Harry Winston to buy Ekati for US$500M

One year after BHP Billiton (BHP-BLT-L) announced it was looking at selling its diamond business, the company has found a buyer in Harry Winston Diamonds (HW-T, HWD-T).

Harry Winston will pay US$500 million for BHP’s diamond division, which consists mainly of its 80% stake in the Ekati mine, in the Northwest Territories.

The luxury jeweler already owns 40% of the nearby Diavik diamond mine with operator and 60% owner Rio Tinto (RIO-N, RIO-L).

BHP’s diamond business includes sorting and sales facilities in Yellowknife, the Northwest Territories and Antwerp, an 80% interest in Ekati, and a 58.8% interest in the surrounding “Buffer zone” at the property, which hosts kimberlites that could have exploration and development potential. The price attached to Ekati is US$400 million, while the Buffer zone is worth US$100 million.

The deal for Canada’s first diamond mine, located about 310 km northeast of Yellowknife, is expected to close in the first quarter of 2013.

Harry Winston will fund the acquisition with debt and some cash on hand. The Royal Bank of Canada and Standard Chartered Bank have agreed to arrange a US$400-million term loan, a US$100-million revolving credit facility and a US$140-million letter of credit to cover reclamation liabilities at Ekati.

The new debt facilities will replace a US$125-million credit facility, from which Harry Winston had drawn $50 million at the end of July. At that time, the company had US$75 million in cash.

Ekati’s co-finders and minority partners Chuck Fipke (10%) and Stewart Blusson (10%) have a right of first refusal on the mine’s sale. One or both men have 60 days to match Harry Winston’s offer, in which case, BHP would have to pay a termination fee of US$30 million to Harry Winston.

Production at Ekati, which has seven years left in its mine plan, has averaged more than 3 million carats a year over the past several years. Over the last five years, Ekati has produced an average of US$750 million worth of diamonds per year.

In a release, Harry Winston noted that production at Ekati is forecast to dip over the next two years, but will then pick up again as mining transitions from low-grade, high value areas to the higher-grade, lower carat value Misery and Pigeon open pits.

In a research note, Edward Sterk, an analyst with BMO Capital Markets, wrote that the debt-funded transaction is likely to be accretive for Harry Winston.

However, he noted a couple of risks to the deal.

“Harry Winston is not a mine operator and success may be contingent on the team at Ekati moving over with the transaction,” Sterck wrote, adding: “Investors holding Harry Winston for exposure to the retail division may be put off by an expansion of the mining division and could reduce positions.”

By BMO Research’s estimate, BHP’s stake in Ekati is worth around US$1 billion, although others have estimated its value at US$500 million or less.

The sale of Ekati comes at a time of uncertainty and instability in the diamond industry.

After BHP announced that it was reviewing its diamond business last November, it sold its 51% interest in the Chidliak diamond joint venture with Peregrine Diamonds (PGD-T) to the junior — and included its entire Canadian heavy mineral  sample database.

Rio Tinto followed suit in March, declaring that it may also divest its diamond division, which includes the Argyle mine in Australia, a 78% stake in the Murowa mine in Zimbabwe, and the advanced Bunder project in India.

Both companies cited the lack of top-tier, long-life, large assets in the diamond space as a reason for looking at leaving the sector.

Harry Winston has a right of first refusal on its partner’s interest on Diavik, but would likely find another purchase difficult given the company’s size.

Harry Winston shares were down 32¢ or 2.3% on the news to $13.13. The stock has traded in a 52-week window of $9.89-$15.80. The company has 84.9 million shares outstanding.