Big news came out of the diamond business Jan. 14 as Harry Winston Diamond Corp. (NYSE:HWD) announced it was selling its jewelry and watch brand to Swatch Group AG (OTC:SWGAY) for $750 million plus the assumption of $250 million in debt. Rumors first surfaced back in October that the diamond miner was looking to sell the brand to focus on mining. Now that it's done so, the deal appears to be a good fit for both parties. I'll explain why.

The Seller
Harry Winston was once known as Aber Diamond and traded on the Toronto Stock Exchange. In May 2004, it acquired 51% of the jewelry and watch brand from Fenway Partners for $85 million. Up until that point its only asset was 40% ownership in the Diavik diamond mine in Canada's northern territories in partnership with Rio Tinto (NYSE:RIO), which owns the remaining 60%. Over the next 17 months, Aber acquired the remaining 49% interest in Fenway for approximately $162 million, putting the total cost to acquire the brand at $247 million.

By that point Aber was more than a diamond company, so it changed its name in November 2007 to Harry Winston Diamond Corp. and listed itself on the New York Stock Exchange. Selling the brand for $750 million, it's achieved a 13.4% annualized return on its investment over a period of slightly less than nine years. That's far better than its stock, which has lost 48% of its value during the same period.

SEE: Diamonds: The Missing Commodity Derivative

The Buyer
Although Swatch is paying top dollar for the luxury brand, it gains entry into the world of jewelry, which accounts for approximately 75% of Harry Winston's annual revenue. It rightfully feels it can boost the operating margins of the luxury brand segment, which haven't kept pace with the mining segment.

Furthermore, Swatch would like nothing better than to walk all over Tiffany & Co. (NYSE:TIF) after the two parted company in September 2011 on less than friendly terms. CEO Nick Hayek has done a good job guiding the Swiss company since taking over from his dad in 2003. With this acquisition, Swatch will be able to compete with the likes of Tiffany, Cartier and Bulgari in the luxury jewelry business.

Make no mistake, with $2.2 billion in cash, this is an easily digestible purchase that definitely fills a big hole in its lineup. Chairwoman Nayla Hayek commented that it "brilliantly complements the prestige segment" of Swatch.

SEE: Have Jewelry Stocks Lost Their Luster?

Mining Only
The question for Harry Winston shareholders is what the company will look like now that it's out of the luxury game. After the deal closes, it will change its name to the Dominion Diamond Co. and focus solely on its existing diamond operation as well as securing additional diamond investments. The $750 million in cash will help it acquire BHP Billiton Limited's (NYSE:BHP) interest in the Ekati diamond mine in the Northwest Territories (offered $500 million), which it announced last November.

In its press release announcing the deal with Swatch, Harry Winston CEO Robert Gannicott had this to say: "At the time that we purchased the Harry Winston brand, resource investment opportunities for diamonds were rare and expensive ... Today there is a range of diamond resource opportunities while the value of heritage luxury brands has increased dramatically. This transaction represents a sound return on our original investment."

He's right about that. The Swatch buyout places an enterprise value of 23 times EBITDA on Harry Winston's luxury brand, compared with 21 times what LVMH Moet Hennessy Louis Vuitton SA (OTC:LVMUY) paid for Bulgari in 2011. It's getting a great price.

In 2012 through Oct. 31, Harry Winston's mining segment generated revenues of $235.3 million, a 25% increase year-over-year. Its operating profit through the first three quarters was $37.3 million, 75% higher than in 2011. My estimate for full-year 2013 revenues for the mining segment is $363 million and an operating profit of $62 million.

Harry Winston estimates the present net value of the Ekati mine to be C$2.6 billion over 10 years. Therefore, its pro forma 2013 revenues with Ekati (not a done deal due to minority interests) could be as high as $623 million with operating profits of $106 million.

Given the luxury brand accounted for 69% of the company's debt at the end of third quarter, excluding the Ekati deal, Dominion Diamond will have $104 million in long-term debt after the luxury brand is sold to Swatch. Assuming this deal and the Ekati deal both go through, the remaining mining segment should have very little debt and significantly more revenue and profits.

SEE: Diamonds Are No Longer BHP's Best Friend

The Bottom Line
This is a great deal for both companies. Harry Winston, or should I say Dominion Diamond, wasn't generating enough profit from the luxury brand because the vertical integration imagined when it made the deal back in 2004 just wasn't there. It will do what it does best, and that's mine and market rough diamonds. Apparently, Rio Tinto's 60% stake in the Diavik mine is available.

Swatch, on the other hand, has 19 watch brands from basic all the way up to prestige, and is the world's biggest watchmaker. It gets to grow another luxury brand while truly competing with the big boys in fancy jewelry.

Everybody wins.

At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.

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