2013 Review of Anglo America's De Beers

www.diamondshades.com/diamondreport publication 1

Companies Diamond Industry Series

Equity Communications

De Beers Group

2013 Review

July 24, 2013

Table of Contents

Overview Page 2

Mine Portfolio Page 3

Exploration Program Page 14

Rough Diamond Sales Page 16

De Beers Diamond Jewellers Page 22

De Beers Forevermark Page 23

Conclusion Page 29

Outlook Page 31



Overview

De Beers is an 85 percent owned

subsidiary of Anglo American Plc. The

government of Botswana has minority

ownership.

Originally established in 1888, De Beers

is the world’s premier diamond

company.

Together with its joint venture partners,

De Beers remains the world’s largest

diamond producer by value, with

mining operations across Botswana,

Namibia, South Africa and Canada.

With its Forevermark brand, De Beers is

also the largest supplier of branded

diamonds to the retail markets

Figure 1: De Beers Group De Beers Group

Main Office

London, UK

Mining Operations

Botswana 50%

Namibia 50%

South Africa 74%

Canada 100%

Development Projects

Northwest Territories, Canada

Explorations Projects

India

Canada

Angola

South Africa

Botswana

Rough Diamond Sales and Marketing

Global Sightholder Sales 100%

DTC Botswana 50% DTC Namibia 50%

Auction Sales 100%

Perth, Australia

Diamond Jewellery Sales

Forevermark Brand Licensing

De Beers Diamond Jewellers 50%



Mine Portfolio

1. Namdeb

Figure 2: Namdeb Diamond Production

Source: Company Reports, Equity Communications

Namdeb is a 50:50 partnership between De Beers and the government of Namibia. Diamonds are recovered from the land and sea floor.

Namdeb has faced severe operating challenges in the last few years with no consistency in profitability. Marine operations have become the mainstay of Namdeb's production with land-based operations expected to have experienced steep decline by 2014.

Namdeb operations are currently unprofitable for De Beers. Safety concerns, equipment failure and the occasional strike have conspired to disrupt operations. Furthermore, for sea operations, extraction costs are above budget while resource recovered is below budget, combining to add an extra 50 percent on budgeted cost per carat of production. For land operations, the Daberas mine is at the end of its life, producing at lower grades and at higher costs. The Elizabeth Bay mine restarted operations in 2012 after being placed under care and maintenance in 2009. In the coming years, the mine will provide up to half of the annual production expected from Namdeb's land operations.

Essentially, Namdeb requires fresh investment of at least US$1 billion to extend and optimize the life of

its mines. The company has split its investment plans between short-term projects to be attained by 2020

and long-term projects to the year 2050.



Namibia is the source of high value diamonds for De Beers with average prices ranging from US$450 to

US$611 per carat but this comes at significant cost to the company. Namdeb is required to pay a royalty

on turnover of 10 percent and company tax of 55 percent on its profits, the net effect being an effective

tax rate of around 65 to 72 percent that increases as profitability decreases due to the fixed element of

the royalty. At current tax and profitability rates, many of the projects that Namdeb would like to pursue

are not financial justifiable because it would take up to ten years to gain return on investment.

Furthermore, there are significant technological challenges to overcome before the achievement of

reasonable extraction costs.

For the above reasons, Namdeb hopes its new US$34 million Sendelingsdrif project will produce enough

large diamonds to help ease funding pressures. Sendelingsdrif is expected to replace production from

Daberas Mine toward the end of 2013 as well as extend the Orange River operations to at least 2022. The

mine is expected to yield about 45,000 carats per annum, with a single average size of 1.5 carats.

Namdeb is also optimizing its marine operations to help boost production. Debmarine Namibia is

currently operating at 100 percent of its fleet capacity with a total of five mining vessels, including the

Grand Banks mining vessel which was recommissioned in 2012 after being laid-up since 2009. The

previously chartered Peace of Africa vessel was purchased from De Beers Consolidated Mines at a cost of

US$79 million. The vessel is expected to produce an estimated 330,000 carats annually, equating to

around 30 percent of Debmarine Namibia’s total production. Capacity enhancements to the Peace in

Africa and the Debmar Atlantic will be implemented during 2013 to target currently unmineable areas

within Atlantic 1, the sea operations.

Nevertheless, we still expect reduced revenue and profitability for Namdeb in the period 2014-2017

mainly because of continuing inefficiency, reduced overall production and the mining of lower ore

grades. Production may increase in the medium term if Namdeb manages to overcome the signficant

technological challenges it currently faces.

Crucially for De Beers, the sales contract which allows De Beers to exclusively market Namdeb production

expires in 2013. Just as in Botswana, the Namibia Diamond Trading Company (NDTC) is compelled to

support efforts to grow the local manufacturing industry. The increase in the number of sightholders to

13 from 10 suggests that more diamonds will be sold locally in future. We expect that Namibia will want

to emulate Botswana's new agreement with De Beers.



2. De Beers Canada

Figure 3: De Beers Canada Production

Source: Company Reports, Equity Communications

In Canada, De Beers wholly owns its two mining operations; Victor mine located in Northern Ontario and

Snap Lake mine in the Northwest Territories. De Beers also has a 51 percent shareholding in a joint

venture in Gahcho Kué, a project in the vicinity of Snap Lake. The project is at an advanced permitting

stage.

Figure 4: De Beers Canada Projects

Development Costs Operating Costs Revenue Snap Lake Mine 975 1200 682

Victor Mine 1022 650 1560

Total 1,997 1,850 2242

US$ millions…as at 31 December 2012 Source: Company Reports, Equity Communications Estimates

De Beers Canada's mining projects have so far proved to be an exercise in shareholder value destruction.

In 2007, De Beers took an impairment of US$965 million on its Canadian assets and shaved off about a

third of the carrying value of Snap Lake and Victor mines before they had even started commercial

production. Another impairment of US$696 million followed in 2009, essentially halving the carrying

value of Snap Lake and Victor mines in the second year of full operations.



Initially conceived at an

investment cost of US$500

million, Snap Lake mine has been

a technical and financial disaster.

Through the end of 2012, De

Beers had invested more than

US$2 billion to build and operate

the Snap Lake mine. Additional

capital investment was made in

2012, with De Beers Canada

battling significant operational

issues at the mine. Combined

revenue for the two mines

operated by De Beers Canada

since 2008 is roughly equal to

what has been spent at Snap Lake

alone.

According to the initial mine

plans, Snap Lake was expected to

produce 1.4 million carats a year

for 20 years at a recovery rate of

1.2 carats per tonne. In 2012,

Snap lake mine produced 870 000

carats at a recovery rate of 0.95

carats per tonne. Carat recovery

decreased marginally from the

previous year due to higher than

expected ore dilution and lower

than expected ore grade.

Figure 5: De Beers Canada production economics

Source: Equity Communications Estimates

Figure 6: De Beers Canada revenue


Figure 7: Snap Lake and Victor Mines combined costs




That being said, an Optimisation Study at Snap Lake mine was completed in 2011 with the hope that this

would help De Beers achieve its investment and production goals for the forecast 20-year life of mine. Full

production capacity of 1.4 million carats per year is now expected for 2014 after being initially planned for

2012. To achieve this, new areas of the Snap lake kimberlite are being opened up.

However, all indications are that Snap Lake will remain a value destroying asset for the foreseeable future.

De Beers faces severe technical challenges at the mine that have a lot to do with water management.

Furthermore, while the diamond bearing rock itself is quite high grade, significant dilution means that out of

every tonne of rock that goes through the processing plant, up to 40 percent is worthless. It is probable that

the mine may never provide a positive return on investment.

The Victor mine has approximately eight years remaining of the forecast life of mine. Extraction costs per

carat are within a similar range to those for Snap Lake, the difference being that the Victor pipe produces

enough high quality diamonds to sufficiently cover mining costs.

Plans are underway to extend the life of mine beyond 2020 but this is going to be very difficult. After several

years of analysis of other diamond-bearing kimberlites in the Victor cluster, the Tango Extension kimberlite,

while smaller and of lower grade than Victor, currently offers the best potential to extend the life of the

mining operation. However, it will not be profitable without a significant reduction in current operating

costs.

Tense relationships between De Beers and indigenous communities living near its mines are also of major

concern. De Beers Canada has recently had conflict with the Attawaspikat community, leading to blockades

of the road that provides access to the Victor mine during winter.

Providing background knowledge, De Beers and Attawapiskat First Nation entered into an agreement

whereby De Beers pays an annual royalty to the Attawaspikat in exchange for mining diamonds in the area.

Many in the Attawaspikat community feel this is not enough and they now want much more.

In general, moves to renegotiate mining agreements have gained traction in many of the indigenous

communities in Canada where there are mining operations. The crust of the matter is this: Indigenous

communities insist the compensation agreements entered into with mining companies are payments for

being displaced from traditional homelands. What they now seek is co-ownership of the resources being

mined - what they feel is real sharing of natural wealth.

For Victor mine, increased tensions between De Beers and the Attawaspikat community could frustrate

efforts to extend the life of mine. The economics of extension are already poor before any additional

concessions to local communities.



Gahcho Kué Project

Figure 8: Gahcho Kué Project

Gahcho Kué

Project

Estimated Project Cost US$686 million

Probable Mineral Reserves 31.3 million tonnes

Grade 1.57 carats per tonne

Production Year 2015-2016

Life of Mine 11 years

Source: Company Documents

The Gahcho Kue project is a joint venture between De Beers Canada (51 percent) and Mountain Province

Diamonds (49 percent). It consists of a cluster of four diamondiferous kimberlites, three of which have a

probable mineral reserve of 31.3 million tonnes grading 1.57 carats per tonne for total diamond content

of 49 million carats. Known as 5034, Hearne and Tuzo, these three pipes will be mined in sequence as

open pits over a forecast 11 year mine life.

The Gahcho Kue Project is at the advanced permitting stage. We fully expect the required regulatory

approvals and permits will be obtained eventually. The time frame is what is not certain but the

development schedule is not threatened at present. Once all required licenses and permits are in place,

construction is expected to take about two years. Commercial production will likely begin in the last

quarter of 2016.

From a financial standpoint, the economics for De Beers Canada are quite poor. It will be a long time

before any positive return on investment if any. From a strategic standpoint, it sounds better for De Beers

in the current global social environment to say it is a global miner instead of a Southern Africa miner.

Crucially, production from De Beers Canada is very important for the long-term survival of De Beers'

supply contract system. Closure of unprofitable De Beers Canada operations would greatly compromise

De Beers' market share and influence in the diamond industry pipeline. When the supply contract system

was first conceived, De Beers could count on contracted production from all major producers to fulfil

client requirements. De Beers no longer markets rough diamonds produced by other producers, effectively

halving its market share of global rough diamond sales from fifteen years ago. Furthermore, decision

making authority on the marketing of production from its Southern Africa operations has gradually been

taken over by its producer-government partners. For this reason as well, we believe De Beers will at some

point try to purchase Mountain Province's 49 percent interest in the Gahcho Kue Project once commercial

production begins.



3. Debswana

Figure 9: Debswana Diamond Production


In Botswana, De Beers’ interests are held through the Debswana Diamond Company, a 50:50 joint

venture with the Government of Botswana. Debswana’s operations include Jwaneng, the world’s richest

diamond mine; Orapa, the world’s largest open-pit diamond mine; Letlhakane; and Damtshaa.

Figure 10: Debswana Diamond Sales

Debswana contributes disproportionately to De Beers' earnings. Jwaneng, in turn, is the most valuable of

Debswana’s mines, contributing 60-70 percent of Debswana’s total earnings. It is also the most profitable

of all diamond mines in the world.



Debswana's average annual

production in the period 2000-

2008 was 30 percent greater

than the 24 million carats

achieved in 1999, following a

decision to boost output. For

the period 2009 -2012, average

production has been 17 percent

lower than in 1999 in response

to reduced global demand but

also including operational

challenges at Jwaneng.

Debswana is very much a

company in transition. We have

gradually observed a changing

of roles at Debswana in recent

years with the government of

Botswana increasingly taking

over chief decision-making

roles.

Our opinion is that

management of Botswana's

principal diamond asset was a

bit irresponsible in the last

decade. It remains to be seen

whether Debswana can do

better with greater input from

Anglo American and the

Botswana government.

Figure 11: Jwaneng Mine contribution to Debswana Production


Figure 12: Jwaneng Mine diamond production

Source: Company Reports, Equity Communications Estimates

Figure 13: Jwaneng mining costs per carat




Late-life mines continue to pose a sustainability challenge for Debswana. Botswana is determined to get as

much as possible out of its diamond resource before the shaky decade after 2020 when its flagship mines will

start to rapidly lose lustre. Nevertheless, the crucial Jwaneng Mine extension project continues to proceed

smoothly and on budget. The project will strip 713 million tonnes of waste, exposing an additional 75 million

tonnes of diamond bearing ore. At least 115 million tonnes of waste has so far been moved since 2010.

Cut-8 will provide access to approximately 95 million carats of mainly high quality diamonds and officially

extend the life of the world’s richest diamond mine to at least 2028, at an annual production rate of 8 to 10

million carats.

Going forward, the challenge for Debswana is to achieve optimum returns from its mines. In the last decade,

Debswana could not take advantage of increased output and rising diamond prices because growth in

production and overhead costs considerably outpaced growth in revenue. In effect, Debswana depleted more of

its resource without getting proportionate returns.

Our view is that there is no reason for Debswana to produce at capacity in the short term. Debswana should

first ensure mining efficiency with the view of boosting production in the medium term. Furthermore, we do

not subscribe to the idea that Debswana will run out of diamonds to mine in the next twenty years. With

balanced production, the cut 8 extension should extend the life of Jwaneng to at least 2030. After cut-8, we

predict the commencement of cut-9 or underground mining to further extend the life of Jwaneng to at least

2050.

All things considered, it is the long-term profit outlook for Debswana that is less impressive because of the

expected increase in extraction costs. Debswana's mines will be around for a long time.



4. De Beers Consolidated Mines (DBCM)

Figure 14: DBCM diamond production


In South Africa, De Beers has a 74 percent interest in De Beers Consolidated Mines (DBCM), with the

remaining 26 percent held by Ponahalo Holdings, which is a black economic empowerment consortium.

DBCM’s operations include Venetia, which produces about 70 percent of De Beers’ production from South

Africa; Voorspoed, a source of large and exotic coloured diamonds; and Kimberley Mines, a tailings

processing facility.

De Beers Consolidated Mines, in its presence form, is a shadow of its former illustrious self. DBCM has sold

five of its mining operations that it was failing to operate profitably to focus on the Venetia and Voorspoed

mines. DBCM was guilty of over-mining in the period leading up to the onset of the global financial crisis.

For instance, by the end of 2008, Venetia mine had incurred a backlog of 40 million tonnes in waste

stripped. Consequently, current focus for DBCM is on improving mining efficiency. The job is made difficult

by the significant problems that afflict the whole mining industry in South Africa such as persistent skills

shortages and often tense labour relations.

DBCM will invest US$2 billion to build the Venetia underground mine. When completed, the new

underground mine will extend the life of Venetia beyond 2040 and replace the open pit as South Africa’s

largest diamond mine. The life of mine plan contains an estimated 96 million carats in approximately 130

million tonnes mined.



Section Commentary

Figure 15: De Beers Group diamond production


Figure 16: De Beers Group quarterly production


De Beers practiced unbalanced mining in the decade 2000-2010 in its efforts to crank up production. Production

was boosted by working high grade areas and by reducing stripping. Now De Beers has got to work lower grade

areas and at the same time make up for the stripping that was postponed until 2010. This mainly affects Debswana

where the Jwaneng mine appears to have been mismanaged for years. Mines which were overmined in South

Africa have been sold off to smaller specialized operators who have since turned them around.

De Beers is now focused on rationalizing its operations in Southern Africa. We are also waiting to find out just

how Anglo American will tackle the very costly Snap Lake mine in Canada in the coming years. Perhaps it would

be in the mine's long-term interest to mothball operations until De Beers can comprehensively determine the best

way to get the mine closer to the initial plans for it.

We believe De Beers will maintain the current level of production until at least the second quarter of 2014. In the

current year, the higher level of production from Debswana will offset reduced production from South Africa.



Exploration Program

Figure 17: De Beers Group exploration spending



Exploration Ground Holdings (square kilometres)…as at 31 December 2012

2007 2008 2009 2010 2011 2012

Angola 12000 9000 6000 6042 3017 0

Botswana 28800 10000 3300 3383 7655 7804

Canada 148000 2100 700 605 248 170

DRC 18800 12000 0 0 0 0

India 0 19700 9300 8733 2128 0

Namibia 0 0 0 0 0 0

South Africa 0 700 1000 995 325 455

Total 207600 53500 20300 19758 13373 8429

Company Reports, Equity Communications Estimates





De Beers’ exploration focuses on the discovery of diamondiferous kimberlites with the best potential to go

into commercial production within five years.

De Beers prioritises its exploration activities in Angola where more than 117 kimberlites have so far been

discovered at a cost of US$250 million. 22 of these have been prioritised for deposit-phase diamond grade

testing to confirm their economic viability. Drill testing for diamond grade in the Lunda Northeast

concession was completed on 14 of the 22 priority pipes with results expected in 2013. The concession’s

seven-year term expired in August 2012. Negotiations are underway for a Mineral Investment Contract

under the more favourable terms and conditions set out in the new Angolan Mining Law, which came into

force in late 2011. The conceptual study for the Mulepe-1 kimberlite was completed in November but

indications suggest a stand-alone deposit is uneconomic under current assumptions

In India, the Mahabubnagar reconnaissance permit period expired during 2012. Application is underway

for the prospecting licence and a number of other reconnaissance permit applications remain pending.

In South Africa, ground geophysical surveys were completed in the Finsch area, and targets selected for

drill testing. South Africa remains highly prospective and specialist reviews of the historical databases

continued in 2012. Several of the De Beers prospecting licence applications are pending.

In Canada, Peregrine Diamonds purchased BHP Billiton's 51 percent participating interest in the 8,580

square kilometre Chidliak project for US$9 million dollars paid over three years. The company

subsequently received US$10 million funding boost from Newstar Securities and the Dundee Corporation

plus a US$5 million investment from De Beers, effectively securing working capital to fund administrative

costs and planned exploration to 2014. The deal also gives DeBeers the option to acquire up to 51 per cent

ownership of the Chidliak project before the end of 2013.



Rough Diamond Sales

Around 1999, with the help of Bain and Co, De Beers reviewed its struggling operations and concluded that it

was no longer viable and also no longer in the company's interest to seek to physically control other producers'

supply of rough diamonds. Instead, De Beers would focus on marketing its own diamonds and become 'Supplier

of Choice' for the downstream market in the diamond value chain.

The Diamond Trading Company (DTC) was then incorporated to replace the Central Selling Organization (CSO)

as the new marketing arm of De Beers. This would also appease regulators in USA and Europe who had become

frightfully dissatisfied with De Beers' monopolistic inclinations. De Beers subsequently implemented a

Sightholder System through which a small number of carefully selected companies would be contracted to move

De Beers produced diamonds down the diamond value chain. These companies would also be required to adjust

their business strategies and align them with De Beers' new goals. At least 90 percent of De Beers' annual rough

diamond sales are to sightholders.

Figure 20: De Beers Sightholders


In 2011, a 10 years sales agreement was signed with the government of Botswana that requires the transfer of

all of De Beers’ functions which relate directly to the sale of Debswana diamonds to Botswana by the end of

2013. Furthemore, the government of Botswana is now entitled to purchase the equivalent of 10 percent of

Debswana production on a run of mine basis and growing to 15 percent by 2016. At capacity, Debswana

produces up to 80 percent of De Beers' annual supply of diamonds.

Because De Beers prefers to mix production from its mines located in Canada and Southern Africa before

distributing it to its clients, the DTC was therefore compelled to move its sales and marketing operations to

Botswana in order to maintain efficiency. DTC Botswana has capacity to handle 40 million carats of diamonds at

any given time. Through various sales agreements in South Africa, Namibia, Botswana and Canada, the DTC is

also compelled to supply local processors with usually up to 10 percent of locally produced diamonds.



Figure 21: De Beers rough diamond sales


Figure 22: DTC price index




Section Commentary

De Beers will gradually phase out its

global sales of diamonds and

concentrate its sales in Southern

Africa. This is inevitable because of

the push by its producer government

partners for more 'local' sales. For

instance, Botswana intends to demand

a greater local allocation of

diamonds from De Beers for

beneficiation purposes in the

remaining two years of the 2012-

2015 contract period. Furthermore,

Botswana has indicated that it will

demand even greater local allocation

of Debswana production in the next

sales agreement for the post 2020

period. In addition to this, the

Botswana government will soon be

distributing up to 15 percent of

Debswana production outside of De

Beers' sales channels.

Figure 23: DTC sightholder sales


Figure 24: DTC sightholder sales Southern Africa


Consequently, diamond processors in other regions of the world should expect a sharp decline in the availability

of De Beers produced rough diamonds. The DTC forecasts that over 50 percent of global availability of high

quality diamonds will be offered to producer countries. Therefore, we expect greater consolidation in diamond

processing of high quality goods. (More analysis is provided in the Manufacturing Review section of the 2013

Diamond Report)

http://www.diamondshades.com/diamondreport





Figure 25: Botswana Beneficiation Drive

Botswana Beneficiation Drive

25 Companies licensed in diamond cutting and polishing since 2004

21 cutting and polishing factories with DTC guaranteed rough diamond supply and 4 with different sources of supply

Goods polished locally grown from US$28 million in 2005 to just above US$748 million in 2012

One of the companies cutting and polishing diamonds in Botswana opened a jewellery factory in 2011

Licensing conditions that require new mines to market their diamonds locally

New goals

Botswana's new marketing agreement with De Beers places greater emphasis on the introduction of advanced cutting technologies

Government of Botswana established a Okavango Diamond Company (ODC) to market 10-15 percent of Debswana production independently

Grow value of rough diamonds polished locally to US$800 million



Auction Sales

Figure 26: Diamdel Auction Sales


Diamdel is a business, wholly owned by De Beers, focused on auctioning rough diamonds. Diamdel traditionally

sold rough diamonds sourced from DTC to non-sightholders through face to face negotiations. In recent years the

company has been transformed to conduct international online auction sales of rough diamonds. These now

account for at least 95 percent of all rough diamond sales by Diamdel. Furthermore, De Beers has now extended

participation in auction sales to the entire market of rough diamond buyers including current sightholders.



Section Commentary

Beginning in the year 2000, De Beers has tried to sideline pure dealers in rough diamonds, preferring to take on

clients that can demonstrate strong manufacturing ability and so forth. Consequently, sightholders in De Beers'

Supplier of Choice system for the distribution of diamonds are obligated to participate in downstream pipeline

activities. For this reason, Debeers prefers to enter into long-term supply agreements with vertically integrated

companies. (Analysis is provided in the Rough Trade Review section of the 2013 Diamond Report)

Key points

Historical working stock valued at US$2.5 billion is no longer available

Current stocks available to clients range from US$400 million to US$800 million

Availability of goods changes from sight to sight in response to short-term production,

Greater volatility in supply volumes and quality

We believe it is purposeless for De Beers to push its clients further downstream when the company does not have

the ability to provide all the necessary inputs required for efficient and sustainable manufacturing operations.

First,De Beers no longer maintains stocks of rough diamonds, striving to produce according to client demand.

Second, De Beers no longer markets rough diamonds from other producers. Finally,the company continues to

experience production shortfalls in some categories for various reasons that include poor mining strategies at

some of its mines. This results in stockouts for some categories. Consequently, some long-term clients have

experienced shortfalls in their allocation of diamonds. The impact varies from sightholder to sightholder because

of De Beers' obligations to government selected sightholders in Southern Africa and Canada.

In reality, no producer has the ability to provide all the diamonds required by a verticallly intergrated

manufacturer in the right quantities. Sightholders based in Southern Africa routinely process 30 percent of

allocations in producer countries and export the rest that often cannot be processed economically in Southern

Africa. With so many forced specialist manufacturers in the dynamic secondary markets, space for profitable

trading activities has opened up in rough and polished diamond markets.




De Beers Diamond Jewellers

Figure 27: De Beers Diamond Jewellers store network


Figure 28: De Beers Diamond Jewellers Revenue


De Beers Diamond Jewellers (DBDJ) is an independently managed 50/50 joint venture partnership between

De Beers and LVMH Moët Hennessy Louis Vuitton SA.

The joint venture was formed with the aim of developing a retail strategy for the De Beers brand based on the

De Beers name which has a very strong consumer awareness and credibility. The idea was to gradually open

150 stores in the main diamond markets from 2002 to 2012.

Key Points

DBDJ is precluded by EU competition authorities from sourcing diamonds directly from De Beers

The joint venture is not yet profitable

The idea has caught on in the diamond industry that it is possible to launch instantly successful international

luxury diamond jewellery brands without first acquiring the heritage and legacy of outstanding craftsmanship.

However, on the other hand, prestigious international luxury jewellery brands with the heritage and legacy

like Tiffany spend at least US$200 million annually on marketing.



De Beers Forevermark

After carefully looking at the dynamics of the global diamond industry value chain, we have had to significantly

reconsider our analysis of De Beers Forevermark. It appears De Beers is using Forevermark to create a diamond

pipeline more in tune with its ambitions for the industry. De Beers Forevermark provides incentives for

salespeople to mention to customers that a particular diamond has been produced by De Beers. It wants

consumers to be aware of De Beers as the premium diamond producer with the aim of greatly boosting the

impression that a De Beers diamond is the best diamond to purchase.

Figure 29: De Beers Forevermark retail doors


Forevermark is fast gaining momentum; in a few years competitors will have to respond in one way or another.

Business Model for the Forevermark Brand

Forevermark, unlike De Beers Diamond Jewelers, is a brand targeted at the diamond industry pipeline, a point

missed by industry observers. The ultimate goal of Forevermark is to make De Beers’ rough diamonds more

valuable than diamonds of other producers. Essentially, De Beers is branding its diamonds so that the diamond

industry pipeline prefers them to diamonds of other producers.



Stage 1

Ninety-percent of Forevermark diamonds come from De Beers owned mines. De Beers selects only top quality

diamonds - within the top 2 percent of global supply - for its Forevermark brand.

Stage 2

Leaning on the strength of its sightholder system, De Beers urges selected manufacturers (Forevermark

Diamantaires) to produce high quality polished diamonds suitable for the Forevermark pipeline. These

diamonds are brought back to De Beers to be graded at the Forevermark Diamond Institue in Antwerp, which

issues a passport-sized report. Manufacturers pay the normal certification fee. De Beers then provides a

Forevermark Diamond Grading Report, featuring the unique identification number inscribed on the diamond

and a specifically designed security hologram, providing reassurance that the Forevermark Diamond Grading

Report is valid and genuine.

Stage 3

De Beers encourages pre-selected retailers to become Forevermark Jewellers. Forevermark Jewellers sell the

branded diamonds to consumers. The license fee is US$10, 000 per store or US$25, 000 per Forevermark

vendor. The sweetener is that De Beers handles all marketing for the Forevermark brand using its vast financial

resources and considerable diamond marketing expertise.

It is a win-win for everyone involved. De Beers gets to control distribution of its top quality diamonds,

Forevermark manufacturers gain pre-qualified retail clients, Forevermark retailers do not have to spend a

fortune to market branded diamonds.

De Beers' vision is for Forevermark to be the world's leading luxury diamond brand by 2015. This is easily

achievable because no other organisation is actively stamping diamonds for branding purposes to De Beers'

level.

Assumptions and Analysis

Stage 1

In theory, the more Forevermark-licensed Jewellers there are out there, the greater the strain on De Beers

already limited high quality production. If the assumption is that consumer demand for expensive high quality

diamonds is strong and growing, the end of it all is that De Beers will sell its top diamonds at a higher price.

These diamonds are already a significant component of De Beers' total production by value.



Top end retailers who are not a part of the Forevermark system may eventually lose their ability to access

high quality diamonds from the De Beers production system.

Tiffany has responded to this competitive assault by entering into long-term supply agreements with small

diamond mines that produce or seek to produce high quality diamonds. (Please refer to the production section

of the 2013 Diamond Report for this analysis.

Harry Winston diamond brand is largely protected because of its association with Dominion Diamond

Corporation, majority owner of Ekati mine and part owner of Diavik Mine. It can also rely on the sourcing

strength of the Swatch Group, its new owner.

Stage 2

In theory, De Beers can now trace all of its gem diamond production from mine to store. That could still

happen within the next decade. So far De Beers has chosen to concentrate its branding effort at the top end of

the market. Starting branding initiatives at the top end makes sense because consumers in this segment are

less price conscious and decidedly more brand focused. There already exists a market for Tiffany diamonds,

routinely sold at a premium to other diamonds of the same specifications.

The requirement for ethical diamonds has gained momentum amongst members of the diamond trade who are

based in traditional markets for diamonds. De Beers is responding to popular pipeline concerns and has

positioned itself well. Forevermark branded diamonds give De Beers’ diamonds protection against

reputational risks like treated diamonds and conflict diamonds.

It is quite possible that the majority of all high quality diamonds will eventually end up being Forevermark

diamonds. The nature of the diamond market is that De Beers' strongest manufacturers are also clients of the

leading diamond producers like Dominion, Alrosa and Rio Tinto. Forevermark manufacturers have the

freedom to produce polished diamonds as they please - as stones or finished pieces, relying on collaborative

research with De Beers on popular trends in the consumer markets. If De Beers' marketing initiatives manage

to grow demand for Forevermark-inscribed jewellery, logic dictates that manufacturers will switch an

increasing proportion of their high quality production to Forevermark.

As such, we expect that grading of high value diamonds may shift from the traditional grading institutions like

the Gemological Institute of America (GIA) to De Beers' Forevermark Institute. Tiffany already successfully

produces its own grading reports. De Beers is of the opinion that those who sell Forevermark diamonds should

not add another report on top of the one it provides to discourage comparison-shopping.




Consumers do not normally differentiate between grading laboratories but De Beers new marketing focus may

reshape opinions. De Beers is improving its grading systems, targeting consistency. The issue of different

grading labs providing different colour grades for similar diamonds has taken centre-stage as it considerably

impacts the final value of a diamond. To gain competitive advantage, De Beers is working with proprietary

colour grading machines at the Forevermark grading facility in Antwerp which have so far proved to be more

consistent and reliable than human graders on colour and clarity. The machines work at high speeds and,

crucially, De Beers is not willing to share the technology with other grading labs.

The Forevermark Institute does some private label for grading for other diamond brands. De Beers only does

this for diamond brands that meet its stringent requirements. Since certification is an important component of

the diamond purchase decision in emerging markets where consumers are less trusting of diamond retailers,

Forevermark can move in to capture significant market share based on the strength of its strong marketing

push.

In 2012 De Beers' Forevermark launched FMX, an online trading platform for its partners to buy and sell

Forevermark diamonds. This platform will likely provide the backbone for the Forevermark pipeline and is

only accessible to those companies - traders, manufacturers and jewellers - that are part of the Forevermark

system. FMX allows authorized suppliers to upload details directly and elect to have their diamonds appear

online automatically, within a few hours or less of when they are graded by the Forevermark Diamond

Institute

The U.S. Patent & Trademark Office (USPTO) issued in 2013 the trademark 'Forevermark Diamond Institute' to

De Beers. De Beers filed for the trademark in 2011. The description of the trademark includes the words

"FOREVERMARK DIAMOND INSTITUTE" inside an outer circle with two black dots adjacent the word

FOREVERMARK. There is an inner circle within the outer circle and that inner circle contains the view of a

diamond from above.

The goods and services provided under this trademark cover scientific and technological developments

through research and design in the fields of minerals and gems; industrial analysis and research services in the

fields of minerals and gems; design and development of computer hardware and software all relating to the

grading, identification, observation, measuring, testing, checking, analysis, inspection, inscription for the

purpose of certifying diamonds, jewellery, precious and semi-precious stones.



Stage 3

The diamond industry has bemoaned the lack of generic marketing of diamonds in consumer markets. Generic

marketing of diamonds was the responsibility of De Beers when it exclusively sold much of the world’s annual

production of diamonds. Times have changed, it is a different world today.

However, what is clear is that the absence of generic marketing has slowed the growth of diamond markets.

Retailers operating in the targeted segment may find it to their advantage to join the Forevermark system if it

means shifting some of the marketing costs to someone else. Forevermark retailers have a high degree of

freedom to display the Forevermark as they wish and one could use the association to drive store traffic. For

example, Forevermark's Center of My Universe campaign appears to have done extremely well in the United

States market.

So far the Forevermark brand has focussed its marketing efforts on diamond products that are generally resilient

in periods of weak demand - bridal jewellery and diamond stud earrings. The target mrket is the luxury focussed

consumer with an annual income of at least US$70,000 and is in the market for large size high quality

diamonds. Incidentally, this is the most popular segment in the top market of USA where Forevermark has

targeted 750 retail doors as quickly as possible.

The Forevermark brand was introduced in Asian markets in 2008 after years of testing. It has now spread to

traditional diamond markets such as the US. De Beers says it has inscribed 500 000 Forevermark diamonds

since 2008. Forevermark has gained momentum since it experienced 40 percent volume growth in 2012 in the

number of diamonds branded. De Beers expects to inscribe 200 000 diamonds in 2013. US$1 billion of

Forevermark diamonds have also been sold in consumer markets since 2008.

De Beers hopes that the growth of Forevermark will eventually allow the company to produce rough diamonds

annually to exactly match world demand.



Section Commentary

DeBeers is aggressively inscribing its diamonds so that jewellers can easily identify diamonds sourced through

the official De Beers network.

Forevermark has not yet reached tipping point. This may happen within five years if volume growth continues

at current pace. Forevermark growth feeds off sentiment in the diamond industry pipeline.

There are two main issues that fuel the growth of Forevermark:

1. If we exclude De Beers and Rio Tinto Diamonds, the other diamond producers have neglible marketing

spend in the diamond industry pipeline.

2. Then there are diamond producers who do more than enough to ruin the image of diamonds

The diamond pipeline is being remodelled to try and emphasize that diamonds from different producers should

not be treated equally. The movement has been growing for years and attention now appears to have shifted to

polished diamonds. The movement seeks to devalue diamonds produced from regions that carry significant

reputational risks through their exclusion from marketing initiatives in consumer markets.

Of the major diamond producers, diamonds from Angola, Zimbabwe and DRC face the greatest risk of

exclusion. Nevertheless, diamonds from these regions would still find acceptance in emerging consumer

markets, where the ethical diamonds movement is not strong.

Balancing things out, the ethical diamonds/branded diamonds movement is only as strong as the chaos, real or

imagined, in Angola, Zimbabwe and DRC - diamond producers with questionable diamond production policies.

When all is said and done, the majority of consumers will always choose the cheaper diamond if there is little

to no difference in quality and specifications.



Conclusion

Figure 30: De Beers Group Revenue


We get the sense that De Beers is a company that is trying to achieve too much in the diamond industry. It appears

De Beers is still trying to implement recommendations that were borne out of the strategic review of 1999. This is

despite the fact that De Beers is a very different company from what it was at the turn of the century.

Ultimately, De Beers wants to be the preferred supplier of diamonds for the diamond pipeline. This is a very

flawed strategy that has also ultimately confused issues for De Beers. Somewhere along the road it got lost to De

Beers that the reason for buying diamonds from other producers was actually for the purposes of controlling

supply into the diamond pipeline. It was Ernest Oppenheimer who first correctly observed that supply and

demand for diamonds needed to be expertly balanced. Nowadays, all diamond producers compete to get their

diamonds into the industry pipeline without much consideration for its health.

Can De Beers brand its diamonds and achieve higher prices in the long-term? The answer is no. A different

producer will soon flood the market and depress prices for De Beers branded diamonds. Afterall, a 1.00 carat F-

color, VS2-clarity, excellent cut round diamond has the same properties the world over no matter who the

producer. Furthermore, it is virtually impossible to stamp diamonds in a way that is visible to the naked eye,

effectively taking away the bragging factor that drives the sales of many luxury goods.



DeBeers can brand its diamonds to prove that they have been sourced responsibly but this can never be used to

achieve differential pricing for diamonds the commodity. If it cannot be done for gold, it certainly cannot work

for diamonds. When prices for a certain category of diamonds rise, they rise for all producers. When prices for

that same category fall, they fall for all producers. If we look at the Kimberley Process statistics for 2012, we

can see that the year was generally not good for producers of high quality diamonds like Botswana, Canada and

Lesotho. On the other hand, Australia, Zimbabwe and Russia did well.

DeBeers appears to be envious of the mark-ups and margins achieved by true luxury goods producers, believing

that their business model can be copied. However, this just adds to the confusion on profit margin expectations.

Luxury goods are proprietary products while diamonds are luxury commodities. Luxury goods producers can

manipulate global distribution of goods by virtue of ownership. For De Beers to control global distribution of

diamonds, it would have to corner the market for diamonds. Put differently, De Beers would have to become a

global monopoly again.

It remains that the best way to manipulate the price of a commodity is to control supply. In this regard, Alrosa

is behaving more like the old De Beers. When diamond markets are soft, Alrosa has the ability to stockpile

diamonds through its arrangement with Gohkran. For this reason, the company has achieved better margins

and less price volatility than De Beers since 2008, the last year of Alrosa sales through De Beers.

De Beers, on the other hand, reversed its strategy of a century by first offloading its substantial stockpile of

diamonds and then subsequently cranking up production (over mining) in its efforts to maintain market share

of sales. Debswana mined more of its high value diamonds while achieving less profit for the efforts because

costs rose faster than revenue. To this day, polished diamond markets are still feeling the impact of De Beers'

decision to offload a substantial volume of diamonds into the pipeline in a short space of time.

Since there are too many companies seeking to enter into long-term supply contracts with a limited number of

major producers, a number of producers have cranked up production to satisfy insatiable pipeline demand.

However, we believe demand fundamentals at the retail end should ultimately influence supply strategies. All

major producers including Alrosa, De Beers, Dominion, Rio Tinto and the Zimbabwe groups have specific

categories of diamonds that they specialize in. We believe it is possible to optimize supply of specific categories

of diamonds with the aim of steadily increasing prices in the long-term. Alrosa appears to be implementing this

strategy quite well, maintaining its average supply at 33 million carats in the last six years. In the same period,

the average price of Alrosa's gem quality diamonds has gone up by 67 percent while the average price of its

non-gem quality diamonds has gone up by 348 percent.



It is well understood that producers need to stimulate consumer demand for the type of diamonds that they

produce. Producers like Zimbabwe and Alrosa have benefited from the growing consumer demand for

affordable diamond jewellery in Asia without having to spend a fortune on marketing initiatives.

De Beers had hoped to grow consumer markets for diamonds to US$90 billion by 2010 through its branding-

inspired marketing initiatives introduced after its strategic review of 1999. The company suspended generic

marketing of diamonds to concentrate its marketing initiatives at the top third of consumer markets for

diamonds, where much of its production is directed. However, De Beers has not been able to meet its goal for

various reasons:

Mature traditional markets are in a period of decline while emerging markets are growing from a very

small base.

De Beers oversupplied its markets cheaply from 2000 and 2008.

Incorrectly targeted marketing initiatives introduced by De Beers have greatly underperformed.

The Forevermark/ethical diamonds/branded diamonds movement is only as strong as the chaos, real or

imagined, in Angola, Zimbabwe and DRC. It is therefore not sustainable to let the threat of conflict and human

rights diamonds be the chief basis for De Beers' long-term strategy. Such issues are a moving target. Moreover,

De Beers cannot guarantee that its mining operations in Canada - where relationships with indigenous

communities are sometimes tense - will never come under attack.

Outlook

Extensively, De Beers has been in the doldrums for more than a decade now, losing a lot of value since the turn

of the century. The recent shareholding change, along with changes at the top of the company, is therefore

viewed in a positive light. Anglo American appears to be in the middle of a comprehensive review of De Beers'

operations, following their acquisition of the Oppenheimer family's stake in the company.

For this reason, it would be superfluous to make future predictions for De Beers at this juncture. A revision of

rough diamond sales processes is already underway.



Progression of the Diamond Market

Our expectations for the diamond market in the short-to-medium term are less aggressive. In the next three

years, we believe annual world production of rough diamonds will receive a boost of 10 to 15 million carats in

mainly lower quality diamonds as the Argyle underground mine also expands to full production. We already

anticipate increased production from Zimbabwe after four new companies were awarded mining licences for

different areas of the Marange concession, doubling the number of companies mining diamonds in Chiadzwa.

What this means is that diamond prices will likely rise at a slower pace than had been anticipated just two years

ago. Add to this the fact that emerging diamond markets are not growing quickly enough to replace diminishing

demand in developed diamond markets.



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© Copyright 2013, Equity Communications Private Limited, ALL RIGHTS RESERVED.

This publication is part of the Diamond Industry Series, a series of diamond industry reports produced by Equity Communications ahead of the 2013 Diamond Report. Equity Communication’s Diamond Report provides detailed analysis of trends in the diamond industry value chain in 2012-2013, from the production end to the retail end. It is in its third edition.

About Authors

Alrosa 2013 Review is based on research by the Diamond Industry Research Team at Equity Communications:

Tinashe Takafuma, Gerald Manyengavana, Romeo Takafuma and Fred Divine.

Supervision was provided by Tinashe Takafuma, Head of Research at Equity Communications. You may contact him by email at: [email protected]

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