Janet Whitman, Financial Post · Saturday, Jul. 31, 2010
NEW YORK — About a decade ago, Bob Gannicott, a prospector and geologist by trade, walked in the doors of Harry Winston Inc.’s flagship salon on Manhattan’s Fifth Avenue and made a rare and unexpected discovery: The iconic diamond business known as the “jeweller to the stars” was for sale.
Mr. Gannicott was only hoping to work out a partnership with the ultra-luxury diamond retailer to help glean better price information for the hundreds of millions of dollars worth of rough diamonds his firm, Canada-based Aber Diamond Corp., was about to start hauling from a mine in an Arctic lake 300 kilometres north of Yellowknife.
But with cash set to roll in from the mine – one of the richest diamond finds in the world – the idea of owning the upper-crust jeweller outright was starting to make sense, Mr. Gannicott said.
He was coming to realize, after a previous pact with Tiffany & Co. failed to pan out, that the only way a rough diamond marketer like his company was going to secure price information on finished diamonds would be to own a retailer outright.
An acrimonious two-decade family feud between two brothers – Ron and Bruce Winston, who were heirs to the company’s eponymous founder – had made some sort of sale or investment a necessity.
The deal took a few years to crystallize but by 2004, Aber had closed on an acquisition for a 51% stake in Harry Winston for US$85-million. In 2006, the diamond maverick bought the remaining 49% for US$157-million.
The strategy has paid off in part: Aber, which in 2007 renamed itself Harry Winston Diamond Corp., has transformed itself from a junior prospector into a high-end diamond marketer that fetches some of the richest rough diamond prices in world.
Things haven’t gone so smoothly on the retail end, however.
Some investors and analysts complain that the Harry Winston retail business – which made its name as red-carpet staple for Hollywood A-listers like Gwyneth Paltrow, Madonna and Halle Berry – has done nothing but lose money, dragging down the mining company’s overall bottom line.
While some are hoping the company will cut its losses and spin off the retail business, Mr. Gannicott defended the unlikely acquisition, saying it is performing as expected and would have turned in a robust profit in 2009 were it not for the financial crisis that gripped the world in 2008.
“We never intended to draw earnings out of this early on,” Mr. Gannicott, the 63-year-old chairman and chief executive of Harry Winston Diamond Corp., told the Financial Post. “We could have just said we’ll leave it at five stores, spend a bit of money on marketing and let it throw off a few million a year…. The idea was to grow it into an international business that, in time, would be worth significantly more value and generate significant earnings.”
Mr. Gannicott, who got his start in the business as a miner when he left his native England for Yellowknife at the age of 19, said the Harry Winston business seemed barely touched since the late 1970s, when the company’s namesake founder died. “The company became like a Sleeping Beauty castle. It’s a good thing nothing silly was done with it, like a perfume line.”
Expanding the retail business is not unlike mining, he added. “When you spend money on exploration, it comes straight off your bottom line. What we’re focused on at Harry Winston is not to take profits now, but to grow it in a sound manner.”
When Aber first took a stake in Harry Winston, the jeweller had six salons: two in the United States, two in Europe and two in Japan. Under its new ownership, it expanded to 19 salons, with six new U.S. locations and three more in Japan, as well as four locations in other parts of Asia – a region that’s expected to see a surge in demand in the coming years.
The company plans to nearly double its store count by 2016 to 35.
To revive its stagnant product lines and marketing efforts, Mr. Gannicott in January hired Frederic de Narp, who headed rival luxury jeweller Cartier’s North American division, as the new chief executive of its retail business.
Mr. de Narp proposed a five-year plan for his new boss that puts the business on a path toward turning an annual profit of 10% through the introduction of new products, jewellery collections, brighter lines and additional watches lines.
“The world has come out of a dark place in the last two years,” the Brittany native told Harry Winston investors at the company’s annual meeting at Toronto’s Fairmont Royal York Hotel in June. “And the market conditions today are right for Harry Winston.”
With only an estimated 15% of the US$150-billion in global jewellery sales spent on branded jewellery, the opportunity for Harry Winston, one of the most prestigious names in the business, is huge, he said.
Mr. de Narp also noted that while demand for jewellery and high-end watches is increasing, local jewellers are being forced to close their doors because of the financial crisis. “Where do they go if those local jewellers close every day? They will go to Harry Winston,” he said.
In a move that will help fund its retail expansion, Harry Winston announced last week that it’s buying back a stake in its rich Diavik diamond mine that it was forced to sell in March 2009 to avoid going under amid the financial crisis.
The purchase from Kinross Gold Corp. – which made the Toronto-based gold producer a handsome profit – will restore Harry Winston’s 40% stake in the mine and give its cash flow a nice boost.
Harry Winston owns the development – Canada’s largest diamond mine – with international mining behemoth Rio Tinto.
Part of the draw for investing in retail is that the mine is a depleting asset and could be exhausted in 12 years, while the retail business can keep expanding as world demand grows.
Trying to strike it rich with another mine would be a huge gamble. Mr. Gannicott noted that since 1870, in the history of diamond exploration, 5,000 kimberlites – the volcanic rock best known for carrying diamonds – have been discovered, 850 of which contain diamonds, and only 50 of which were economically viable to mine.
In sharp contrast, the gold industry discovered 1,025 viable mines in the same period.
Still, Mr. Gannicott isn’t ruling out hitting on another mining development.
One potential target, according to some industry analysts, is Toronto-based Mountain Provinces Diamond Inc. It’s main asset is a 44% stake in Gahcho Kue, one of Canada’s largest diamond deposits and the largest diamond mine under development around the world.
“We talk all of the time, but it’s a question of value,” said Mr. Gannicott. “Its share price is already substantial.”
Investing in retail gives the company a chance to participate in the two most lucrative ends of the business: selling rough diamonds and finished jewellery.
Mr. Gannicott originally thought its Diavik diamonds could be sold directly to its Harry Winston salons and made into fine jewellery in the Fifth Avenue townhouse that is home to its flagship store.
But the Canadian government frowns on such transactions, preferring instead that the rough diamonds be sold on the open market to ensure it gets the maximum tax windfall. “They prefer arms-length sales,” said Mr. Gannicott.
Some analysts and investors would prefer the company give up on retail and focus on the part of the diamond business that’s given it the most success and the highest profits.
“If the retail part contributed zero you could ignore that and focus on the mine part of the business, but the fact is, historically, it’s been a negative contributor to earnings,” said John Hughes, a Toronto-based analyst with Desjardins Securities Inc. “It’s taken away from what the mine has done.”
Mr. Hughes had a “buy” rating on Harry Winston’s stock, but downgraded it to “sell” a few months ago after the shares zoomed above $10.
The stock’s had a huge run since, sinking to a low of $2.62 last year before Kinross came to the rescue and took a stake in the company.
It ended regular trading on the Toronto Stock Exchange on Friday at $12.74 a share.
“It’s an expensive stock by all measures unless you assume there’s a sustained turnaround in the retail business,” said Mr. Hughes. “I’m not willing to ask my clients to take that risk, given the history of consistent operating losses. I don’t think there are any quick fixes for the retail business.”
John Kaiser, an independent analyst and editor of the Kaiser Bottom-Fishing Report, said that owning the Harry Winston salons will give the company a longer life beyond when the Diavik mine is depleted. But he’d also like to see the company invest in another mine, such as the Gahcho Kue. “It’s a natural,” he said.
Mr. Kaiser said he advised his readers to buy the stock after Kinross took a stake in the company and he’s now mulling whether to remove that recommendation now that the shares have had such a spectacular run-up.
While Wall Street might be skeptical of the Canadian miner’s retail ambitions, others see strong upside for the brand, which was almost frozen in time as the Winston brothers squabbled over their fortune.
Milton Pedraza, chief executive of the Luxury Institute, a research firm that follows the industry, said that long-term prospects for the Harry Winston brand are very good, based on his surveys of the super rich with individual net worth of US$5-million or more.
“I can say, ‘My dear darling, I just bought you a diamond from 47th Street,’ ” a district in midtown Manhattan well known for its row of diamond wholesalers, Mr. Pedraza said. “Or I can say it came from Harry Winston or Cartier. That will have far higher value psychologically, even if it has the same carats.”