Anglo american de beers seminar – 3 november 2014



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ANGLO AMERICAN DE BEERS SEMINAR – 3 NOVEMBER 2014

MARK CUTIFANI, PHILIPPE MELLIER, BRUCE CLEAVER,


PAT LOWERY, GARETH MOSTYN

Mark Cutifani

Ladies and gentlemen, very good to see you here. Quite a good turnout actually. I’m very pleased to see you this afternoon. I am going to be relatively short because I think it is most important to get the De Beers team up under Philippe. I’m just going to make a few very quick observations. Firstly, to answer the first question, De Beers fits the Anglo American portfolio like a glove. It’s a firm and determined hand. Our relationship has been a long one and we do know each other like an old married couple. So if I could say that our most recent transaction, the 40% stake purchase, is a bit like renewing one’s marriage vows. Today you will hear how the relationship is continuing to develop and improve, mature. And if I could say, based on the results we’ve seen so far we’re very pleased that we have renewed those vows and certainly very happy with the progress the team has made.


Anglo American’s value proposition to shareholders is a relatively simple one. We are the mining industry’s diversified miner. We believe our portfolio mix will outperform our peers through the cycle as we focus on quality assets across ten commodities. Some may get nine, some may get 11; if you throw palladium in you will get ten. A mix of commodity, geography and downstream market diversity is unique in our industry, helping us manage risks and recognise opportunities not available to other industry players. Our focus on mine to market value opportunities will help us reduce cost and realise prices to support margin growth. And we have certainly seen that in the relatively short time that we’ve been working on both of those areas. And in De Beers you will see that story play out in a slightly different way, but nevertheless a very consistent approach in terms of what we’re doing across the business.
Supported by a capital discipline that we have been articulating in terms of our five key steps. Very focussed on value delivery, and of course in De Beers with the new investments that we’ve been talking to – really incremental additions to the portfolio – we see a very exciting story. So the reason why we believe the mix works is we understand the market and the nature of the diamond business. That is as Anglo American with our team. We operate in complementary jurisdictions and the breadth of the Anglo American reach supports De Beers in its strategic positioning. The new Anglo American operating model and the technical depth we are building with De Beers will support their improvement and our own improvement across the group. And if we look at the significant savings that we’ve made already in terms of the integration I think the value proposition is a compelling one.
Right across the board the depth that we’re building in the talent pool will certainly support De Beers achieve its objective. And as a final comment, Philippe reminds us with his executive committee that diamonds is not a commodity. Our involvement with De Beers does give us a unique perspective in terms of markets, and an extra string to our bow, in our view, in making sure that we are taking the learnings that they have developed over the years back into our long-term relationship model that we think is also another key differentiator that we are building in this industry. Looking at the realised prices and how we are doing against our peers in met coal and other commodities we think that relationship model is a very important one.
To simply demonstrate how far we’ve come in a very short period of time, De Beers has delivered a material and improved contribution to our first half earnings, as you would have seen. The De Beers team is well on the way to hitting its and our 2016 ROCE target for the group even after taking into account the price paid for the 40% stake. So at the De Beers level I’m very impressed with the progress they’ve made. Certainly across the board good progress on all fronts. We have seen a number of value opportunities that will help us exceed that potential we first saw back in 2012. So, again, making sure that that investment is a very strong one, or certainly one that will enhance both groups. So, without further ado, I will pass over to Philippe. I know you as well as we are very keen to hear the De Beers story.
Philippe Mellier

Thank you Mark. Now we are going to switch from a slight Australian accent to a very strong French one now. I hope you can understand what I am going to say. We are going to present and after that we will have around half an hour for Q&A at the end of the presentation.


I’d just like to make some introductory comments to set the scene, and after that with the team we will move into more detail. Here I am with key members of my team, Bruce Cleaver, who is the Executive Head of Strategy, Pat Lowery, our Executive Head of Technical, and Gareth Mostyn, our Finance Director. Bruce will cover the industry and the midstream part of the business, and Pat will be covering the upstream part of the business and the financials will be with Gareth.
We all believe at De Beers that we are very well positioned for growth. In the next one hour and a half during our presentation we will try to give you a sense of why we are of this opinion. I hope that many of you have been reading very carefully the 2014 diamond insight report we recently published. I have seen that some have it. And we have provided some spare copies on your left here. I think it is going to give you a good flavour of why the industry is looking at the future and where the opportunities in the diamond pipelines are lying ahead of us. We will be very happy to take any questions you may have at the end of the presentation.
As you may have heard before, and Mark has already said, diamonds are different and diamonds are not a commodity. But they fit the profile of commodities in some ways. There are many important distinctions to be made when we compare diamonds to other products in the portfolio of Anglo American like iron or platinum. The fact that diamonds are not homogenous is one obvious example, as it means that there is inimitably more complexity in the selling and marketing of our product and an attendant requirement for more specialist knowledge when looking to maximise value of every diamond we sell.
Perhaps the most significant difference to consider today relates to motivation to buy them. People really don’t need to buy diamonds in the same way as they need to buy iron for large-scale manufacturing activities like cars or infrastructure, or platinum for automotive reasons. For many reasons this insight has been the cornerstone of De Beers’ and the diamond industry’s success in the past and today, and we have been able to employ our marketing expertise to establish a uniquely powerful emotional niche for diamonds, the famous diamond dream.
So although people may not need to buy diamonds in the same way as they need to buy iron or platinum, telling your beloved that she doesn’t need a diamond engagement ring is not really an option certainly for the males that are present here today. What this means is that consumers’ desire for diamond jewellery is the only true source of value in the diamond industry. And understanding the consumer is therefore crucial to sustainable success in the diamond industry.
Over the course of the afternoon for the next one hour and a half we will give you an overview of the assets and the activities within De Beers. We believe this represents the investment highlights. We believe that the value of De Beers is driven by a unique combination of tangible assets, intangible assets and a highly favourable industry outlook, and our ability to capitalise on this fully as a result of our full range of activities and operating structure. We will cover that in more detail with Bruce later on.
Of course one of the most important of our tangible assets is a portfolio of mines well positioned on the cost curve with long life reserves. Pat will be going through that in much more detail. Intangible assets include our rough diamond trading expertise, our iconic brand strength – the De Beers brand is clearly one of the most well-known brands around the world – and outstanding relationship with key stakeholders. Each of these is fundamentally important to our ability to thrive today, as well as our potential to grow. And our growth prospects are further enhanced by a favourable industry outlook that sees growth in supply outstripped by growth in demand even in the most pessimistic outlook.
As this demand is expected to be driven substantially by the growth of middle classes in emerging markets such as China and India today, potentially Indonesia or Philippines tomorrow, this represents an important point of difference for the Anglo American portfolio. Diamond demand has spiked later in the economic cycle than other commodities, and this significantly mitigates some demand side risks. We will address each of these areas in more detail, but one more important point to make at this juncture is that when it comes to De Beers the whole is more important than the sum of the parts.
De Beers’ strategy is focussed on sustainably capturing the maximum value of each carat mined. This is something I repeat with the team many times a day. As consumer desire for diamond jewellery is the only true source of value in the industry we put the consumer at the start of the pipeline and then develop a holistic strategic approach to support this insight with our activities elsewhere in the value chain. And we cover most of the points in the value chain.
De Beers’ activities span the diamond pipeline, and this differentiates De Beers from other companies in the diamond business, providing a unique competitive advantage in many areas. For example, understanding consumer trends, different diamond jewellery markets, trading in the marketplace like credit terms, inventory and so on and so forth, and how to best mine and sell rough diamonds. And on the other side, understanding upstream trends and the capabilities of midstream players supports the development of effective strategies for downstream activities with Forevermark and De Beers Jewellery.
The process of De Beers’ integration with Anglo American has provided a number of benefits in many upstream areas. For example, technical expertise from Anglo American has been instrumental in the improvement at the Snap Lake mine in Canada. Clearly Pat will be covering much more of that a little bit later. So this is it for my very short introduction. I will be back here to talk about the company structure. I would like to invite Bruce on stage to talk about the industry overview.
Bruce Cleaver

Thank you Philippe. Before I start I think it is probably important to spend a bit of time placing the industry in context. Hopefully at the same time this will help explain to you why we think the diamond industry is such an attractive industry, and why we think De Beers’ position in the diamond industry is such an attractive place, so why we feel so well positioned in this industry for the future.


I also touch in this section – although it is not the principle purpose of today’s presentation – on just a few future trends that we see in the world that faces us. A lot of that is contained in the Insight Report that Philippe mentioned. But I think it is very important to note that we think hard about the future consumers and the future world into which we will be selling diamonds.
To start with an obvious point, I think it is very important that we bear this point in mind as we go through this presentation. Diamonds are an end consumer product only. Polished gem diamonds set in jewellery account for effectively 100% of all diamond value. So I think it is important to bear this in mind along the way through this presentation. Other precious metals such as gold and platinum, as you all know, have other uses too, be they for investment purposes, industrial purposes or even in the autocatalyst industry. But there really is no other use for polished gem diamonds than end consumer demand.
It is probably also worth bearing in mind as we go through this that there are a number of reasons consumers buy polished diamonds. Probably the two most important are firstly an extremely important emotional need. So people do feel the desire very strongly to express emotions by purchasing polished diamonds. And secondly, they represent, in a not insignificant amount, a financial store of value. So those are the key reasons why people will buy diamonds ahead of any other product when they are in this area of purchasing.
Another thing to bear in mind on the right-hand side of that slide is no two diamonds are the same. This to some extent explains why it has been so difficult to create an investment class in diamonds. Those pictures on the right-hand side of the picture are to some extent obvious, but it is worth remembering this. On the top you have one diamond worth $500,000. That could be 50 to 100 carats for example. You have a smallish parcel of diamonds in the middle worth the same amount. And at the bottom you’ve got quite a big bucket of diamonds. These will be less that 0.1 of a carat. So thousands and thousands of them which collectively will be valued at $500,000. So no two diamonds are the same.
Growth in demand for diamonds is very strongly correlated with greater economic activity. So there are two pictures on this slide. They both represent indexed polished diamond consumption in the US against two obvious measures. One is real GDP growth and one is personal disposable income. Generally speaking when people feel positive they are inclined to spend more. It’s not unusual in the luxury world. When they feel negative they are inclined to spend less. When we touch later on about why we feel De Beers is so well positioned in the industry we bear this in mind, because our core markets are markets that are performing very well.
Touching on that now, the two main markets for polished diamond sales are the US and China. And our analysis leads us to think that they will remain the key markets for diamond consumption for the considerable future. So, on the left-hand side of this picture, diamond consumption as at 2013. The US represents about 40% of global diamond consumption, greater China about 16% - and we include Hong Kong which is a considerable venue for the purchase of diamonds – India 8%, Japan 6%, the Gulf (largely Saudi Arabia, but not only) about 8% and the rest of the world 22%. So you will immediately see from that that the US and greater China, which are economies that are, relatively speaking, in good shape and growing quite well relative to the rest of the world, are our two core markets.
And if we flip to 2018, our forecast, you will see that that analysis remains largely the same. So we say that the US in 2018 will represent about 40% of the then diamond market. China will have grown to 19%. India will have grown a little bit to 9%. I think India may of course grow much more, but it is a complicated country to predict. A slight tail-off in Japan and the Gulf. You will see that our principle markets, the US and China, are very well positioned. That is why we feel so positive about the industry going forward over the next few years.
Continued Asian purchasing, particularly Chinese middle class growth, really do make us feel positive about the emerging world. This slide shows you projected growth in middle classes in emerging markets. This is the reason why we feel on the non-US side (remember the US is our most important market and will continue to be so) there is considerable upside for us. The left-hand pie chart there shows projected growth of middle classes in emerging markets from 2013 to 2018. And you will see in China the current projected rate is 129%, India 72% and very good growth in other emerging market countries too. So in Indonesia, which is at this point not a big market, a significant amount of growth.
The right-hand side of the slide shows you what this means in absolute terms. So the bar chart there shows the number of new projected middle class households in 2018 from today. You will see in America already 75% of US households are described as middle class. Another 13 million homes will be added to that. But on the right-hand side is the really interesting piece. Up to 100 million middle class homes to be added in China over this period and 27 million in India. Frankly, even if China’s growth is slightly slower than that we are still talking about considerable numbers of new entrants into the middle classes.
Diamonds are also an aspirational purchase, so it plays very neatly into the emerging middle classes. It is also important to remember that the US, which is a much more mature market and where the buying characteristics are quite different to India or China, will remain our core market. That is also encouraging given the economic developments in the US.
Turning now to the supply of rough diamonds in 2013. I will touch a bit on demand and why we feel we are in such an attractive industry. In 2013, by our analysis, about 146 million carats of about $18 billion in value at the rough level...the numbers on the previous slides were different to this because that is what we call polished wholesale prices, which is the price at which polished is sold on the wholesale market. The production of the world’s supply in 2013 on the left-hand side of this picture we have broken down by geography. You can see some big differences in volumes as opposed to values. So in volume terms Russia is the biggest producer. It produces about 25% of all of those carats. In volume terms on our analysis the DRC was the second biggest at 19%.
A few points on this. The DRC is a producer of a large number of very low-value alluvial diamonds. So the average dollar per carat in the DRC is about $10 to $12. Those who follow the Kimberly Process will know that the Kimberly Process numbers are different to ours and are slightly lower than ours. The one area where there is a considerable difference is in the DRC. Their number is quite a lot lower than ours. We are still analysing their number before we decide whether we make any changes to ours. Ours are based on a number of historic databases. But in terms of value, which is what this is about, it is actually largely at the margin. Botswana is the third biggest. And then you will see the other countries on that graph on the left-hand side.
When we look at this in relation to value – so now we’re going to look at the value of rough diamonds sold – this we have done by company, not by country. So we say that about $18 billion of rough diamonds was sold in 2013. These are all done at what we call SSV, which is the De Beers terminology for standard selling value. That is the value at which rough diamonds are sold to rough customers. A lot of the analysis you will see later will be based on this context of standard selling value. De Beers in 2013 was the biggest producer of diamonds by value. The De Beers Group produced about 33% of global supply in 2013. Alrosa, the now listed Russian state entity, is the second biggest. Rio is 5%, quite a lot bigger in terms of volume but not that high in terms of value. And then all of the juniors that many of you might know about are at 14%. And then a few others making up the pie chart. You will see this is another reason why we feel De Beers is so well positioned. We have a very strong market position, 33% of the diamond wealth by value.
The other side of this is then to look out at what our view on the future production of the world will be. And this is part of the exciting supply demand dynamic that you heard Philippe and Mark both refer to. This is a chart produced by McKinsey which models all committed projects, all possible projects and all probable projects. It does discount a few of those which have not got past the permitting or financing stage. But you will see that what is really attractive for us about the future of this industry is that supply will continue to grow quite slowly and peak in about 2017 and then gradually tail off. That is of course one of the reasons we think this is such an attractive industry. It is very unlikely that there will be a glut of supply coming onto the market.
The projects that are not modelled in this graph are really in terms of global diamond production at the margins. Between them even if they were to get financed they wouldn’t make any real change to the dynamics in this slide. This is one of the things that is so attractive for us. This is not an industry with a considerable amount of marginal production which can easily be brought on stream should there be an increase in price. So we feel very comfortable that the production portfolio of the world will look largely like it has over the next ten years.
On the other side of that is the so-called supply demand curve. What we do here is we model projected growth in diamond demand. And that is very much correlated to growth in GDP, growth in spending, and in the particular markets in which we are strong, against the growth in production. What this slide says to us is that however this all plays out there is a considerable gap between growth in demand and growth in supply, and that again is very attractive for us.
There are many things that could fill this gap – and it is a complicated question as to what it is – but for us certainly one of those we would be hoping is price. There is a healthy position generally for us in both the industry and our market position in the industry.
Before I turn back to Philippe to start getting into a little bit of detail on De Beers, the future industry trends which are set out in the diamond Insight Rooklet Philippe mentioned, as I say it is very important that we think very deeply about the future because this is all ultimately about consumer demand. And we do spend a lot of time thinking about the future and trying to position ourselves best for the future. We launched the Report in Hong Kong a couple of months ago. It is really aimed at the midstream, downstream and producer governments, all these key partners who we work with. But it has insights which are interesting for all of us.
Here are some key insights. Obviously we can go another time into more detail on this, but these are some of the key insights we left that audience with. Firstly, diamond production we expect to decline slowly after 2020. Secondly, producer governments will seek increased value chain participation. We have certainly seen that a lot in De Beers over the last ten years or so. Secondly, technology will transform all phases of the value chain. That is not just exploration and mining where technology is fundamentally important to the future, but in all the other areas.
For example, in the midstream, technology has already assisted diamantaires, cutters and polishers in improving their yield, in other words the amount of polished they get out of a diamond when they cut it. There are considerable advances in technology in the downstream. I will touch a little bit later on about synthetics. There is another area that we keep a very close eye on. And our fight against undisclosed synthetics is being won by our investment in technology.
Really important for us are the shifting needs of new consumers and the increased importance of brand and ethical sourcing. Philippe will talk in a little while about brands, but brands are becoming even more important in the future in the luxury world. And of course we are extremely well positioned with both the De Beers name and the Forevermark brand. So we are well positioned for that. The context of ethical sourcing is becoming more important. We would see that becoming a bigger trend in the future. And our Forevermark brand, which Philippe will talk about, plays very well into that.
Online has become a much more important tool in both researching and purchasing diamonds. Not something you might expect on a purchase like a diamond. In the US last year one in six diamond purchases were done online. Not necessarily at the high end, as you would expect, but in terms of pieces one in every six purchases was done online. And 40% of consumers did their research online before going into a store in order to make their purchases. Even in China 25% of purchasers last year researched their purchases on the internet before they went in store and made their purchase. That’s a significant trend that retailers need to be aware of and understand how to deal with.
For us competition comes not only from our own direct competition but from other luxury categories, because after all we are all chasing a share of wallet from consumers in the luxury end. And we are dealing with some very significant luxury businesses with significant marketing budgets. And then lastly, and I will touch on this on a later slide, the question of undisclosed synthetics and how that will be dealt with. That’s the wrap up of the industry overview. Philippe, my colleagues and I will now talk a little bit more about De Beers itself.
Philippe Mellier

Thank you. I just wanted to spend a few minutes to talk about the structure of the company before we go into more detail. This is the slide with the whole detail. We go from the retail on the right-hand side up to exploration on the left-hand side. Pat is going to cover the left part, what we call the upstream. Rough diamond sales will be covered by Bruce. I’m going to come back to talk about the downstream part of the business and the Element Six subsidiary we also have in our portfolio which is quite an important one.


So clearly this is the full structure of the company. I have to say that, since the integration when Anglo American bought the 40% of the Oppenheimer family, we have derived a significant benefit. And we now have access to a global talent pool. Gareth and Pat coming from Anglo American here today are a good example of what I’m just saying. We have also access to the latest mining technology. That is very important in what we do in the upstream part of the business. It is a substantial benefit to have access to a common supply chain and asset optimisation techniques which have been very helpful. And you see that the numbers from Pat are looking pretty good in that regard.
The 15% shareholding from the government of the Republic of Botswana – we are always going to make reference to it as GRB – is clearly showing the strength of our relationship, which is a longstanding relationship between the GRB and De Beers. It spans over 45 years and started in 1969. So as you can see if you look at what we have on the upstream part of the business most of our activities are centred in Southern Africa, South Africa, Namibia and Botswana. So we are going to focus more on this part of our business right now.
So, for the last 45 years, we have enjoyed an extraordinary relationship with the GRB. It is maybe one of the most famous PPPs in the world. The name of this partnership is Debswana, our 50/50 joint venture between De Beers and the GRB. It has been extremely successful from its creation in 1969. And we can see if you have been in Botswana recently the full extent of what we have been achieving together, because in 2013 diamonds represented 26% of Botswana’s GDP and 76% of the export value in Botswana. 40 years ago Botswana was one of the poorest African countries and maybe one of the poorest countries in the world, and today it has reached the status of middle-income nation. And we can say today very proudly that diamonds have been contributing a great deal in switching that result.
Thanks to our relationship we have benefited from a long-term sustainable supply of the world’ leading diamond producing country by value, i.e. Botswana. Today Debswana is the biggest producer of rough diamonds for the group, producing 22.7 million carats in 2013. And our current sales agreement, which is a ten year sales agreement, runs until 2020 with the current mining license running until 2029.
Ever since we began the partnership 45 years ago we have always renewed the sales agreement and the mining licenses, and our industry-leading beneficiation activities in Botswana, including establishing a sorting and valuation JV with the government, and relocating recently our international sight sales, have strengthened the partnership further. And we are supporting the GRB in achieving its economic and social objectives. So, exactly one year ago, we migrated all the rough sales activities from London down to Botswana. And last month we had the tenth Sight this year in Botswana celebrating the one year anniversary there. It has been extremely successful, and the government is very happy there with what we have been achieving together. That’s very important. We have been working together in achieving that.
If we move to Namibia we are enjoying a similarly strong relationship with the GRN - the government of the Republic of Namibia. It is also a very long-term partnership because we established the very first company in Namibia called CDM at that time in 1927. So, even earlier than in Botswana. And we created our first JV in Namibia in 1994. Today we have two 50/50 joint ventures in Namibia with the GRN. One is Namdeb Holdings, running both land and marine operations in Namibia for mining, and we have Namibia DTC for sorting and valuation in Namibia. In Namibia our current mining license has recently been extended up to 2035. So we have a huge visibility in front of us in Namibia.
If we switch to South Africa, in South Africa we own 74% of our operations. The remaining 26% are owned by our empowerment partner, Ponahalo Holdings, in line with South African legislation. We operate Venetia, South Africa’s leading diamond mine, and we are currently undertaking a project to extend the life of mine to 2040 at a cost of around $2 billion. Similarly to Botswana and Namibia we are undertaking there the sales of rough diamonds to in-country cutters and polishers. And we are assisting the downstream industry in South Africa in close cooperation with the local government.
This combination of industry-leading mining expertise and outstanding partnership through beneficiation activity in all the countries where we work provides us with what we believe is a very strong and sustainable relationship with some of the major diamond producing countries around the globe. In my presentation we have not included our Canadian operation because in this country it is a wholly-owned operation and we don’t have an in-country sorting operation. We are just mining and exporting down to Botswana what we mine there. And we will cover the Canadian operation in Pat’s presentation.
So this is the overview of the De Beers structure as it is today. I didn’t cover in all the detail, but I think the slide is pretty comprehensive and gives you a good look at what we are made of today. I would like to call Pat to talk about our upstream operation for De Beers. Thank you Pat.

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