Harry Winston to buy Ekati for US$500M

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

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

The luxury jeweller 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 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 will result in a post-tax, US$200-million impairment to the carrying value of the Ekati asset in BHP’s next financial results.

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

“Completion of this acquisition will bring the opportunity to marry our Canadian diamond sorting and marketing skills with an experienced mine operating and development team, a world-class operating asset and future growth potential,” Harry Winston CEO Robert Gannicott says in a release. “Together with our existing mining business, these assets will serve as our platform for sustained, disciplined growth in the upstream diamond sector.”

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.

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

Edward Sterck, an analyst with BMO Capital Markets, writes that the debt-funded transaction is likely to be accretive for Harry Winston, adding 26% to its net present value per share. Sterck has raised his rating on the stock to “outperform,” and increased his share price target to $16 from $13.

However, because Ekati has been a marginal asset for BHP, it hasn’t provided regular guidance for the mine, so Sterck says his estimates are provisional on further guidance from Harry Winston, which should be forthcoming when the deal closes.

Sterck derives some comfort from the high levels of free cash flow Ekati has generated, most recently US$308 million in 2011. But it’s possible that BMO’s assumptions are based on outdated or inaccurate information, and that Harry Winston may not have enough cash to service the debt it’s taken on, and may have to issue some equity, Sterck says.

Harry Winston does not have operational experience as a miner, but since Ekati’s management team will stay at the mine under its new owner, that is less of a concern.

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 declared in March that it may 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 Rio Tinto’s 60% interest on Diavik, but Sterck says it may not be able to consolidate its ownership in the mine, which is expected to produce 8.3 million carats this year and has 11 years of mine life left.

“They’re buying Ekati with debt, which I presume is collateralized on the asset itself . . . I guess there’s no reason they couldn’t do the same for Diavik,” Sterck told The Northern Miner. “Now that said, I’m not convinced that Rio Tinto is a seller. Rio Tinto’s just having a strategic review, it’s not an active selling process in the same way that BHP have held.”

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 to $15.80. The company has 84.9 million shares outstanding.