Reinvigorated is certainly the keyword for Gemfields. Having completed a reverse takeover, the company has moved from would be coloured gemstones producer to, well, an actual gemstone producer. If you fancy reading the AIM Re-admission document, be warned – it is over 300 pages long but it does contain an incredible amount of information on Gemfields assets, the market it works in, and the countries it operating in. For the rest of you, read on for the very condensed version.
The old Gemfields
Gemfields was originally set up to consolidate, at first, the emerald industry in Zambia. Zambia is one of those African countries that has a fair amount to cheer about. After a disastrous attempt to privatise its huge copper industry, the winds of change finally swept in and industry was sold back to the private sector. Since then things have been on the up, not least thanks to the appreciation in the value of copper. Gemfields isn’t interested in copper though; it’s after coloured precious gemstones – and Zambia is in the top three regions in the world for them. The coloured gemstone market includes a wide range of stones, but the most commonly known are sapphires, emeralds, ruby, opal, beryl and amethyst.
The worldwide demand for these stones is considerable, but unlike the diamond industry which is consolidated, and thanks to DeBeers has impressive brand awareness, the coloured gemstone market is highly fragmented and suffers from serial underinvestment. Gemfields wanted to change that, and had a good crack at it. The company quickly secured a footprint in Zambia and moved one mine into production, while owning a 50% stake in an amethyst mine with the Zambian Government. What tripped up Gemfields was the sheer difficulty in proving up a resource on an emerald mine. We won’t go into the technical garble, but suffice to say Emeralds to not distribute themselves nicely in the “ore” which makes it very difficult to predict grade. And when grade control is tricky, you can run in problems very quickly.
Pallinghurst Resources
While Gemfields was attempting to generate sustainable production from its mine, next door, Pallinghurst Resources had acquired a 75% interest in Zambia’s largest emerald mine, Kagem. Pallinghurst also picked up additional ground in the emerging gemstone sector in Madagascar, and furthermore acquired the rights to the Faberge brand for use with gemstones other than diamonds. Pallinghurst is an interesting beast. It was essentially set up to invest in three sectors: raw materials required for the production of steel, platinum, and finally, the gemstones industry.
Within the gemstone sector, Pallinghurst has inked two deals. First for the Kagem Mine and associated interests, and second, the marketing rights to the Faberge brand for coloured gemstones. A third investment, in the diamond sector is harder to forecast, but nonetheless Sean Gilbertson, one of the founders of Pallinghurst, and the new CEO of Gemfields, hinted that an agreement may be struck with Russian diamond group, Alrosa. Pallinghurst is headed up by Brian Gilbertson, former CEO of BHP Billiton – a serious heavyweight. Behind Pallinghurst are several big players, including South African investment bank, Investec, that have committed US$200 million each in capital for investments.
Gemfields, Pallinghurst and the Kagem Mine
Gemfields new mine and Pallinghurst's Kagem Mine share a boundary and are continuous on the same belt. In November 2007 Gemfields was brought in to manage the Kagem Mine, which required some serious mining expertise. The result was immediate. Within six months of taking over management of the mine, emerald production was up almost 300%. It appeared to be a marriage made in heaven. Gemfields had the operational expertise; Pallinghurst had the mine and cash to fund improvements in production and security. So the two companies did a deal.
The new company is still called Gemfields, but Pallinghurst is the largest shareholder and has control. The Kagem Mine meanwhile, only covers 10% of the licence area, yet should be producing around 15% of the world’s emerald supply by 2009. Production is expected to reach 1.44 million tonnes per annum by 2009. Gemfieds Mbuva-Chibolele mine, which has been put on hold for now, and the Kamakunga prospect are also continuous with Kagem. In other words, there is still plenty of life in the old mine yet.
Production, polishing and cutting
Gemfields is now about to embark on the next stage of its development. The company isn’t interested in selling rough emeralds into the market. Instead it is keen to replicate the DeBeers model where added value is retained by cutting and polishing its own product. About 50% of the emeralds produced, by value, will be sent to the company’s own operation in India before the end of the year is out. The balance will be sold direct as rough or through auction.
The theory is simple. Supply and demand applies to efficient markets but there is no efficient market in emeralds, let along the entire coloured gemstone industry.
Faberge
So how does Faberge fit into all of this? To cut a long story short, Pallinghurst has the long game in mind. The consolidation of Zambia’s coloured gemstone industry is long overdue, but the action doesn’t stop there. Pallinghurst wants to be involved in all gemstones, and wants to sell its high end stones to its own sister company that can market them through the Faberge brand -Pretty clever thinking, as the group as a whole keeps control of the value chain.
Arguably more important, Pallinghurst has cash, and in today’s market, that is very important to fund vertical growth into multiple gemstone industries and will also add value by cutting and polishing its own product before selling the best products to Faberge. It is important to note that gemstone mines in general generate the vast proportion of their revenues from the small number of large stones they extract. Using those stones with the Faberge brand should ensure prices increase for the high end emeralds produced.
Summary
The Gemfields of today is a much more compelling investment case with its larger mining interests, strong support from Pallinghurst and management team that blend operational skills and corporate experience.
Cannacord Adams has set a price target of 48 pence using a discounted cash flow model that assumes profit before tax of US$11.2 million on turnover of $34.7 million for the full year ended 2009. Those numbers could be conservative if Gemfields can execute its development plan and Faberge can enhance demand for high end coloured gemstones.
In recent weeks, Gemfields has also made an offer for Tanzanite One, which if successful would substantially broaden its production portfolio and diversify the group into a third coloured gemstone. Additional acquisitions in the future are almost a certainty.