Sarine Tech: Coming back brighter

Sarine- A key supplier of diamond processing equipment

Sarine is a high-tech diamond equipment innovator whose equipment are mainly used to process rough diamonds to consumer-ready polished diamonds. They produce a whole range of equipment that are widely used by diamond manufacturers to scan, cut, and grade diamonds. I highly recommend this video that showcases Sarine’s innovations over the years. Sarine’s technologies have been so revolutionary for diamond manufacturers that it commands above 90% market share in the space.

Screenshot from Sarine’s May 2021 Corporate Presentation

Struggles amidst dominance

With its dominance as a supplier of manufacturing equipment, one might be surprised to learn that Sarine has been suffering from falling revenues and profits over the last 5 years. There are a couple of reasons for this:

  1. Most diamond manufacturers operate in India. India exports about 75% of the world’s polished diamonds. So yes, Sarine’s main geographical market is India. But they are facing illicit competition from parties that have infringed on Sarine’s patent produced a pirated version of Sarine’s machine, robbing Sarine of a lot of revenue. Sarine has brought these guys to court. But the legal system in India is not the most efficient. The court case is expected to drag on for some time before a ruling is given, and even then, there may be unexpected outcomes. A good news is that the alleged main culprit, Diyora & Bhanderi Corporation, has been raided by the government tax officers in January. This is a good news, but its not enough as Diyora & Bhanderi is still offering its pirated products and services to customers today.
  2. The manufacturing segment that Sarine dominates is not a high value-add segment. Margins are low among the manufacturers who use Sarine’s equipment as there are few differentiating factors between them. Hence, despite having a dominant market share, Sarine cannot price its technology too exorbitantly. Currently, in terms of pricing, they are striking a decent balance, achieving consistent gross margins of about 65% in the last 5 years.

Reasons to be optimistic for a turnaround

1. Strong global demand for diamonds

Consumer demand for diamonds have spiked in late 2020, and demand continues to be hot in the first half of 2021. Bloomberg reported in June 2021 that there is an intense buying frenzy for diamonds. In fact, demand is so strong that Russia, the world’s largest producer, is drawing down on its diamond reserves just so that it can meet demand!

This is good news as many of these diamonds would have gone through Sarine’s machines. Sarine generally earns money by first selling diamond scanning/ processing equipment, and then charging a small fee per use of the equipment. Since it has a dominant market position, we can expect better financial performance as the global diamond market grows.

2. Establishment of partnerships with upstream and downstream participants

We previously mentioned Sarine’s challenges in the mid-stream market which is plagued by piracy and low margins. Sarine is making a push to get more involved with the upstream and downstream players. I will deliberate on two promising solutions that involve these participants – the Sarine Diamond Journey and e-grading – in the subsequent sections.

But of particular significance is Sarine’s blossoming relationship with the world’s largest diamond miner, Alrosa. Alrosa has collaborated with Sarine to use its Sarine’s DiaExpert® 3D-mapping, Galaxy® inclusion scanning and other technology in its rough diamond auctions. Sarine’s equipment has proved to be particularly useful when the pandemic hit. Since buyers were unable to fly in to inspect and buy the diamonds, Alrosa had to resort to digital auctions to sell these diamonds. It was proven that using Sarine’s technology, all the required info of rough diamonds can be scanned and shared effectively to buyers. The digital auctions were very successful, and I believe going forward, even after the pandemic subsides, digital auctions will continue to gain in popularity over physical ones.

Alrosa has also decided to track its diamonds with Sarine’s Diamond Journey. This is a huge endorsement from a huge player for Sarine’s traceability solution.

Aside from Alrosa, Sarine is also partnering with big names like Tiffany & Co. for its e-grading solution. These established names are unlikely to resort to piracy. So Sarine will get all the revenues it deserves from their partnership.

3. Pickup in adoption of Sarine’s Diamond Journey

Sarine’s Diamond Journey is a record of a diamond’s journey from mine to consumer. They have made a cool video of it here. It addresses concerns that many modern consumers have about the ethics of the diamond trade (blood diamonds mined by slaves or child labour). Moreover, it brings customers closer to their diamond (a purchase often steeped in significance and emotion). Retailers can share with customers for instance, that this stone has been waiting for you underground in Botswana for 100 million years. It was dug out last year, and travelled to Israel to be cut and polished before landing in our store. Now it is waiting for you… Ok there is a good reason why I’m not a diamond salesman but you get it. It is a great tool for storytelling both for the retailer and for the giver of the diamond (if it is to be given as a gift).

If this becomes widely adopted, Sarine will be able to earn from selling machines to scan these diamonds, as well a from the fees it gets when the report is generated. It will also stifle copyright infringers as the diamonds scanned using fake Sarine equipment wont be uploaded into Sarine’s cloud for the Diamond Journey report.

But a solution like Sarine’s Diamond Journey (SDJ) needs scale to succeed. Consumers will only demand diamonds with SDJ if it is well known and everyone else’s diamonds have SDJ. For this to happen, a significant number of diamonds carried by retailers must come with SDJ. And this can only happen if miners and manufacturers have gotten on board SDJ to begin with.

Tough to get this going. But when scale is achieved, it will be self-reinforcing in a virtuous cycle.

There is a possibility that this does not take off. Indeed, I think the stock market is not pricing the success of this into the stock. But I am optimistic about their chances of success because Sarine has the advantage of already dominating the mid-stream scanning and polishing market.

Adoption of Sarine’s Diamond Journey is also already picking up pace among miners and manufacturers. Current partners include:
– Alrosa, the world’s largest diamond producer by carats
– Lucara, the Canadian miner operating in Botswana renown for large stones
– Stargems, a leading rough secondary wholesaler in Dubai
– Grib , a large rough diamond wholesaler based in Belgium
– At least 14 other leading polishers in India and Israel

4. Growing its e-grading business

If you have bought a diamond before, you would be familiar with the GIA certificate. The manufacturer ships the diamond to USA where GIA professionals grade and certify it. The GIA is certificate has widespread credibility. But there are still a few areas that can be improved on:
1. GIA inspections still involve human checks, which is still subject to the possibility of errors, however low
2. There are hefty shipping and insurance costs involved in sending the diamond to GIA for grading and back
3. The GIA grading process is a time consuming one due to shipping as well as the inspection in GIA’s labs. It can take nearly a month just to get a diamond graded before it can be sold. Currently, GIA has a severe backlog of cases, causing bad delays for manufacturers and retailers
4. GIA grades diamonds according to its own (widely accepted) standards. But some premium retailers such as Tiffany & Co may demand more stringent criteria and more detailed reports. Some institutions such as China’s National Gemstone Testing Centre also want different tests and presentation of diamond grading results.

Sarine has created an e-grading solution to address these problems. Its e-grading solution uses an Artificial Intelligence (AI) – based Clarity technology to provide automated, objective and more precise Color grading.

I don’t think demand for e-grading will ever come from consumers. Most of us are really quite ok with the GIA information. In fact, most consumers can hardly tell the difference between a crystal and a diamond. So we are not too bothered with the small details about color or clarity. We can’t tell the difference anyway. If this takes off, it will most likely still come alongside a GIA certificate. But there is still opportunity for this to do well.

Firstly, there is a good opportunity among premium retailers who want more special grading reports. Customers may question why they should pay so much for a diamond from a premium retailer if it has exactly the same GIA 4Cs grading as the diamond in a mass market store. This is where Sarine can partner with the retailer to produce a report with extra information going beyond the 4Cs to demonstrate the quality of diamonds beyond the traditional 4Cs. Sarine already partnered with Tiffany & Co to provide them with such a solution through Sarine’s e-grading. Snagging a big name like Tiffany & Co. will help open many doors among the other high-end brands, who also provide their own-branded reports alongside GIA’s.

Secondly, Sarine’s e-grading solution has found itself a friend in China. As you can imagine, China does not like the idea of being beholden to standards and tests set by Americans. Or to have their whole diamond industry reliant on the USA for grading. China’s National Gemstone Testing Centre (NGTC) has therefore partnered with Sarine for its own grading needs. Sarine and NGTC has launched a Co-Branded Light Performance Grading Report in September 2020. It is still too early to tell if this will be successful. But the diamond grading market is worth US$500M annually, with a lot of future growth coming from China. Sarine, with an expected 80% gross margin on its e-grading business, will do very well if its partnership with NGTC excels in China.

Thirdly, Sarine’s e-grading works also for lab-grown diamonds. Lab grown diamonds are quite unlikely to be sent to GIA for grading as it won’t be worth the costs. They will go for a cheaper solution such local (non-GIA) labs, who could be Sarine’s target customers for e-grading.

Conclusion

I consider Sarine to be a growth stock. It is quite impossible to tell how successful it will be with its new solutions. How much market share it will get, how profitable these would be. It will involve a lot of guesswork. But based just on what is already happening, the current share price of around $0.70 is inexpensive. If Sarine’s Diamond Journey and e-grading business manages to reach critical mass, then this could be a multi-bagger. I have invested some (but not too much) and am excited for the ride ahead.

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