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Sergey Vybornov, President of ALROSA – “Sales to Gohran do not Mean Going into the Thriftbox”

03 february 2009

There is not a single industry in the world economy left unaffected by the crisis. The luxury market is no exception – people stopped spending money to buy diamonds. Sergey Vybornov, President of ALROSA, in his interview to the Vedomosty Daily told how diamond mining companies would back up the market and how ALROSA was going to weather out rough times. Some time after the interview was taken, Alisher Usmanov, being the controlling shareholder in the Metalloinvest Holding, ventured an off-the-wall idea: he told Vedomosty that the first step towards a diversified mining-and-metallurgical giant in Russia could consist in “merging Metalloinvest as the biggest ore producer and Nornickel, a pace-setting manufacturer of nickel, copper and platinoids. Further on, they could be joined by some coal producer, as for instance Mechel. ALROSA also wonderfully fits into this array.”

Asked to comment this declaration, Sergey Vybornov said “he was not acquainted with this idea and so far there was nothing to comment.”

In what way has the current crisis in the world and Russian economies affected the diamond industry?

The current situation is unique – nothing similar has ever happened. Based on the experience of our industry I can say that this crisis has psychological shade. Polished diamonds sales are a reflection of people’s mood. This is not an article of prime necessity, but a token of relationship. What we sell looks more like a service, not a commodity. Our clients’ disposition was affected by the crisis and we see that sales went down. Judging by the New Year sales in the United States the luxury market crimpled 20-25% - these are only preliminary data. Till the end of this year, as I believe, demand will recover, but there is one substantial negative point – the market has accumulated very big stocks containing primarily rough diamonds but polished diamonds as well. The stocks were first piled up by the Indian manufacturers and now they are being spread along the whole chain. By various estimates, these stocks are worth $15-20 billion compared with annual rough diamonds sales reaching about $10 billion. The situation in Russia is unique; in the fourth quarter our sales of polished diamonds grew 40%, although this was in the low-price segment. However, the volume of sales is not great. In Russia people were initially used to invest in diamond jewelry evaluating stones and gold separately and often those were not the best quality.

Which segment of the industrial chain turned to be affected most by the crisis: diamond mining companies – diamond cutters – jewelers?

Diamond cutters are the most vulnerable part of the diamond pipeline not only during the crisis, but at any instance of changing market environment. At the level of diamond mining, the average margin is 40%, while on the other end, at the level of brands, it is 60-70%, whereas in the middle it is merely 1-3%. Having such a margin, any movement, even a mistake while buying rough, often brings about deadlocks. Banks operating with rough and polished diamonds were affected. Our business counterparts and we as well are afraid of a price slump. Polished diamonds are not a cheap commodity, but here the laws of demand and supply are working on a sentimental level: it depends on whether a person is going to make a present or not. Banks, for instance do not discard stocks and neither do mining companies. We have left the market and are selling exclusively to Gohran. We want to back up the market and our business colleagues for we are the only company which can afford this “luxury” since we are assisted by the Finance Ministry and because there is Gohran. De Beers and other mining companies are closing production. We have to live through a tough moment, which is winter and spring, and evidently then little by little we shall start our return to the market. This is easy for us also because the year 2009 for ALROSA is the busiest year as far as the construction of underground mines is concerned. We shall spend a maximum amount of money for these purposes. We cannot curtail financing since this would mean to relinquish mining.

In what other way are you going to back up the market?

The producers of rough diamonds - ALROSA, De Beers, ВНР Billiton, Rio Tinto, and Harry Winston - will announce a marketing campaign this February to promote polished diamonds. The project is titled as Generic Diamonds Marketing – we shall promote diamonds without pinning them to where they were polished or mined. This is a joint contribution of diamond mining companies into market development. I believe that heavyweight players in other parts of the diamond pipeline will join us. Historically it turned out that no one ever advertised the value of diamonds. There were good and efficient marketing campaigns promoting right-hand rings or Trinity rings – but no one ever thought that a diamond is an investment value. Besides, diamonds are really eternal. For example, at the Udachny Diamond Field – this one of our diamond pipes – the age of stones is 2.4 billion years. The age of the Earth is 2.8 billion years. Bear it in mind that every stone is unique and for people it was difficult to view it as an investment instrument.

What amount are you going to sell to Gohran in 2009?

All in all [every year] we sell $2.8 billion worth of diamonds. We would like to preserve the same level of sales this year. Sales to Gohran are a market measure and do not mean going into the thriftbox. We have created a shortage of Russian rough. This gives us a good ground for our negotiations with the greatest stock holders – the biggest dealers and diamond cutting companies, those which we are dealing with to have long-term contract relations. This is our work for the future.

In what way are you going to build your relationship with De Beers now that the rough diamond trading agreement, under which all the exported diamonds were shipped to De Beers only, has expired?

We have closed the agreement, and this was done by mutual consent, in December 2008. We have won the legal process versus the European Commission and can sell exported diamonds to De Beers only, but we shall not do this. ALROSA should have its own sales market and its own customers. ALROSA has spent too long a time or, putting it more correctly, has been always under the wing of De Beers. Much to my regret, currently they are not able to control the market, since their market share shrank to a great extent and they have neither capacities, nor funds [to control the market]. This is actually whence the joint marketing venture of all the diamond mining companies has taken its origin.

What will be the sales policy of ALROSA? Will you have your own sightholders?

We have not been prepared for the crisis from the sales point of view. Here is a simple comparison – at the start of the crisis our customers just vanished altogether, because there were a lot of them. Whereas De Beers continued to sell rough diamonds to its sightholders for some time, although their sales diminished in volume. Of course, it would be logical to have our own clients, sightholders, whose business needs to be supported in harsh times. Provided that when something happens like what is going now they will back up diamond miners. Unfortunately, ALROSA was not in time to re-structure its sales: 50% of its diamonds were bought by De Beers and 50% went to the domestic market at a huge discount. This was going on for 50 years. It was only in 2007, when Vladimir Putin signed a decree cancelling quotas – this was the last and final step towards liberalization of the diamond market. Before that, the market was strictly divided into De Beers’ part, which was not ours, and our part. The last one is actually not entirely ours as well, because the major part of diamond cutting enterprises in Russia is backed up by investors from Israel, India and China. Now all our clients are equal. During the last six months we are attending large-scale manufacturers of polished diamonds, particularly those who are holding an additional position on the jewelry market.

Which, for instance?

We are selling rough directly to Tiffany & Co. Virtually, this is the end of the diamond pipeline - they are so far the only company which succeeded in establishing their own rough diamond team. As far as I know, there is not a single other jewelry company which managed to do this. This is an ideal option since we could sign a long-term agreement, understanding that this manufacturer needs rough diamonds of a certain size, quality and color. For us it’s a guarantee of sale. However, to pack all our rough under such contracts is a very complicated thing. Again, the crisis is going to mop up this market in the worst way, so we have to see, who will remain.

And how is ALROSA’s own diamond cutting business going on?

We are in the second place in Russia. Before the crisis came we launched a new brand and are going now to develop it, although it is not the best time. The brand is in a specific niche of polished diamonds made of high-quality rough diamonds bearing appropriate color features. The stones are designated not only for corporative, but also for major private clients, who will be able to buy polished diamonds for investment purposes.

Will this be just a regular polished diamond?

Yes, this is a very expensive polished diamond. It’s a pilot project, very small in size - about $10-15 million. Rough diamonds, as we have said, have never been considered as an investment vehicle. We believe that it is high time to promote this quality of polished diamonds. This is really a brand since all the polished diamonds will bear a hologram image saying it is ALROSA. People will be able to buy them by one or by two stones. This subject is new for us and not related to serial production.

After the state obtained control over the company, has the government of Yakutia changed its attitude to ALROSA?

I do not see any fundamental difference between the Ministry of Property Relations of the Republic Sakha (Yakutia) and the Federal Property Management Agency of Russia – both represent one state-shareholder. There was a conflict between the representatives of the Ministry of Property Relations of Yakutia and some part of the management. Now it is over.

Before the crisis ALROSA planned to diversify business – are the plans valid and will they be implemented?

The idea has been set forth by Finance Minister Alexei Kudrin. It was about hedging risks. Rough diamonds do not have their own economic cycle like metals: gold or copper. Essentially, the more diversified is the mining business, the lesser risks has the company. Such global things like we have currently with everything dropped down occur rarely. But now, under crisis conditions, diversification, which can distract funds from major production, is not evidently worth talking about. On the other hand, ALROSA has historically built a group of different companies around it. To say the truth, it all started in the first years of capitalism in Russia. There is no sense in keeping them all. We have marginal oil assets and we intend to get rid of them in Yakutia.

Does it mean that the possibility of buying an equity stake in Polyus Zoloto is now closed for ALROSA?

Why do you mention only the buying option – they were many. As you see, the price for gold is now stable, while the price for diamonds is unfortunately not. Luckily, we are a closed stock society and avoided any damage on the stock market. However, now it would not be correct to get money from Gohran and give it to a private investor.

What will happen to ALROSA’s marginal assets?

We have bought four iron ore fields in Yakutia. Now we think what way to go – so we shall contact the Ministry of Natural Resources. To develop the fields we need capital investments which we were able to find before the crisis, but now, to my view, this turns to be a problem. There is some foreign interest towards these deposits. But all this should be agreed with the government, since the deposits by their reserves can match or even surpass the Kursk Magnetic Anomaly.

Will you sell or invite an investor?

We shall not sell, but may be we shall find an investor. And here I cannot say there is any interest inside Russia.

What is the debt of ALROSA for the end of 2008?

All our debt is unsecured and the creditors do not require backing for this is a question of trust. I can say that we had a great relative weight of short-term debt. We have restructured it completely turning 44.2 billion roubles into “long” money. We got it in December from the VTB Bank. In broad terms, the situation looks normal. We shall get rid of non-core assets and decrease the debt accordingly.

To what extent will the debt be decreased by way of selling marginal assets?

The amount may be substantial - $600-700 million.

Are you not afraid that this year the company’s Eurobond covenant, which requires the corrected EBITDA be 3.5 times higher than interest payments, will be breached?

No, it will not be breached taking into account that we have restructured our debt and are decreasing it.

What is going on with KIT Finance, whose 45-percent stake was purchased in the end of the last year by the ALROSA Investment Group belonging to the diamond mining company?

On the whole the situation is moving to the final straight. It is improving; the bank is getting clients; Gazprombank has rendered its support; there is an agreement with creditors about a certain period during which they will not raise their claims; but I feel this period will be shorter than it was initially set. I have the impression that RZhD is interested in gaining control over this asset.

How did it happen at all that ALROSA became a co-owner of KIT Finance after it ran into financial problems?

Any other creditor of KIT Finance could become its shareholder; this happened because we and RZhD are state-owned companies. Evidently, the state felt comfortable to have such shareholders and not someone else.

How much does KIT Finance owe your company?

There is an agreement with creditors under which we do not disclose this information.

Currently, in this crisis period, have you any free time left for yourself? How do you spend it?

Virtually I have no free time. I like motor-cycles. I know what’s what about them, and I have quite a long experience of sports driving. As you know, it is impossible to drive in Moscow or at least it is uncomfortable. So when I have some free time, me and my friends take lease of tracks and ride there.

You have to travel around the world a lot. Where do you like it best?

Yes, I have to travel from Yakutia to Angola many times. If you mean some country as a sort of affection… I have worked in France for five years and by comparison it was probably there.