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Gary Ralfe

Nov 1, 2001 3:40 PM   By Martin Rapaport
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Gary Ralfe

By Martin Rapaport

Martin Rapaport interviews Gary Ralfe, managing director of De Beers, who speaks about market conditions, Supplier of Choice, conflict diamonds and the new De Beers brand.

Martin Rapaport: How is the DTC reacting to the world situation?

Gary Ralfe: We are very carefully considering the impact upon De Beers/DTC and the entire diamond industry, including consumers and the diamond pipeline and trying to adapt our supply policies to respond to the demand coming from the marketplace. We are also showing solidarity with and flexibility to DTC sightholders — our major stakeholders — to ensure that the diamonds we sell them meet their requirements. Thus, we hope to supply them with diamonds for which they have a market in polished and which they regard as profitable.

MR: Is there concern that diamond demand will diminish significantly because of the attack in the U.S.?

GR: Yes, of course that must be a concern. If the investment markets initially marked the great luxury houses down significantly in terms of their share price, the same would have applied to the expectation of a luxury product like diamonds. We’re certainly not immune to what will be happening to luxury goods as a whole.

The initial feedback tells us that apart from an increase in engagements that took place in America after September 11, there was a serious drop for some weeks in typical consumer spending. Since then, I’m reassured by other anecdotal evidence that more normal patterns of consumer expenditure are emerging in the big retail chains of America. I believe that the horrendous attacks per se might have had a short-term effect upon the market but assuming that the geopolitical problems are in due course resolved, they will not have a lasting impact upon the market.

We must distinguish, however, between the political and economic consequences of September 11. Before then, the financial markets were undecided about the direction the American economy. It is now the general consensus that September 11

has put Q3 GDP in the United States into negative territory and it is likely that Q4 will follow suit. Technically we will therefore have a recession. The initial impact upon the Dow and NASDAQ was of course negative — perhaps less than people had thought — perhaps it was that delay of four or five days before they reopened. That might have attenuated some of the impact as was initially registered on other stock exchanges around the world. But all of these things — be it the impact on the share market — but more significantly the impact upon American GDP — are likely to be negative for diamond jewelry acquisition. That is what we would expect.

I would go on to say, however, that I do not share the view that one meets in the diamond market. The concern that consumer spending on diamond jewelry this year compared to last year is going to be reduced by more than ten percent. That is not the view that we at the DTC have. Our analysis certainly up to September 11 was that if global spending had diminished in dollars by 6 to 7 percent in the first half of 2001, because of the decline already registered in H2 of 2000 for this whole year, we were looking at a reduction in the annual spending of less than that 6 to 7 percent.

I think that because of September 11 and more importantly because of its impact on the U.S., that we’re now looking for the year as a whole at more than a 6 to 7 percent decline, but our corporate view is not yet that it would be more than 10 percent. In other words, we’re looking to less than a 10 percent decline — 2001 global and annual compared with 2000 global and annual.

MR: What is your outlook for 2002? When will we come back to growth?

GR: Outlook for 2002 is as good as my view about the American economy. I have a view that the American economy will be at bottom in the first half of next year; that the remedies being applied, be it by Mr. Greenspan at the Fed or the government in terms of pumping money into the economy, some of this of course indirect because of the war effort, will result in growth in the U.S. economy in the second half of 2002 and that will feed through into diamond jewelry acquisition.

MR: How have the markets outside of the United States been performing and what are your expectations there for next year?

GR: The second market — Japan — as you know is running at below 15 percent now of the global diamond retail pie compared with the U.S. 50 percent. I’m afraid that Japan did worse than America in the first half of the year and I believe it will do at least as badly as America in the second half of the year. So we’re not going to see any growth from Japan to compensate for the decline in America. I’m pleased to say that there are other markets where we do see growth. It looks as though in terms of polished wholesale prices (PWP) the world’s third largest market now is India and there is growth there. There is also growth in China and the U.K. So there is some growth and I’m hoping that there will continue to be some growth throughout Europe this year. All of these added together, however, do not help to correct the fall in consumer expenditure both in America and Japan.

MR: Do you anticipate any demand for diamonds as a store of value because of the political wars? Do you think Middle East demand will increase? I hesitate to use the term investment, but perhaps diamonds as a store of value?

GR: And I would not encourage diamonds as an investment. When that was tried by some in our industry in the flight to the tangibles in 1980, it had disastrous consequences for our business when those diamonds flowed back into the market. As a store of value, yes. I believe that behind the purchase of particularly more expensive diamonds there is always the feeling that this product is a store of value. That might be more prevalent now. But I don’t particularly think so. I think that diamond jewelry expenditure might outperform other luxury goods in the American season because of what our product stands for — it stands for love, for family values and commitment.

MR: Has De Beers been stockpiling diamonds now?

GR: Given the drop in demand for diamonds, De Beers will this year sell fewer diamonds than its potential intakes, including the diamonds produced at all of its mines. And that means that the DTC needs fewer diamonds from our producers under delivery entitlements and that there will be a short-term increase in inventory, but that is a normal state of affairs when demand falls.

MR: Is the stockpile rate at the 25 percent it was the last time there was a quota?

GR: Absolutely not. At the moment the deferment of purchases is only a few percent.

MR: Have rough prices declined and has De Beers lowered its rough prices?

GR: There’s no doubt as one hears from the market that rough prices have declined this year and that is what we should expect with the considerable pressure there has been upon polished prices given the large polished inventory at the cutting centers, and indeed the pressure upon liquidity. So rough prices in certain categories have indeed fallen. In August we adjusted our prices in response to the market.

MR: The general market has been very weak but prices for the better colors in the larger sizes have been relatively very strong. Is De Beers holding back larger better quality rough?

GR: No we’re not. We continue to sell those articles for which there is demand.

MR: How is the DTC helping their sightholders cope with the situation? Are they allowing selections of goods?

GR: Let me say there has been one sight since the 11th of September. At that sight, I myself spoke to our sightholders and said that given that they had made applications for boxes prior to the 11th of September anyone who wanted now to change his mind and refuse the boxes that had been allocated to him in response to his application would be entitled to do so, without any concern. And there were some returns. Rather less than I thought there were going to be. For some time this year we have been pursuing a policy of our clients being entitled to select out of their gem boxes of +2 carats, those diamonds that they did not want to take and having them removed from the box. That policy was extended before the 11th of September to 3- to 6-grainer gems as well. So that’s another important area in which we’re responding to our sightholders’ needs and current trading conditions. The DTC has also responded by urging our clients to apply for no more than what they really wanted to buy from us. So in those three ways, and in any other way that our clients want to bring to our attention, we are eager to be flexible and to try and help.

Another response which you might find surprising under current conditions, has been to respond positively to requests from our clients for more goods in certain desirable boxes.

MR: Have you been selling less rough at the sights than last year?

GR: Yes, they have been significantly smaller than last year.

MR: Given the smaller sights and the financial restructuring of De Beers that has resulted in sizeable debt, will De Beers be under pressure to increase rough sales significantly in the future?

GR: Clearly this matter enjoys my very close attention. You’re absolutely right that the old public De Beers had a much stronger balance sheet and greater borrowing capacity than the new private De Beers. Having said that, we still have ample financial capacity. Our new shareholders organized a revolving credit facility of $1 billion for De Beers against which we have not drawn anything at all. Between that and the way we are running our own mining business and recognizing our commitments next year, including the servicing of DBI’s debt, we are feeling confident that we have our business, our own company and its financial resources under close scrutiny and under prudent control.

MR: Has DTC been under pressure by the banks of the diamond industry to lower the level of sights?

GR: No. I have not heard from any single bank manager in that regard. Not as bluntly as that, and I don’t believe my colleagues have either. I last sat down a couple of weeks ago with all the Indian bankers after they had attended our regular sightholder dinner there. It is true that the CEOs of the two major Antwerp diamond banks came across with the delegation of the HRD in about the middle of the year and clearly they were expressing concern then about some of the ratios, about the increase in outstandings and about the liquidity of the industry. I would hope that the banks take comfort from the market responses that we have been making and more particularly the tighter distribution of our goods.

MR: Is the DTC concerned about market liquidity?

GR: Yes, I am concerned about market liquidity. The figure of over $6 billion of borrowings is as high as it was last year and that’s in spite of the much reduced tempo of business. The indication is very clear that the credit terms being advanced by the trade to polished buyers have lengthened, as you’d expect in a buyer’s market, and that is the principal reason why that figure has not come down. So yes, it is a concern to us. I would be most concerned to see it rising. I don’t believe that the banks under current conditions would consider it prudent to allow borrowings to rise and it’s clearly important for us that that figure is not increased if we’re going to go on selling our sights even at their reduced level.

MR: Has the market situation changed the advent of Supplier of Choice? Given the poor demand does it make sense for people to continue with these grandiose marketing schemes?

GR: It’s absolutely right for the industry to continue to expand its marketing ability. First off, I don’t call the marketing schemes grandiose. I believe that people who are prepared to continue investing in the marketing of the diamond product are making an extremely good investment. The current market should have absolutely no impact upon the formal introduction of Supplier of Choice. That is going to be determined by our ongoing dialogue with the European Commission. I hope that we can launch formally as soon as possible because I am passionate and optimistic about the medium and longer term prospects of our business, and I believe that the more effort and the more investment that we as an industry make in marketing, the greater and more just the returns to the diamond business will be compared with other luxury goods.

MR: Will the talks with the EC about Supplier of Choice result in significant changes in how Supplier of Choice will work?

GR: It’s too early to comment on that other than that we are engaged in a constructive dialogue. We are having positive and fruitful talks with the Commission and I hope that these will be concluded in the near future.

MR: Will the DTC be announcing any new sightholders in the near future?

GR: Yes indeed. Our sightholder list should be dynamic and based on the objective criteria that we would like to apply to the selection of sightholders. There has been a hiatus on new sightholders while we pursue our dialogue with the EC about Supplier of Choice. Once that has concluded, then indeed, on an ongoing basis we should be looking to recruit new sightholders.

MR: When do you expect the dialogue with the EC regarding Supplier of Choice to conclude? And when would you expect there to be announcements of new sightholders?

GR: Let me say I must use the verb “hope.” I hope the talks will be finished before the end of the year. If that’s the case then we would want to have the formal launch of Supplier of Choice in the new year and then to make a decision about new sightholders.

MR: Has any agreement with the Russians been reached regarding the Russian marketing program?

GR: No agreement has yet been finalized but we have made good progress with our Russian colleagues about an extension to the trade agreement, and following the recent trip that I had two weeks ago. I’ve come away confident that this process will result in a renewal, but I cannot be specific about the timing.

MR: What is De Beers’ position in regard to conflict diamonds?

GR: First of all, in regard to conflict diamonds, De Beers through DTC boxes, enjoys the credibility that no diamonds that we market are conflict diamonds and there is an undertaking on each sale, invoice from DTC to this effect. That no diamonds are acquired by us in contravention of any UN resolution and the diamonds we are selling are sourced only from South Africa, Botswana, Namibia, Tanzania, Russia and Canada.

MR: What is the situation with regard to Angola?

GR: Our operations in Angola had been limited to prospecting. We have suspended our prospecting operations pending resolution with the government on outstanding issues and those outstanding issues have to do essentially with the fiscal terms on which we would be able to create a mine of any payable deposit and the confirmation that we’d been able to market those diamonds in spite of the current monopoly which has been created in Angola. So that’s where we stand in relation to Angola. We hope that we will be able in due course to meet properly with the government in order to resolve these outstanding matters. Angola is highly prospective for diamonds and we are anxious to continue our prospecting there. It’s our dream that one day we should be able to find and create a large diamond mine or mines in Angola.

MR: Are there too many sellers of diamonds in the world today? You see Leviev, Canadians and Russians. It’s nice that De Beers is interested in even more diamonds, but isn’t there already too much competition in the rough markets? Is there an oversupply of rough diamonds building up?

GR: There’s actually more than one question there. Obviously, in H2 2001 there’s an excess of supply over demand, but as we look forward, and given the sort of global economic growth that we expect, we think that that will not continue to be the case. That’s the reason why, either in our existing mines, or in mines yet to be brought into production, we would be able to increase supply in the future to meet increased demand. In addition, we have a passionate belief that our new marketing strategies are going to be growing incremental demand for diamond jewelry. We intend that diamond jewelry sales should outperform GDP and obviously that means an increase in diamond supply or an increase in rough diamond prices. So that’s the first part of the question — the most important one.

As for the second part of the question: Is there too much competition? Well, one must look at that. Perhaps the old De Beers, before our transformation would reckon that there was too much competition. At that time we were transfixed by managing supplies to the market. The new transformed De Beers is looking to grow demand for diamond jewelry. We are now totally focussed upon creating additional demand for diamond jewelry and improving channels for our own diamonds to be efficiently distributed to the retail marketplace. We hope, in due course, to be able to differentiate our product from our competitors’.

MR: Are the Diamdel offices buying rough diamonds on the open market?

GR: Yes, they certainly are, provided the goods they purchase are accompanied by appropriate documentation proving that they were not sourced from conflict regions.

MR: Are the diamonds Diamdel buys being sold by De Beers to sightholders?

GR: No, they are not being sold by De Beers, but Diamdel continues to trade on the open marketplace on its own account.

MR: What is the level of De Beers polished diamond activity?

GR: It’s been modest at less than two per cent of our total turnover.

MR: Is De Beers manufacturing all these diamonds or are they also buying the polished diamonds on the open market?

GR: Both. The major portion of the turnover derives from its own polishing activities but there’s also some trading of polished in the marketplace.

MR: How is the De Beers brand developing?

GR: It’s developing well. LVMH has put a great deal of human resource behind the project and I’m impressed by the work that it’s been doing. Obviously, the market will be the ultimate judge of the De Beers brand and I hope we’ll see the first indications of that when the first De Beers retail outlet opens in London some time next year.

MR: Will De Beers’ stores be competing with your customers’ customers? Retailers are quite concerned about that. They don’t look forward to having to compete with a De Beers store across the street.

GR: If you’re talking about competition between this independently managed and operated retailer and other jewelers who are our customers’ customers, yes, that is the case. I can understand that their initial reaction might be one of concern. But I reiterate the theme that we believe that the diamond jewelry sector is under spent in terms of advertising and it is under branded. We believe that the introduction of new brands, not just the De Beers brand, but many other brands as well into the retail marketplace with all the additional advertising expenditure and all the additional glamour should help to revive the diamond jewelry sector and make it more competitive and more interesting for the consumer.

MR: So the plans for the De Beers brand haven’t been put on hold because of the current world situation?

GR: Absolutely not, and I can only say that I’m impressed at the amount of interest that the senior people at LVMH are putting toward the whole project.

MR: Are the open market prices for diamonds lower than the DTC prices?

GR: In certain instances yes.

MR: Isn’t their concern that this will diminish the financial capacity of the sightholders and reduce their financial strength?

GR: Well, not necessarily. Let me say that it is not in our interests that sightholders be weakened. On the contrary, we want a healthy and thriving downstream industry.

MR: What advice would you have for smaller diamond manufacturers in the current market environment?

GR: In a difficult market, obviously, one must exercise due caution in one’s borrowings and trading.

MR: Is there any concern that manufacturing capacity will decrease and not be able to come back online sufficiently in the next year?

GR: Absolutely none at all. There’s extraordinary flexibility in our business. And in most parts of the world it’s seen how flexible the business can be to the market and nowhere is that more apparent than in India.

MR: Looking beyond the current tragedy in the U.S. and short-term economic uncertainty how do you see the future outlook of the diamond industry in the medium to long term?

GR: In the medium to long term, I see it optimistically, and I believe passionately that our business has not gone in the right direction during the 1990s and that De Beers and DTC as a leader in the industry needs to encourage the development of a new focus to the whole industry. I believe that is what our new strategy is focused towards. Perhaps not in the next year or year-and-a-half. The strategies we want to put in place are not an event, but a process. They are methodical business plans that have to be introduced patiently and carefully over a number of years. But I have absolutely no doubt that the sort of policies that we want to bring into our own behavior and into the behavior of those with whom we’re trading, are ones that will lead to growing the overall diamond jewelry business and that will make for a more exciting and a more profitable and above all, a growing industry in the years to come.

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Tags: Angola, Banks, China, Conflict Diamonds, Consumers, De Beers, Diamdel, DTC, Economy, Government, HRD, India, Japan, Jewelry, Leviev, LVMH, Manufacturing, Namibia, Polishing, Production, Russia, Sightholders, Sights, South Africa, United States
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