strategy and investments in operation under new market challenges. New goals and tasks require new ideas and new competencies. In my opinion, today we managed to form a professional and efficient team that knows its business well and is most focused on the result. Time will tell whether these personnel decisions were correct, I bear full responsibility for them. Our shareholders, as far as I know, are happy with the reshuffle and I feel their support.

The forecast plan of privatization until 2019 includes a sale of 8% of ALROSA - apparently, 4% from the package of the Russian Federation and 4% from the package of the Republic of Sakha (Yakutia). But the republic was against further reduction of its share. What is the position of Yakutsk and will this be discussed in the fall, when the five-year shareholder agreement expires?

As far as I know, there is no work being done at this stage. And the shareholders have to decide themselves in what way they will sell, in equal shares or not - we as management do not participate in making this decision. I know the official position of the Republic of Sakha (Yakutia), as they have repeatedly expressed it - this issue is not on the agenda.

Does your vision of ALROSA's strategy correspond to the company’s strategy approved for the period up to 2023?

Our business, unlike banking or insurance, does not need substantial re-arrangement of the strategy every two years because of new threats.

ALROSA will continue to follow the strategy as it was adopted in 2013: we remain the largest diamond mining company, we do not go into any other segments or resource groups and we continue to dispose of non-core assets. Yes, since 2013, the macroeconomic environment has changed dramatically - exchange rates, inflation, prices for rough diamonds and their various assortments. We have new challenges from the synthetic diamond market that we need to address – it is not critical, but it is a new reality that must be taken into account in the strategy from the point of view of marketing and other areas of development.

And we need to improve the operational efficiency of our business every day. At other diamond mining companies, less than our size, the margin is steadily declining, and it is becoming increasingly difficult for them to develop. The new diamond fields are few, production costs are inflated, while rough prices remain flat, and sooner or later one can get caught in a tight corner. We have already had the year 2008, when ALROSA could not sell anything at the market and almost all the amount of mined diamonds was bought by the State. There was also 2015, when diamond prices fell by 15-20%. The company should be prepared for the fact that the market is becoming more volatile. The strategy will be approved by the Supervisory Board in the summer of 2018, but there will be absolutely no surprises, it will be just an update of the previous strategy.

You said that the Mir mine after the last year's accident will start in 2022-2024, and how likely is the scenario that it will not start at all?

We do not consider such a scenario for ourselves and believe that the restoration of the mine is a matter of time. This is a very good and easy-to-understand kimberlite body with a good carat grade per ton, which is one of the highest for our diamond deposits. Accordingly, its development looks economically expedient. But it is necessary to evaluate all project decisions and analyze the feasibility study. The most difficult issue is associated with the project solution, because the water-bearing complex in the mine has not gone anywhere. Most likely, we will need to somehow get to the bottom of the quarry and ensure the capture of water, which continues to flow. After we can find such a solution and pump out 24 thousand cubic meters per day, it will be possible to sink new shafts and go to restore the mine. But we still need to understand at which mine levels the work should be started. We will engage the entire leading scientific community, Russian and international experts, because the project is complex. The company can afford to look for a quality project solution in the course of several years.

Are there any fears that if the mine is restarted, then some people will refuse to work there? Or is there no special choice for the people in Mirny?

No, the matter will definitely not stand this way. Taking into account the emerging technologies for hydro monitoring and providing the safety of underground operations, we will check ten times everything related to work on such sites before we start the reconstruction project. It is definite that no one is going to risk the lives of people, so the mine will be launched only when it is ready in terms of all risks and absolutely safe.

As for the situation in Mirny in terms of unemployment, I think we have coped well with it. We continue to develop the Internatsionalny mine and the Verkhne-Munski project, we mine diamonds on placers, all our subsidiaries in the city continue to function. We have already employed over 700 people to fill the company's current vacancies, most of which are in Mirny. About 140 people left for other cities filling similar vacancies in Aikhal and Udachny, where there are operating underground mines as well. Approximately 300 people resigned by agreement of the parties with large remunerations. Some people left due to retirement age, some people planned to leave the region from the start and used this opportunity, some people are considering alternative employment. So far, there are less than 50 people left open to question and today we have for them an up-to-date bank of 370 vacancies to choose from.

I believe that it was a tremendous operation professionally performed to offer employment to people. We were supported by some other large miners, for example by Kolmar, which offered their vacancies. Together with the Agency for Human Capital Development in the Far East, we held an employment vacancies fair in Mirny last December joined by several industrial companies. We will continue to assist people in finding jobs, and I think that soon we will finally solve this issue.

Do you plan to replenish the dropped-out diamond output of Mir by buying other assets, for example, the Grib mine [bought by Otkrytie Holding in 2017 for $ 1.45 billion. – Kommersant.]?

We do not have an ambition per se to buy something to replace the dropped-out output of the Mir mine. As before, ALROSA still remains the world’s leader in diamond mining. Last year, we reached a record level of production even despite the accident, having mined almost 39.6 million carats, which allowed the company, among other things, to create the necessary reserve for 2018. This year, the company will produce 36.6 million carats, which is the level of 2014.

As for the Grib diamond field, it is a good asset, absolutely easy-to-understand in terms of its prospects. But its value may be simply assessed based on its future cash flows. If you take into account the value of the deal mentioned in the press, then the asset's price is significantly higher than the market multiplier for valuing ALROSA's shares. That said, the life cycle of our deposits is much longer. To re-buy an asset with such a high premium does not make sense - it will damage the shareholders. So, there is simply nothing to discuss at this stage.

Are you interested in further integration into diamond manufacturing by way of a joint venture or purchasing the above mentioned Kristall?

Recently, we visited Kristall. In principle, we had a good impression: they have modern equipment, a fairly compact production setup, they streamlined their costs quite well in recent years. It seems to me that by providing a certain assortment of diamonds to this factory and streamlining costs further, it will be possible to reach at least an acceptable financial result. They really suffered after the export duty [for diamonds. – Kommersant.] was abolished, but we don’t expect that polished prices will continue to fall much further, so even if they just will stay flat, Kristall has a good future. It is necessary to help the factory by all means, there are 1,600 jobs at the factory and it is producing very high-quality goods. And then the question is to what extent we and Kristall should be together: this should be studied and studied properly.

Do the methods used to attract foreign diamond manufacturers to Russia prove to be effective? The Eurasian Diamond Center (or EDC, opened by TBSS for ALROSA in Vladivostok) and the advantages of access to rough offered by Yury Trutnev to diamond cutters, do you think this is the right way to go or not?

I would like to see the diamond manufacturing capacities in Russia develop rather than stagnate, because it means taxes, jobs and maintaining cutting and polishing expertise. We welcome the establishment of the EDC, we welcome the arrival of investors to Vladivostok and guarantee that we will provide a certain percentage of our diamonds to the Russian market. This does not lead to any distortions in our marketing policy and does not infringe on the interests of our existing customers. There are no preferences in diamond viewing sessions given to Russian customers, as this was recently said in the press - this is strictly monitored.

And the price of diamonds, for example, for resident companies in Vladivostok is absolutely the same as for any other of our clients. We do not give any discounts, but we understand that companies that come to the Far East to manufacture diamonds should have stable contracts in order to plan their activities. Recently, there was a meeting with one large Indian company that expressed a desire to invest in a diamond cutting factory in Russia, and among other things they were considering Vladivostok. We will try to offer them the right assortment.

At the same time, there are a number of restrictions that need to be addressed in order to try to attract more companies. These are labor issues and personnel training. Of course, in terms of net cost we are losing to India. But this can be overcome by focusing on a certain assortment. The cost of cutting particularly large, premium stones does not affect their final price as much as in the case of small diamonds, which is why it is actually impractical to cut small diamonds in Russia, while starting from 0.5 carat and above it can be effective.

This year, we have lent serious support to the Russian factory Kristall, which used to buy large amounts of rough from us not directly, but through intermediaries. Now they have a solid direct contract, which will allow them to stabilize their financial situation and promote the development of a unique enterprise.

In 2015-2016, De Beers decided to decrease sales to support prices, while your production and sales are rather steadily increasing (without taking into account the accident at Mir). Are you ready to restrain output in case of rising costs and falling prices?

In the coming years, ALROSA's production will fluctuate in the range of 37-38 million carats, it is impossible to increase it due to technological reasons. If we reduce production, then, firstly, we will immediately have higher fixed costs. Secondly, taking into consideration the current state of the world's production capacities and the growth in demand for our goods, we are confident that we will not face the task of reducing production at least in the next five years or so.

ALROSA reduced production in 2016, among other things, reacting to a drop in prices, but the company accumulated a good stock, which we sold in 2017. Our sales exceeded production and everything that had been accumulated was sold. This year, the company’s sales will also exceed production levels.

What is now cardinally affecting the market? Why are polished prices decreasing in recent years, despite the balance between rough and polished diamond imports and exports in India, which you often cite as an example?

Pricing trends for both rough and polished diamonds in the market are affected by many different macroeconomic factors: economic growth or deceleration in certain regions, exchange rates and unpredictable things - for example, the tax reform in India or fighting corruption in China. Volatility has greatly increased in recent years, and we expect that it will continue. But volatility does not mean going “all the way down,” but rather noticeable fluctuations including ups and downs within one year.

Polished diamonds in a number of categories were really losing their value and in a number of categories they went up in price, especially fancy color diamonds. We see an influx of investments in fancy color diamonds, especially large and unique stones - if you follow the auctions, their price has greatly increased. Small-size categories have been shedding their value in the last few years and the inventory held by diamond manufacturers has been changing in volume. Now we see that after the New Year holidays and on the eve of the Chinese New Year, their inventory is at a minimum level. Demand for jewelry and diamond products is good: this is confirmed by the results of sales in January. Again, this is upheld by the fact that we see a stable demand for rough diamonds: this means that everything that is bought is being cut and sold, otherwise the demand for rough or rough prices would go down. In a long-term perspective, we believe that prices will remain stable.

And how do you assess the impact of synthetics on the market?

Our task is to market natural rough and polished diamonds. Jewelry and luxury selling companies invest a lot of money to support the demand for their goods - as we see, they have grown significantly in recent years. Meanwhile, polished sales grew at a much slower pace. The industry established the Diamond Producers Association (DPA) and we held the first meeting in Moscow on December 7, 2017 attended by all the colleagues: De Beers, Dominion Diamond, Rio Tinto Diamonds, Petra Diamonds and others. Last summer, ALROSA decided to start financing the DPA allocating quite decent amounts and we expect to keep this funding next year. The total budget of the association is about $ 60 million. We are not going to seriously increase it and now the question is about the effectiveness of these expenses and marketing pay off. We believe that we are spending the money correctly, and although our work continued in full swing for only half a year in 2017, there is an effect, and we expect the results this year will be noticeable.

Does the secondary market of polished diamonds affect the demand?

We do not see a strong impact or some serious projects for re-cutting polished diamonds. Still, it is a valuable thing that is preferred to be kept in the family. Yes, investment diamonds come out to the market, but we see at auctions that often the opposite happens, and the price is growing - from year to year, such stones are resold with a premium of 10-15%. This is a separate market, quite interesting.

Will you promote the program of trading investment diamonds on the exchange, which was announced by Andrey Zharkov? There is evidence that diamonds lose up to 50% of the original value when sold in the secondary market (online), which is not a good promotion for investment diamonds.

We continue to follow, with interest, the projects that are being launched and have already been launched in Singapore, India and Israel. We believe that the demand for investment diamonds will continue to grow. It is important that there is both liquidity and transparency, so there are certain achievements, but we do not expect that any such projects involving ALROSA will be implemented in the first half of the next year in Russia. These instruments carry certain risks for customers, and it is necessary to make sure that the buyer is protected and understands what and at what price he or she buys.

How do you feel about Diamundi Pte Ltd’s project to launch the “brillcoin,” a virtual currency based on diamonds? ALROSA was to be one of the diamond suppliers for the project, but the latter was criticized by the Central Bank.

Within this project, we happen to be just a supplier of high-quality diamonds manufactured in Russia, selling them at market prices, and our role is limited to this only. In general, I think that this project, if launched correctly, will be quite interesting.

In your opinion, has the consolidation in the diamond market been already completed and is any further movement in this direction possible or not?

It seems to me that it is impossible. Historically, the aggregate share of ALROSA and De Beers has been between 60% and 70% of the total output in recent years. Today, it is impossible to see some new player emerge with new output volumes and a new market share, because even if new significant diamond deposits will be discovered tomorrow, it will take at least five years to start mining operations there.

A number of pioneer companies that specialize in developing the former diamond fields of De Beers and those of other miners in Africa are now under great pressure due to the macroeconomic situation and some unjustified hopes. But they handle their costs very well, they are likely to remain in the market and they have a good expertise. We perfectly understand the mining capacities of all market players, and it seems to me that there will be no consolidation, as every company goes its own way. For example, Dominion Diamond was recently put up for sale, and none of the diamond miners actually participated in the negotiations - it was bought by investors from outside of the industry. As far as we know, currently there are no consolidation movements underway in the industry.

Is the company's sales office in New York already functioning?

The trading office was actually frozen after the scandal with the theft of diamonds happened in 2016. But we are going to send a new manager to this office and resume its activity. This manager will perform both representational functions, and perhaps, market and sell our unique diamonds. We will cut and polish them ourselves after the successful project with the Dynasty Collection - the first one so broadly presented by the company around the world. We are going to launch this office, but it's not the kind of volume and business that we have in other parts of the world.

Do you have other offices being open abroad?

We are opening an office in Mumbai (Bombay) in the near future. The situation is that up to 90% of rough diamonds produced by ALROSA comes for cutting and polishing to India in some way or another, whereas we do not sell rough directly to India. The market is arranged in this way and this is profitable for buyers, it is a decades-old established sales system. But nevertheless, we see a demand for diamonds from small Indian companies that cannot become our customers due to the fact that they have extremely small demand focused on a certain range of diamonds. Currently, the Indian tax system does not allow us to open a full-fledged trading office, so we will launch a compact office with representative functions and communication with customers and the Mumbai Diamond Exchange. But we are sure that the leadership of India will take measures to increase the sales of diamonds in the country.

For ALROSA, the change of Angola's President and the change of management at Endiama – were these developments positive or negative? What kind of sales system did you propose to your partners at Catoca, your joint venture with Endiama?

Angola is an area of strategic interests for the company, and I have already visited this country four times since joining ALROSA. The new CEO of Endiama, Jose Manuel Ganga Junior, has long been the head of Catoca, and he knows the asset well, and ALROSA knows him well, and we see that decisions are being taken immediately. We welcome the changes that are taking place in the diamond market of Angola. As you know, we agreed and are in fact closing the deal to increase our stake in Catoca to 41% in the coming days, and at a good price. Next to Catoca there is one of the world’s largest diamond deposits, Luaxe, which is very good in terms of diamond grade and which has been developed by Catoca for a year.

We expect that the system of diamond sales in Angola will become more transparent, and these issues were discussed at a meeting with the country’s new President, João Lourenço, and were supported by him. Further meetings were held with Endiama and Sodiam, following which it was declared that Angola was going to make the investment climate more attractive for diamond mining companies. Being a global leader both in diamond mining and in diamond sales, we have taken the responsibility to offer to the leadership of Angola and the country’s companies various patterns, which could help to maximize the price of diamonds produced not only by Catoca, but by any alluvial or primary deposit in Angola. Within a few months, we expect decisions on the organization of sales, first of all at Catoca.

Why is the Chinese stakeholder in Catoca, China Sonangol (18%), does not participate in the redemption of the stake held by Odebrecht, which is unloading the asset?

We initially agreed with the leadership of Angola that if Odebrecht goes out, the package will be divided in half between the Russian and Angolan sides. The Angolan side decided that this would be Endiama.

No objections on the Chinese part? Do these accords violate the shareholder agreement on Catoca, if there is any?

No, all the decisions are approved by the Supervisory Board of Catoca and there is a decree signed by the President, which clearly regulates the transaction. The Chinese shareholders did not lay claim to any part of this package, as far as I remember.

Is it clear, how much the development of Luaxe may cost and how will this project be financed? It was said that the total amount could be about $ 1 billion and that money for the first stage can be given by VTB.

We believe that we will be able to significantly optimize the investments due to the fact that the field is located close to the existing Catoca field with two concentrators, and some of the ore can be beneficiated there. The life cycle of Catoca expires in 2034, and respectively, the entire infrastructure remains in place, so it is logical to transport the ore there for beneficiation, as the distance is 20 km, thus avoiding to erect the same facilities at a distance.

Luaxe will need certain investments in the infrastructure around it and a small expansion of production capacities. There are different options depending on the output, but we believe there will be no billions of dollars spent there, and probably we will limit our expenses to several hundred million dollars. There were no negotiations with anyone on financing. In principle, today, if necessary, ALROSA can itself make any investment in Luaxe at the expense of the current cash flow. At the same time, we can follow the path of project financing. As long as these same issues are not yet solved by Endiama and are not thoroughly worked out, the project does not suggest any serious burden for ALROSA. So far, we expect to beneficiate the trial lot of kimberlite ore from the field in late 2018 - early 2019 and then proceed to develop the final feasibility study, already having a clear idea regarding the quality of diamonds.

What are the prospects for the company’s operation in other countries - Namibia, India, Venezuela?

We do not hold negotiations neither on Namibia nor on India. We had a proposal from the Indian side to consider participation in the Bunder deposit, but we know that it is extremely difficult - due to both the ecology and a number of territorial restrictions. We have a clear focus on Russia and Angola, and today we are not ready to deal with projects in other countries, if this is not some very obvious topic related to economics. Therefore, if someone will sell some functional asset, we are ready to have a quick look at it, but we have no appetite for high-risk geological exploration in other regions.