Monday, March 30, 2020

Smiles and frowns as diamonds come home

Driving in Botswana’s murderous summer heat from the Sir Seretse Khama Airport near Gaborone to the city, one immediately passes an enormous construction project ÔÇô the new DTC Botswana building. And next to this, DTC-to-be is the new Debswana building in the making. The surrounding construction is reminiscent of the building craze in places like Dubai. Actually, when driving around town one finds at least half a dozen diamond factories all in various stages of completion.

The Republic of Botswana, under the stewardship of President Festus Mogae, is celebrating something akin to its “Diamond Independence Day,” some 35 years after diamonds were discovered in the country. If one had to identify the actual commemoration date, it would be the May 23, 2006. This was the historic day on which the government of Botswana and De Beers signed three separate agreements, which were spelled out in over 1,000 pages. Such agreements were hailed “as cementing one of the most enduring and most important partnerships in the global diamond industry for decades to come.”

The diamonds of Botswana are celebrating a “homecoming” ÔÇô the largest producer in the world is set, by 2009, to also become the largest distributor of rough diamonds. The new DTC Botswana building┬áis developing at an astonishing speed. It will be ready by September of this year; after the Christmas holidays, the sorting staff that presently occupies the Orapa House will move into the new building.

By the first of January 2008, which is the beginning of the new contract period with Sight holders, allocations will be made from Botswana. The 1,000-page contracts contain a clause that clearly says that every sight holder will have the option to decide where to pick up or see his sight: Gaborone or London. Botswana government officials hope that each and every sight holder will come to Gaborone at least a few times a year, perhaps accompanied by family members to combine sight pick-ups with a safari in the Kalahari Desert.

One way or the other, next year (or 2009 at the latest) will mark the end of the historical and traditional role of London, which has been the heart of rough diamond distribution for a few centuries. The move to Gaborone will mark the end of the DTC as we have known it for decades. The added value that had so far escaped the people of Botswana will now be earned by the ultimate owners of the nation’s mineral resource.

By 2009, according to the signed agreements, the 16 or so planned factories in Botswana will be allocated at least $500 million worth of rough annually. “Each factory will get precisely what it needs so that there will not be a need to trade locally or export the non-usable rough,” predicts Kago G. Moshane, the Deputy Permanent Secretary of the Ministry of Minerals, Energy and Water Resources. “All these factories will be making money, they will be profitable. We know that they can be profitable, without having to subsidize the rough,” he adds with conviction.

Talking with various government officials and intellectuals within the Gaborone business elite, one senses a recurrent theme: there seems to be a lingering sense of resentment, or maybe sadness, for the many years of diamond added value that has been lost. For instance, a repeating sentiment that can be heard is, “This all could have happened 10 or 20 years ago and even with greater ease.”

Historically, De Beers ÔÇô in collusion with the government ÔÇô had made clear that it was not possible to profitably produce in Botswana. One official bluntly said that the two token but large manufacturing companies that had been operating for a long time (one of which was owned by De Beers with Gareth Penny as its first factory manager in the early 1990s) had been told “not to report profits.” Doing otherwise would have contradicted the formal position of the rough producers. For example, the minutes of a November 2000 Debswana board meeting, as a matter of routine, noted that the company’s Teemane diamond factory “is expected to break-even in five years from the year 2000…” (As the factory was sold to Diarough in 2003, we expect that that target probably was achieved before the “planned” break-even…)

That now-abandoned position about the impossibility of manufacturing profitably in Botswana was eloquently phrased by former De Beers Managing Director Gary Ralfe in a 2001 interview in Diamond Intelligence Briefs:

“Particularly in the case of Botswana, [the absence of manufacturing] is a recognition of economic realities. Botswana’s best interests are served precisely by having Botswana diamonds polished in the places where they can most economically be polished. Botswana is such a major [rough] producer and the Botswana Government has such a clear view about these matters, that they recognize the truth of this. For a major diamond producer like Botswana, it would be national folly to prescribe that any percentage of their diamonds needed to be beneficiated locally. What Botswana, as the world’s major diamond producer needs to do, is to ensure that diamonds reach the place where they can achieve the highest price and that gives by far and away the best return to Botswana in terms of fiscal revenue.”

That truth was more a matter of policy than of reality. And what had been called a “national folly” has now become part and parcel of the undertakings between De Beers and Botswana. Penny, Managing Director of the De Beers Group, confirmed on the “Diamond Independence Day” that “De Beers fully supports Botswana’s desire to establish a downstream diamond industry.” He also said that he was “pleased to announce that diamonds will be made available locally for cutting and polishing factories in Botswana.”

The economics is still broadly the same. However, the policy has changed; the mantra was replaced, thanks to the agreements signed on the “Diamond Independence Day”. Like every Independence Day, it was the result of a long and arduous struggle.
None of this really settles the question of whether a manufacturing operation can make money. The government’s position is very clear: would two of the world’s leading diamond companies (Diarough and Leo Schachter) really be staying in Botswana if it wasn’t worthwhile? Please note that one company, which sold its factory after it had “a non-performing asset,” appearing in its balance sheet for ten years, is now coming back to establish a new factory. If setting up in Botswana wouldn’t be worth it ÔÇô these companies would know it. What’s more, they would be the first to know.

Times have changed ÔÇô and so have the personalities involved in the diamond industry. Varda Shine and Gareth Penny, the De Beers team that is leading the Botswana revolution, would not take the risk of having some 16 of their best and finest clients invest huge amounts of capital if they thought that it “will not work.”

Critical Mass Needed to Achieve Margins

Who better to ask about Botswana than the oldest, largest, and most experienced players in the Botswana diamond-manufacturing scene? Take Leo Schachter Botswana (Pty) Ltd., located in Molepole, a 50-minute drive from Gaborone. With only a few hours notice, relying on the company’s well-known credo of candidness, accountability, and integrity, we found ourselves quizzing the company’s financial manager, Marina de Jager.

Before going to see Marina, we knew that in 2006 there were five factories operating in Botswana: Leo Schachter, Diamond Manufacturing Botswana (DMB), Teemane Manufacturing Company (Diarough), Eurostar and Pluczenik. We knew that all the rough used by these factories had been imported, and that total rough diamond imports into Botswana in 2006 amounted to 130,000 carats, valued at $63.2 million. We also knew that not all factories work on the same goods. Eurostar, for example, also manufactures two-grainers. Most others have 3-8 grainers as core goods.

As the largest factory, Leo Schachter Botswana accounts for 35 percent of all carats consumed by Botswana factories, representing 45 percent of all imported rough by value. The average per-carat value of all rough consumed in Botswana is $484.95. Eurostar’s type of rough would cost some $206 per carat, and this exerts downward pressures on average values. Leo Schachter, we believe, is using rough valued at $521.00. Clearly, as Leo Schachter Botswana uses almost as much rough (by value) as all the other five together, the experience of this company would certainly be indicative and characteristic of what can be achieved.

After a previous visit in 2001, we wrote: “The factory’s (established 1993) initially concentrated on ‘ideal cuts’ in which yield is sacrificed in order to get the highest quality make. Soon thereafter, the owners successfully retrained the workforce to handle also commercial qualities, where the optimization of yield is generally more important than the make. It also required greater cutting skills. The yield generated out of the rough is 48 percent.”

Marina told us on this week’s visit that recently the production yield had risen to 50 percent. This was due to an investment of some $1.5 million in state-of-the-art technology during the past two years, which was a part of a restructuring by a new manager, Danny Shachar. In a short time, Danny had increased both manufacturing yield and productivity.┬á

“As the company’s financial manager, I can tell you that last year our company made a nice profit,” said Marina, rather matter-of-factly. She couldn’t possibly have known that, for the first time in almost 20 years, a factory openly and proudly admitted to making (some) profits.

There is something else that is even more significant: except for one manager (and two cutters of very large goods), the entire factory is operated and managed by Batswana ÔÇô locally trained people who climbed up the ladder to management responsibility. Leo Schachter Botswana is basically a locally operated and managed company ÔÇô and it is a successful company.

This is more than just good news in general; it is important and encouraging news for all the newcomers to Botswana, who have submitted business plans based on training and running-in period during which losses will incur ÔÇô with profitability planned in a 3-year time span.

Yield Compensates Higher Labor Cost

Some of the basic data applies to all the local factories. The minimum monthly wage is $94 guaranteed, and the balance is productivity-related. The average wage is $224 per month. The number of workers comes to 311. A quick back-of-the-envelope calculation shows that the increase of two percent in production yields equals almost 70 percent of the annual company wage bill! This underscores the difference improved technology and production skills can make.

Currently, Leo Schachter Botswana still manufactures the 3-8 grainer box, but it has now also opened a fancy cuts department, a special Leo Brand department (the brand is sold in 2,000 shops throughout the world), and a new large stones department. “The diversification of products has positively impacted our profit and loss,” said Marina.

The Botswana government has “learned” to make the calculations itself. When rough is imported, the number of stones is recorded next to carats and value. Monthly reports on cutting, inventory, and sales must be reported. A company’s yield can be monitored by government as it sees how many stones come in, and how many polished ones go out.

The government wants to get away from the stereotypes and to get rid of the image of factories losing money. At the end of the day, the sustainable positive image that Botswana wants to achieve must be based on sustainable facts.
I assume that Eurostar, which imports small goods (at an average of 16 points sawn) and runs an extremely efficient operation where the trainers and supervisors are “on loan” from the Chinese operations, must also be profitable, based on cost-per-carat production data. But this is an assumption; I haven’t been able to hear that first hand.

The message from Botswana is this: you can profitably run an operation there, but don’t view it as an “excuse” to get rough only to manufacture it elsewhere, as we all have seen happen in other regions. Leo Schachter proves that manufacturing in Botswana can profitably be done.

For quite a few years now, Botswana has hosted the world’s largest, most profitable and longest-life diamond mines. It is the world’s most valuable diamond producer with a 2006 mined output of 34.3 million carat valued at $3.38 billion at an average value of $98.50 p/c. This is a 7.5 percent increase over 2005, when 31.9 million carat valued at $3.13 billion was mined. This output represents about a quarter of the world’s entire diamond production (by value). By 2009, Botswana will not only be the principal producer, according to the scenarios and the agreements with De Beers, by that time, some $500 million will be sold to 16 local manufacturers.

Though we had also been skeptical, we now believe it is feasible. That is good news to the factories that plan to operate in Botswana and even better news to the government. But the people who should really be jubilant are Varda and Gareth. Through their commitments to the government, De Beers is locked in. Failure to deliver has ceased to be an option in Botswana.

With the right partners ÔÇô and I think the country has the right partners ÔÇô Botswana is a success story in the making.