There was never much strategic rationale for the corporate marriage that created Harry Winston Diamond Corp. Aside from a common interest in diamonds, the Toronto-based company's two main assets – a 40-per-cent stake in the Diavik diamond mine in the Northwest Territories and the Harry Winston chain of ultra-high-end jewellery stores – were two very different businesses with little in common.
Luckily, the company's decision to split in two by selling the 24-store Harry Winston chain to Swiss watchmaker Swatch Group AG for $1-billion (U.S.) represents an amicable parting. Harry Winston management has done an impressive job creating value in the retail business, which it bought in two separate transactions in 2004 and 2006 for $242-million, and is selling for an impressive 23 times operating earnings. At the same time, it is renaming itself Dominion Diamond Corp. and gearing up to invest more in diamond mining at a time when it makes strategic sense to do so.
Since 2004, the company has tripled the number of Harry Winston stores, geared the business more toward high-growth Asian markets and tapped the higher-margin but lower-end part of the business (relatively, that is) by offering more moderately priced watches and jewellery. As a result, retail sales in the first three quarters were up by 5 per cent, to $314.5-million, over the previous year, while operating profit rose by 65 per cent, to $20.5-million, as operating margins jumped to 6.5 per cent of sales from 4.2 per cent. Margins still fall well behind larger peers such as Tiffany & Co., due to the chain's smaller scale and prolonged aversion until recently to selling anything less than top-end product, but the retail operation now has greater opportunity to grow, thanks to its new deep-pocketed owner.
Dominion, meanwhile, is already looking ahead to doubling, even tripling, down on the business of mining rough diamonds from Canada's Far North. The company in November struck an agreement to buy BHP Billiton's Ekati Diamond Mine for $500-million, subject to BHP's other joint venture partner not exercising its pre-emptive rights. And it has long eyed Rio Tinto's 60-per-cent share in Diavik, a stake that is worth an estimated $1-billion to $2-billion. Rio Tinto is expected to put its diamond business up for sale this year following a strategic review of the business, and Dominion has first right of refusal on Diavik.
It's a good time to be bulking up in diamond mining. After a string of setbacks that depressed rough diamond prices for two decades – including the economic slump in diamond-crazy Japan, the rise of the unregulated blood diamond trade in Africa, destocking by Russia and De Beers, and the global financial crisis – prices spiked dramatically in 2010. They fell back in the second half of 2011 but are forecast to remain at historically high levels and rise by between 3 per cent and 7 per cent a year, thanks to a growing gap between rising demand (led by India and China) and stagnant supply.
Some breakups work out well for both parties. This should be one of them.
Sean Silcoff