How Dominion Diamonds is taking on global titan De Beers

From pure-play miner to vertically integrated retailer and back again

 
Aerial view of the Ekati Diamond Mine in a snow-covered landscape
Dominion Diamonds’ Ekati mine in Canada’s Northwest Territories. (Jason Pineau/Air Canada/Getty)

Robert Gannicott knows diamond mining is all about booms and busts. He lived through the giddy years a decade ago, when the market was on fire with speculation, and weathered the lean times after the financial crisis, when gem sales dried up. He’s seen mega players snap up tantalizing new stakes that turned out to be barren and watched industry giants like Rio Tinto and BHP Billiton move in and out of the diamond space. He knows the risks of the game, so he’s not going to say that the company he now helms, Dominion Diamond Corp., is heading for a boom. But it certainly seems as if it could be.

Thanks to recent efforts to consolidate its mining operations in the Northwest Territories and some savvy decisions on Gannicott’s part, the Toronto-headquartered diamond producer is quickly becoming Canada’s answer to Luxembourg-based De Beers. Dominion Diamonds’ two active mines helped the company earn $498 million in profits last year—and should still be producing glittering stuff for years to come, according to Gannicott. He should know: He’s been around mining for close to 50 years, and he has built Dominion into North America’s only significant pure diamond producer by combining deep industry acumen with unabashed opportunism and razor-sharp timing.

“There are more things to be found yet,” says the 67-year-old veteran, who moved from his U.K. home to the then-frontier town of Yellowknife as a young geologist. His career took him all over the North (including Greenland, where he did mineral exploration work), before he assumed the CEO position at the five-year-old diamond company Aber in 1999. It was a crucial time for the nascent Canadian diamond industry: Tantalizing deposits of diamond-rich kimberlite had been discovered in the Lac de Gras region, about 300 kilometres north of Yellowknife, and mining companies had rushed in to stake claims, hoping the next big diamond supplier might be Canada. (Exploration expenditures soared to more than $1 billion by 2004.)

Ekati, the area’s first significant mine, began production in 1998, spurring an influx of activity that would see diamonds go from a zero-dollar industry to one that represented 20% of the territorial economy by 2002. Globally, the industry had also arrived at a turning point. After maintaining a near-monopoly on the market for more than a century, De Beers was losing its control over diamond production and retailing, as Rio Tinto challenged its dominance and began marketing gems on its own. Aber (and other players) seized the opportunity to start selling diamonds directly to retailers too, grabbing some of the market share that had previously seemed unattainable.

“There was sort of a myth out there that if diamonds weren’t managed by De Beers, the whole market would crash, because they had so many diamonds in their basement,” Gannicott recalls. “That was never true. Since the market opened, the price of diamonds has only risen. It’s been a really big change for the industry.” And as global awareness about the horrific practices surrounding the mining of so-called “blood diamonds” in Africa intensified, Aber’s Canadian provenance didn’t hurt its prospects.

In this changing milieu, one of the key things that has separated Gannicott’s companies from the also-rans has been his skill in pouncing on opportunities as they arise. “I’ve always been willing to sell something if I thought the price was too high not to,” he says. In the resources sector, that sort of pragmatism can be unusual: Given the tremendous capital outlay involved in developing a mine, it’s easy for executives to get attached to projects in anticipation of a payday that may never come.

Barely a year into running Aber, for example, Gannicott sold a key asset, the company’s 32% interest in the Lac de Gras Snap Lake diamond project, because De Beers wanted it (Gannicott also had reservations about how profitable the project would ultimately be for Aber). The cash allowed Aber to deepen its development at the nearby Diavik mine it had long held an interest in, which started production in early 2003 and appeared undervalued by the market, in Gannicott’s view.

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At the time, the global diamond industry had become red-hot. A variety of factors—including increased demand for luxury goods in emerging markets—amped up exploration and development efforts the world over, and the cost increases that came with intense competition for limited resources made Gannicott anxious. Diversification seemed like a smart option, so when the opportunity arose for Aber to buy retailer Harry Winston in 2004, he made a quick, if surprising, decision to acquire it.

It was a brash move for an exploration and production firm to tack on a high-end jewel retail arm, but it made perfect sense to the pragmatic Gannicott, who liked the efficiencies of operating in what he described then as “the two bookends of the diamond pipeline: mining and retail,” and who also saw the brand’s prestige as having great potential in such emerging luxury markets as China. “I thought it was undervalued and that with our knowledge we could bring something to it,” he says. “I knew we could source diamonds for the chain in a very efficient way, and the knowledge we’d be able to gain would be very useful in selling rough diamonds we were producing in our mines.” So Aber became Harry Winston.

Some analysts questioned the deal and, indeed, while there were some successes, it wasn’t a runaway hit. Aber paid US$266 million for Harry Winston in two transactions in 2004 and 2006, and invested another US$36 million in the retail business to integrate the companies and expand the chain’s retail outlets—something Gannicott deemed essential to achieving significant earnings. The move into retail coincided with the financial crisis, however, and an overall downturn in luxury sales. Although high-end purchasing surged again by 2010, giving the retail side an operating profit of about $14 million for the year ending Jan. 31, 2011 (compared with a loss of $15.7 million the year before), Gannicott started to reconsider whether the retail game was worth it.

Meanwhile, the production side of the business—at this point, concentrated at Diavik—was thriving. The mine produced 7.2 million carats in 2012, up from 6.7 million a year earlier. So, when word came in 2012 that BHP Billiton was looking to sell its 80% stake in the core zone of the region’s massive Ekati mine, the prospect seemed too promising to pass up—especially since watchmaker Swatch was sniffing around the Harry Winston brand. With great confidence, he made the decision to pivot again. Swatch paid US$750 million for Harry Winston, plus US$250 million in related debt.

“I think, very frequently, great achievements involve a generous amount of luck. Being able to sell Harry Winston at the same time that there was an opportunity to buy Ekati was undoubtedly one of those hole-in-one days,” he says.

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Market watchers liked the deal too. Shortly after it closed, BMO Capital Markets mining analyst Edward Sterck told the Northern Miner that choosing mining over retail made sense for the company, given the number and size of diamond mines expected to come on stream over the next few years. “My outlook for diamonds really is that supply is going to be more and more limited relative to demand,” Sterck said. “In that sort of environment, I think the retailers will have to become more competitive in terms of the prices they pay for diamonds and, as a consequence, maybe concentrating on the production and the mining end of the spectrum makes more sense.”

Gannicott took the cash from the sale and rolled it into buying out BHP. With that, the firm once again rebranded, this time as Dominion, and firmly established its future as a producer. It solidified that mandate in June of this year by buying out FipkeCo’s 10% interests in the mine, bringing Dominion’s stake to 90% of Ekati’s core and 68.8% of the so-called “buffer zone” surrounding it.

Owning two active mines so close to each other has created some tidy efficiencies for Dominion, including better return on the not-insubstantial infrastructure and logistics costs of operating in such a remote region. And the firm’s profitability has been robust since the Ekati deal came through. But big questions remain about Dominion’s future, the most pressing of which are related to the maturity of both Ekati and Diavik. Is there anywhere to go but down?

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At Ekati, the company expects to start extracting from a high-grade kimberlite pipe called Misery in 2016 and has others in the works. One of particular note is the Jay pipe, a potentially lucrative development currently awaiting regulatory approval. Similar uncertainty surrounds Diavik, where majority stakeholder Rio Tinto—with which Dominion has a joint venture partnership—has yet to decide whether to proceed in developing a pipe called A21. For investors, that means something of a holding pattern, albeit a temporary one. “I think Dominion will be in a bit of a lull over the next year or so, but we’ll see a really big bump come 2016,” says Matthew O’Keefe, vice-president and senior mining analyst at Dundee Capital Markets Research. “There are some major catalysts coming, and we think they’ll all be positive.”

If the Jay approval comes through—and O’Keefe is one of several analysts who believe it will—it would extend Ekati’s life by another 10 years and firm up Dominion’s consolidation of an area that has some of the richest and highest-value diamond deposits in the world. And that time is exactly what Gannicott needs to plot out the company’s next phase: further development of the Lac de Gras region—and possibly an increase in Dominion’s stake in it. Rio Tinto is reportedly reassessing its mining activities (in addition to its Diavik stake, its diamond assets include Australia’s Argyle mine, the Murowa mine in Zimbabwe, and Bunder, an advanced project in India) and is expected to make a decision on them by the end of the year. If Rio Tinto decides to opt out of diamond mining, it may choose to sell all of its assets together, but it’s possible that the Diavik stake could be sold separately, with Dominion considered a likely bidder.

But even without a bigger piece of the action, Gannicott envisions plenty of potential in Dominion’s assets.“We can see mine life at Ekati going beyond 2030, which gives us a good timeline to set up an exploration program so we can find more things to add to that,” he says.

The fact that there are multiple profitable kimberlite pipes on each of the Ekati and Diavik properties—which sit in the same geological formation—suggests to him that the region’s prospects won’t end at the bottom of the pits currently being mined. “There’s a big area of geology that’s been underexplored in the region,” he says. “We now own well-built and well-managed infrastructure right in that area. It’s a great base for us to be able to further explore and develop.”

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