By John Helmer in Moscow
New Russian diamond mine is bigger and better.
Blind Man’s Buff is a game which, in King Henry the Eighth’s time, was played by men at court to grope for ladies.These days it entertains children to hide from the blindfolded one, who plays “it”, and must catchwhoever he can, until no-one is left in the game.
It isn’t customary for respectable stock exchanges to play games with blindfolded shareholders. Nor is it lawful for the management and proprietors of listed companies to treat their minorities as “it”.
As details emerge of the deal that was signed early this week for the world’s largest new diamond mine — the Verkhotina project in northwestern Russia — the terms of the transaction warn of two possible disputes over the equity in the asset. One is whether the Kremlin will agree to the shareholding split, allowing De Beers a 49.99% stake in the project, through its affiliate Archangel Diamond Corporation (ADC); and LUKoil, a 50.01% stake, through its wholly owned subsidiary, Arkhangelskgeoldobycha (AGD).
ADC, the Toronto listed diamond miner whose shares have been suspended from trading for six months, has just issued a detailed 10-page summary of the deal which Nicky Oppenheimer signed in Moscow early this week. One proviso in the text is that “completion of the Transaction is subject to, among others, the following conditions precedent: the receipt of all required consents or approvals from the Anti-Monopoly Service of the Russian Federation with respect to the Transaction and, if applicable, any approval required pursuant to the new draft Russian foreign investment law if enacted and in force prior to Completion; and the approval of the Transaction by the TSX Venture Exchange.All conditions precedent must be satisfied prior to 1 June 2008 failing which either LUKOIL or Archangel is entitled to terminate the Transaction.”
This gives the Kremlin just six weeks to approve, or else either side can call “it”. Nicky Oppenheimer of De Beers, and his new partner, Vagit Alekperov of LUKoil, didn’t spend long with President Vladimir Putin, and the record of what he said has not convinced either side that his support for their deal today may not be modified tomorrow.
What makes this uncertainty sharp is that the Russian legislation has just been enacted to establish the Russian equivalent of the Committee on Foreign Investment in the US (CFIUS), run by the US Treasury. And that body allows itself not less than 90 days, before it issues rulings on whether to accept proposed foreign investments in strategic American assets. De Beers and LUKoil have insisted that the untried new Russian organ, without so much as a telephone, boardroom, or secretariat at the moment, will say yes in 46 days.
Not even the fully operational Federal Antimonopoly Service, whose approval is usually a rubber-stamp if the Kremlin issues the order, can rule on a transaction so swiftly.
The transaction prospectus, which goes to the Toronto Stock Exchange this week, has news that is both good and bad for diamond miners and investors.
The good news is that De Beers has completed a new technical assessment of the Grib pipe, at the Verkhotina license territory. By digging deeper and pricing higher, ADC’s asset is now worth more than $8 billion.
According to the new company document, “the Grib mineral resource comprises a large indicated mineral resource estimated to contain 50.2 million carats at US$105 per carat and an inferred mineral resource estimated to contain 24.3 million carats at US$119 per carat to a depth of 774 metres below surface. By extending the resource at depth, the estimated resource represents an overall increase in diamond content from the 67.4 million carats of +1mm diamonds, at an average diamond value of US$79 per carat, first reported by Archangel in 1999.”
“By volume, 63% of the mineral resource is classified as inferred and is thus subject to a high degree of uncertainty. However, by estimated value, 65% of the mineral resource is classified as indicated, thus underpinning the rationale for the Transaction.”
“Located directly below the estimated inferred and indicated mineral resources, an additional potential mineral deposit has been estimated to contain 6.8 million to 12.9 million carats at US$118 per carat to a depth of 1,050 metres below surface, such estimated tonnage, grade and diamond value are conceptual in nature as they result from insufficient drilling to define a resource.”
The bad news in the ADC deal document is the $225 million price De Beers has agreed to pay LUKoil, in order to receive the asset it has spent a decade in court trying to recover. The rationale De Beers, and its financial advisor Rothschilds, have accepted for paying this ransom is that the cost of litigation has already been great; and that even if ADC won against LUKoil in both the Colorado and Stockholm litigations, it would face an uphill battle to collect damages from a Russian court.
According to the ADC transaction summary, ADC will make the buy-back in three stages — $100 million in down-payment, when and if the transaction closes; $75 million when LUKOIL and ADC agree to go ahead with the construction of a diamond mine at the Grib Pipe and AGD gives its accord to mine; and $50 million when commercial diamond production starts. It is estimated by the Russians that the mine go-ahead is unlikely before 2011; and commercial production by 2015.
This makes sensible hedging of the financial and political risks in a project, which has been haunted by domestic raiders ever since the deposit was discovered in 1996.
The agreement with LUKoil provides that De Beers will hold a 49.99% stake, and LUKoil will hold the rest. De Beers will act as technical consultant to the project, retained by the project operator, AGD, the LUKoil owned geological company and license holder.
The payment and equity arrangements indicate a total valuation of the asset at $450.1 million. Depending on what discount you apply for the value of money seven years off into the Russian future, the discounted current valuation of the new diamond deposit is about $170 million today.
In addition to paying LUKoil to buy into AGD, DeBeers and ADC say they have agreed to negotiate a settlement with Michael Krel’s company Almazny Bereg (“Diamond Shore”) for the 10% stake he has formerly owned in the project, in alliance with ADC. Krel is the last of the originals in the project, and he pre-dates De Beers’ entry. No amount of compensation is identified yet. But if it relies on the asset valuation, Almazny Bereg’s stake may require a buy-out price of $17 million or equivalent. How this is to be included in the fund-raising immediately proposed is not clear.
There is also an agreement that when it comes to funding work on the project, the two sides have to settle “key matters relating to the Verkhotina Project, the Verkhotina Licence and/or AGD which require to be agreed jointly between Archangel and LUKOIL, including the agreement of work programmes, budgets and cash calls.”
ADC says it will try to raise the buy-back price for Alekperov and LUKoil by a private placement of shares. ADC also says that it has agreed with LUKoil and AGD on “provisions relating to dilution in the event of failure to provide required funds”.
Dilution ought to be a red flag for the Toronto exchange, and for Ontario regulators, although, as Mineweb has already reported, Robert Shirriff, a lawyer and board member of ADC, is at the same time a director of ADC, a director of the Ontario Securities Commission, and a director of several other De Beers companies in Canada — De Beers Canada Holdings, De Beers Canada, and Diapros Canada.
The only ADC shareholders to agree to the deal so far are DeBeers and Firebird, which report that they own 58% and 19% of ADC, respectively. The ADC release says that Firebird has not agreed to subscribe more than $25 million to the buy-back. De Beers says it will offer $116 million to the subscription. These amounts correspond to the pro rata value of the money required for ADC’s down-payment to LUKoil, clearance of debts owed (to De Beers), and the cost of work to restart project development.
Holding the remainder of the equity, minority shareholders stand to see the value of their stakes rise substantially, when the Toronto exchange resumes trading. However, they may also face a dilution of their shares. According to ADC’s announcement, “if Archangel fails to raise the minimum offering by Completion, De Beers has agreed to provide an unsecured, non-convertible, interest bearing standby term loan to Archangel in the amount of US$115 million in order to ensure that Archangel has sufficient funds to meet the Initial Payment and short term working capital requirements.”
This is a short-term, twelve-month expedient. For such a loan ADC says it will be obligated to pay De Beers interest at LIBOR + 3.5%, plus a 1% management fee. These terms will not be put to minority shareholders for their approval. Instead, an “independent committee” of the board has already judged its fairness, and approved.