Kinross Invests In Ailing Harry Winston

Kinross Gold (K-T, KGC-N) is raising some eyebrows with a surprise move into the diamond business, starting with a US$150-million offer for stakes in diamond miner and retailer Harry Winston Diamond (HW-T, HWD-N) and its 40%-owned Diavik diamond mine in the Lac de Gras region of the Northwest Territories.

The deal will leave Kinross with a 19.9% direct interest in Harry Winston, and a 9% interest in the mine, which is operated by 60%-owner Rio Tinto (RTP-N, RIO-L). The two Canadian companies say they will consider future diamond mining investment opportunities as well.

During a conference call on March 19, Kinross president and CEO Tye Burt assured investors and analysts that gold would remain the company’s focus.

“We look at complementary minerals that have the same multiples as gold,” Burt explained, giving silver and diamonds as examples. “This is one of the great mines of the world and one of the great mines of the diamond world. . . We saw it as a good way to add value.”

Kinross will pay US$104.4 million to subscribe for 22.5% of Harry Winston’s stake in Diavik (for a 9% interest in the mine). Kinross will also complete a private placement of 15.2 million Harry Winston shares for US$3 apiece for a total of US$45.6 million. That gives Kinross another indirect 6% stake in Diavik, for a total of 15%.

No estimate was given on how much cash the investment would bring in for Kinross. Rio Tinto is currently reviewing its budget, which will clarify expenditures for the rest of the year, including significant underground development work at Diavik.

The offer comes at a time when diamond miners are having a tough go of it. That includes Harry Winston, which also announced that it has suspended its dividend. Major diamond producer De Beers has suspended production at its Debswana joint venture in Botswana, which produces half of De Beers’ yearly output — and one-fifth of the world’s — from four open pits. The company also laid off 220 people from the Snap Lake diamond mine near Yellowknife in an effort to match production with demand.

Harry Winston doesn’t have the option to cut production because Diavik is making money for Rio Tinto, which has its own debt problems to deal with in its base metals business.

Now Harry Winston will use the proceeds of the Kinross deal to repay an existing US$50-million debt, which the company’s chairman and CEO, Bob Gannicott, says was just reduced from US$75 million earlier in March.

“This investment will strengthen Harry Winston’s balance sheet and is a great endorsement for the fundamentals of our business by a major gold mining company,” Gannicott said.

Harry Winston will soon be needing funds for its portion of an underground expansion project at Diavik, which has already been delayed until the third quarter. The plan is to mine completely from underground by 2012, lasting until about 2020 depending on reserves.

Rio Tinto has also put a US$50- million project on hold that involves additions and modifications to the processing plant that will help recover much smaller diamonds.

During the Kinross conference call, investors unfamiliar with the diamond business voiced concerns about Diavik’s viability, but Gannicott reassured them that the mine is still “cash profitable” — even with a 30% drop in rough diamond prices since last summer.

But Nick Sayce, a consultant who has many years of experience in the diamond industry, says it’s usually best to “stick to your knitting” when it comes to mining, pointing out that diamonds are a completely different commodity than gold in terms of both mining and pricing.

Diamonds are very much a luxury item, and they’ve been faltering at the retail level.

“It’s a commodity that’s fallen out of favour at the moment,” Sayce says. “Diamond prices have really dropped off and it’s not an area that is going to cause much excitement. . . I don’t think you can expect to see much good news in the way of the diamond sector at the moment.”

Charles Wyndham of WWW International Diamond Consultants, says recent improvements in diamond prices are positive, but don’t change the larger picture. The volume of rough diamonds put in the market has been very restrictive, he says, so if mines start producing more, prices will suffer.

“The market just cannot absorb very large quantities of rough diamonds at the moment,” Wyndham says. “And it’s in that context that mining companies have got to find a way for themselves to survive. It’s very tough out there.”

From Harry Winston’s end, Kinross’s support will be helpful, but an analyst on the conference call asked whether Kinross was overpaying for its stake.

The gold miner paid a significant premium over Harry Winston’s share price, which closed at US$1.88 in New York the day before the news was released on March 19.

Burt said US$3 per share was a good deal over the long term and that Kinross bought into Harry Winston at an opportune time.

“Harry Winston’s share price has been pushed down dramatically by the credit issues in the capital markets and the current consumer situation. . . We think it’s a significant discount to the net present value and so does most of the Street,” Burt said.

Harry Winston’s share price responded positively to the news: in Toronto, shares soared 35%, or 80¢, to $3.08 on a trading volume of 3.2 million shares.

The stock has a 52-week high of $32.15 (reached last May) and had sunk to a new low of $2.19 per share on March 9.

Kinross shares on the other hand fell nearly 4%, or 86¢, to $22.80 on a trading volume of 6.4 million shares.

Harry Winston reported net earnings of US$71.9 million for the third quarter, ending Oct. 31, 2008.

As of 2007, Diavik hosted reserves of 21.9 million tonnes grading 3.5 carats per tonne for 77.1 million carats.

Annual diamond production at Diavik has grown to 11.9 million carats in 2007 from 3.8 million carats in 2003. Harry Winston expects 2008 production to come in at 6.6 million carats, but year-end financial results won’t be out until about April 2.