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Upper cut

21 May 2012 By John Foley

It’s hard to think of a company more plugged into the 0.1 percent than Graff Diamonds. The UK diamond merchant, which in 2011 sold rocks worth almost $100 million to a single customer, plans to list its shares in Hong Kong, in an offering that could raise $1 billion and value the whole at $4 billion. Strip out the hype over the ascent of the super-rich, and the valuation looks solid if not a steal.

The business model is pure plutocracy. Around half of Graff’s revenue in 2011 came from pieces worth more than $1 million. Whereas the likes of LVMH or Prada rely on expanding wealth, Graff can benefit simply from growing inequality. That helps explain its 25 percent revenue growth over the past three years.

Against that, investors have to weigh unusual risks. Sales could prove lumpy, since Graff gets around half of its revenue from just 20 customers. Billionaires, especially in Asia, can fall from grace alarmingly fast. There’s also the risk of false confidence. The super-rich are often touted as shock-proof spenders, but that was proven wrong in 2009, when Graff’s sales fell by 25 percent.

To see what Graff is worth, split it in two. First, there’s a super-high-end retailer. If Graff can expand last year’s $624 million of retail revenue by 15 percent, and sustain its current 20 percent margin, it could make $165 million in retail operating profit by 2013. Pop that conservatively on the 10 times multiple that LVMH commands and it’s worth $1.7 billion.

But Graff has another asset – its remarkable $880 million inventory of rocks, valued at cost, and mostly bought when prices were lower. Assume a market value twice as high, in line with the increase in high-grade diamond prices over the past five years, and these could be worth $2 billion. Combine the two parts, and $3-4 billion looks like a fair price.

What remains to be seen is how Graff will handle public life. It’s likely that the Graff family, which is selling down just under a quarter of its stake, has a plan, though is staying mum about what. Ramping up store numbers and that inventory seems certain; and its clean balance sheet means big acquisitions are likely. Hopefully the Graffs won’t forget that in the diamond business, value comes from the illusion of scarcity.


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