TORONTO With proposed sale of its retail arm, Harry Winston Diamond Corp HW.TO has clearly signalled its ambition to become a leader in Canadian diamond mining, a strategy that make sense for the company despite the risks.
The company - soon to be known as Dominion Diamond Corp - made a clean break from jewellery retailing on Monday with the sale of its luxury arm to Switzerland's Swatch (UHR.VX) for $750 million (466 million pounds) in cash plus the assumption of $250 million of debt.
It also already offered to buy BHP Billiton Plc's BHP.L majority stake in the Ekati diamond mine in Northern Canada, and the next logical step is for Harry Winston to acquire all or part of Rio Tinto's majority interest in the Diavik diamond mine, also in Northern Canada.
"I think we're going whole hog here," said John Hughes, a mining analyst with Desjardins Securities.
Rio Tinto has been shopping around its diamond business, including its 60 percent stake in Diavik, since March 2012. Harry Winston already owns a 40 percent stake in the mine, located just below the Arctic Circle.
While it remains unclear what price Rio's stake would fetch, it is clear that Harry Winston is now in a far better position to pay for it.
Even if the Toronto-based company looks to pay down some of the debt it would take on to buy Ekati for $500 million, it would still have cash left over. (That deal could fall off the rails if minority shareholders elect to exercise their right of first refusal.)
Indeed, Chief Executive Robert Gannicott said in a statement on Monday the sale of the retail arm leaves the company "well equipped to realize upstream opportunities in an environment where cash has become a strategic resource."
BACK TO BASICS
Such a strategy would mark a return to its roots for the company, which started out as Aber Diamond Corp and discovered the Diavik deposits in 1994. Aber took a 51 percent stake in retailer Harry Winston Inc in 2004, increasing it to 100 percent in 2006.
But there are inherent risks, too.
Diamond deposits are rare in Canada, and those that exist are in the remote northern realms of the country, where the climate is inhospitable and infrastructure minimal.
Ekati and Diavik are both fly-in-fly-out operations, located in a barren region where temperatures can dip well below minus 30 degrees Celsius in the winter.
Running a mine in such a harsh climate is no easy task, and the company is likely to face difficulties in making the transition from minority partner to operator.
"They, historically, have not been an operator," said Edward Sterck, a mining analyst with BMO Capital Markets. "So personnel is a risk - they need to have the right people in place to operate these mines."
With production at Ekati, Canada's oldest diamond mine, wrapping up in 2017 and Diavik's mine life ending in 2023, Harry Winston will need to find new supply to replace those depleted assets. But viable diamond deposits are rare, and while there is good exploration potential around the existing mines, there are no guarantees of finding one.
There is also the risk that the company could pay too much to secure the Diavik stake, or end up saddled with assets in Zimbabwe and Australia - part of Rio's larger diamond portfolio - that don't fit with Harry Winston's Canada-only focus.
If the company is unable to reach a deal with Rio on Diavik, it may have to turn to buying development-stage assets to build up its production base - a more risky alternative than buying an existing producer.
Even so, most analysts agree that the sale of the retail arm makes the new Dominion Diamond far more attractive to investors looking for exposure to diamond mining.
"It is a much more easily understood asset base than trying to mix sectors," said Hughes. "I would suggest this is a big positive for Harry Winston shareholders."