By Ashley Bailey
, Monday, July 09, 2007
The following presentation was given by G. Loet Kniphorst, Global Head, International Diamond & Jewellery Group at ABN AMRO Bank N.V. at the WFDB/IDMA Presidents Meeting in Amsterdam June 2007.
Ladies and Gentlemen,
It is a pleasure for me to be invited at this (WFDB) Presidents’ Meeting, especially since it is held in my home town of Amsterdam. Not often I get the opportunity to come to Amsterdam for the diamond business, as most of our clients and events like this one are located elsewhere.
Reading up on the Netherlands in Chaim Even Zohar’s book From Mine to Mistress, I noted that the history with the diamond industry goes back 400 years and a number of the present Dutch diamond houses date back untill early and middle of the 19th century. Since the middle of the 20th century, Amsterdam’s position as a manufacturing centre has significantly decreased. However, Amsterdam has done a remarkably good job in maintaining its status as city of diamonds.
I believe the international diamond industry can learn an interesting lesson in marketing from studying this case.
Over the years the diamond industry has changed, but the speed of change appears to be going faster and become more complex.
In order to put things in the right perspective, let us look at the diamond pipeline and the way it has developed in recent years.
Most of us are aware that statistical information in the diamond industry tends to be scattered around and many of the figures simply do not add up. The data on the screen though are consistent with most sources, with the exception perhaps of the level of retail sales of diamond jewelry, for which $68.5 billion is at the lower end of the estimates and around $74 billion at the higher end.
When first of all looking at the development over the years, you can see that
- the value of the rough production has gone up consistently – from $8.8 billion to $13.5 billion, or an increase of over 50 percent;
- the diamond content in diamond jewelry sales went up with more than 30 percent;
- however, retail sales went up with less than 20 percent, over a 7 year period.
In terms of growth for a luxury item, this is far from spectacular. I should note that the 2006 figures for the jewelry sales are up with approximately 10 percent as compared to 2005, which is significantly more than in recent years.
But, where is the money made? In mining and in retail sales. The man in the middle is being squeezed.
Of course we should not forget that at the start of the pipeline, the mining requires major investments while, at the retail end, the inventory, marketing campaigns and investments in brick and mortar also require major investments.
So, the conclusion is, if you take the costs of all these investments into consideration, then the diamond industry is not as profitable anymore as a number of years ago.
Following the pipeline development, growth of the bank debt appears to be unstoppable.
The exact figures for the bank debt in the various centers have in recent years also become a topic of dispute. For Tel Aviv and Antwerp most people will agree. Although Antwerp has seen the arrival of 2 new banks and is also being serviced by some banks in London. Mumbai has many banks servicing the industry, but the consensus for bank debt is between $4.2 and $4.5 billion.
For New York it depends how we define the diamond companies; where a less limiting definition could perhaps almost double the figure from $2 to $4 billion. For the sake of consistency we base our estimates in a similar manner as we have done in the past and use the more restrictive number. Add to this figure about $600 million in securitization programs and perhaps another $400 million from other centers like Hong Kong, Dubai and Johannesburg and you can conclude that the bank debt has more than doubled over a 6 year period.
Libor interest rates certainly have had an effect as well. If you consider that every full percent rise in interest rates adds approximately another $100 million to the bank debt; should rates rise further the effect will not go unnoticed.
Be it as it may, most important of all is the fact that the diamond industry is not the same any more. The whole environment is changing.
We have tried to compare all the forces that influence the industry in one slide. It has become quite a busy one but I hope it does visualize all the changes that in many ways are forced upon us.
It is not my intention to dwell upon each aspect of this diagram at length but I like to briefly highlight the main aspects.
The fact that overall the business is not growing very fast, that there is overcapacity in manufacturing and that there are many players in the market chasing the same goods, leads to a strong rivalry in the market, which in turn leads to pressure on and reduction of margins.
On the other hand we have Legal/Regulatory Requirements.
The requirement to know one’s customer becomes stronger and stronger. Governments, suppliers and banks alike want to be able to monitor and verify where the business is coming from and where it is going to.
The rise of the Internet has made entry into the market much easier and also forces additional price transparency upon the industry. The changing regulation in southern Africa may also influence the entrance of new (local) players in the market.
Threat of Substitutes
Next to the perceived threat --and I must add opportunities-- of synthetics, there is also the threat of other luxury goods. A recent analysis of United States sales, for instance, claimed that the increase in sales of flat screen TV’s, has had a negative effect on jewelry sales.
The community requires from the industry that it acts responsibly, socially and environmentally as well as ethically. Often the NGO’s and the media are the most vocal in this respect, but governments, suppliers, buyers and banks have similar demands.
The changing role of De Beers obviously has had a major impact, also its recent announcements of reduced output. I will come back to that in a minute. New mines are expected to come on stream and may further change the market share of some of the traditional suppliers. Combining a mining company and a jewelry retail company, termed as forward integration, of which we have seen several examples may also change the balance.
The Internet is improving the consumers’ knowledge of prices and creates more and more possibilities for a potential buyer to compare prices. Furthermore, certain specific conditions in the market are still causing an anomaly, where increases in the prices of rough are not followed by similar increases in the prices of polished.
Especially the majors in the USA have dictated conditions which have forced vendors to either become more efficient or to loose margins to the extent that it becomes unprofitable. Also by joining together to buy rough diamonds, like we have recently seen in India with Diamond India Limited, one can improve the buying power.
Size and Structure
I have argued in the past for diamond companies to become more structured in a corporate manner. I have received criticism from some that I was out to kill the small family businesses. I personally do not see why a family business, either small or large, can not be structured as efficient corporate organizations. In fact many family businesses in the diamond sector have done so already.
The rough index has gone up significantly, while the polished one is only slowly, slowly moving up.
What is quite clear is that volatility in the prices of rough has increased and we expect it to increase further.
Much of this volatility is a result of the changes in the dynamics of our industry. As we have seen since 2000, the industry leader De Beers renouncing its custodial role and in the mean time its market share has fallen below 50 percent for the first time.
It means that the diamond industry loses its blanket of protection that was provided by De Beers and becomes much more like any other commodity based industry. As a banker this means that we have got to reappraise our attitude to the risks that our customers take. It is absolutely essential that the industry starts to manage its risk professionally.
Do I believe bank debt has more or less reached its peak? In fact I do.
Although new banks may enter, bank debt may be switching from one bank to another, but under the current circumstances, I believe the maximum level has more or less been reached. Therefore there is a need for the industry to attract alternative funding and for instance the Indian equity market has shown already last year it can play a role in this respect. Also a number of inventory and receivable securitization programs in Antwerp have contributed as a new source of funding, although enhancement by standby bank credit is still required. But for major outside investors to come the way of the diamond industry, through diamond funds, individual investors and private equity, it is necessary to have objective price indexes and to develop financial instruments that mitigate and limit the inherent risks of the business.
It is important to attract additional funding, as the graph in the middle is showing, the expectation for the future is that demand for rough diamonds is strongly going to outstrip supply.
To deal with this situation efficiently, is going to require a paradigm shift in how the industry relates internally and most importantly externally. Much more than lip service has to be paid to price transparency. The resistance of providing clear, unambiguous and independent information must change.
The core issue is that there has to be an objective, multiple sourced and independent price source used by the industry and which is acceptable to those outside the industry and in particular those that will provide funding to the industry.
If the industry is going to be able to take advantage of the positive future we are expecting, it must not allow its growth capacity to be blocked by banks or other funding providers being unwilling to take on growing risk as the industry itself grows.
Too much capital is locked in inventory. Having to hold stock and sit on it when margins in the cutting centre are declining rather than growing is not a healthy scenario.
It is no secret that there are many attempts at creating financial instruments for diamonds. Any financial instrument, be it based on physical delivery or non physical, such as trading on an index, is predicated by the need for an objective pricing mechanism. Similarly diamond funds are being created but so far have only had a modest success due to lack of a benchmark price source.
We at ABN AMRO have taken a lead by sponsoring a Polished Diamond Price index which is listed on Bloomberg and Reuters.
Multiple sourcing of data is essential and the index we sponsor is multiple sourced, currently by 20 companies, and we strongly encourage companies to participate on price feed contribution.
The methodology used to produce the index must be totally transparent as well as consistent, based on a logical weighting.
There is a huge opportunity for our industry. I would strongly urge the industry to exit to the unthinkable, become genuinely transparent and join in to create a pricing mechanism that can be used to provide the financial instruments that we all need.
We at ABN AMRO believe that the diamond industry needs the acceptance of an objective, consensus price source which will be the benchmark on which valuations can be based, trading can depend on and financial instruments like futures can be structured. To that extent we will participate in a workshop about derivatives later this week, organized at the premises of the Antwerp Diamond Centre by PolishedPrices.com, to discuss with representatives of the financial markets and members of the diamond community how such mechanisms can be developed.
Perhaps as a final remark I can reiterate that my Bank, ABN AMRO, has been committed to the worldwide diamond trade for many, many years. We consider ourselves a stakeholder in the industry. In recent months, our bank has been the subject of many speculations, who will take us over and whether ABN AMRO will be split up. We in the International Diamond and Jewellery Group believe we can and will continue to service the business.
And whoever will take us over, will encounter a group that is a market leader in the diamond industry, with committed highly experienced staff, working efficiently and generating strong revenues year on year. We therefore look to the future with confidence and expect to continue to service the diamond industry for many, many years to come.
Thank you for your kind attention.