Like the masterful business analysis that goes on between the ears of Berkshire Hathaway's (NYSE: BRK.A) founder, Warren Buffett, the happenings in the diamond business will forever be a mystery to most of us. That's right, I'm talking about a girl's best friend.
For decades, The Diamond Trading Corporation (DTC) of De Beers Centenary AG, or as it is better known, De Beers, has controlled the international diamond game. Estimates are that De Beers controls 70% of the world market for rough, uncut, gem-quality diamonds, and despite token political pressure to dismantle De Beers' significant influence, it remains the world's most powerful diamond broker. Why do we care about this?
Well, if Rule Maker investors are serious about considering Tiffany & Co. (NYSE: TIF), we need to understand the ballpark where Tiffany dirties its pale blue uniforms. That ballpark may as well be called De Beers Field.
According to Tiffany's latest 10-K, it derived approximately 37%, 38%, and 40% of fiscal 1998, 1999, and 2000 net revenues from "products containing one or more diamonds." The 10-K also contains some rather candid language about De Beers control over the diamond industry and the risks associated with upsetting this delicate balance in the diamond industry. "Sustained interruption in the supply of rough diamonds or an over-abundance of supply or a substantial change in the marketing arrangements... could adversely affect Tiffany and the retail jewelry industry as a whole."
In an attempt to offset De Beers' influence over Tiffany's diamond supply, in 1999 Tiffany acquired a 14.9% interest in Aber Diamond Corp. in Canada. Aber controls 40% of one of Canada's largest diamond mines, the Diavik Diamonds Project. Tiffany made the $71 million investment in the hopes that it would "enable Tiffany to secure a significant portion" of its future diamond needs once production commences in 2003. That's all fine and dandy, but Tiffany management knows that the Aber purchase is equivalent to the U.S. drilling for oil off Alaska's coast: It buys us some bargaining leverage, but it can never release us from our dependence on Middle Eastern oil.
Besides, De Beers is seeing to it that Canada's newly discovered diamond mines -- Diavik, Ekati, and Winspear -- don't get too far out of its sight. In response to the emerging threat of Canada's diamond mines to the De Beers cartel, the company purchased a 35% interest in the Ekati project and took over Winspear, thereby rendering Canada an annoyance rather than a threat.
If Tiffany sells polished, cut diamonds and De Beers sells rough, uncut stones, what's the big deal? Well, Tiffany is afraid of the January announcement by luxury goods retailer LVMH Moet Hennesy Louis Vuitton (Nasdaq: LVMHY) and De Beers to establish a 50/50 joint venture to "develop the global consumer brand of De Beers." The plan is clear: The new company will market and sell diamond jewelry under the De Beers brand, making it a direct competitor to Tiffany.
According to Fortune magazine, De Beers spent $150 million on advertising campaigns last year. The irony is that those sentimental commercials that end with the tag line "A Diamond is Forever" are pushing polished diamonds, a product that De Beers doesn't sell. Not yet, at least. According to the joint venture, it will not buy rough diamonds or source polished diamonds from De Beers' resellers. But the watchdogs across the pond that put an end to MCI/Sprint and GE/Honeywell aren't ready to take the new company for its word: The European Commission (EC) has launched an in-depth investigation to probe 1) whether De Beers will be able to favor the joint venture by supplying rough diamonds, and 2) if a De Beers brand will unfairly raise the barriers to competition. Their investigation is expected to end in August.
A fierce competitor
Controlled by the Oppenheimer family, De Beers has built a global empire in some of the most hostile parts of the world. And I'm not talking about the weather. From the political turmoil in South Africa to the kleptocracy in the former Soviet Union, De Beers has had its way. Its duplicitous corporate structure allowed it to continue operating in South Africa despite antiapartheid sanctions. Even the U.S. Department of Justice has an outstanding indictment against the company from a 1994 price-fixing case that prevents senior management from traveling to the States.
Imagine deciding to start up a global software company that builds PC operating systems or breaking into the soft drink industry with a cola that tastes a little different. These would be simple tasks compared to what Tiffany faces with De Beers. A more likely comparison may be competing in the hamburger business against the world's largest cattle farmer. That said, Tiffany is not starting from ground zero -- it has been in business since 1837 -- but it will soon be challenged by a company that has controlled the diamond trade for nearly a century. Tiffany & Co. is about to face its toughest competition.
A mild hangover thanks to a decline in U.S. wealth, a stalled Japanese economy, and fluctuating currencies have failed to derail Tiffany's steady growth. Rule Makers have waited this long for the world's premier jeweler; perhaps we should wait for the temperamental EC to rule before we move forward. I'm sure they won't run out of little blue boxes by the end of the summer.
Todd Lebor wonders how many rounds of golf a Tiffany's engagement ring could buy him. At the time of publication, he didn't own any of the companies mentioned above. Todd's holdings can be found online, along with the Fool's complete disclosure policy.