LONDON (Reuters) - De Beers' far from sparkling results show its management is finally tackling costs and over-production, but that won't stop Anglo American Chief Executive Cynthia Carroll fretting about the diamond group's debts as she tries to wriggle out of Xstrata's (XTA.L) bear hug.

Anglo's (AAL.L) 45 percent stake makes it the biggest shareholder -- with the Oppenheimer diamond dynasty owning 40 percent and Botswana 15 percent -- in the world's largest diamond producer, which borrowed heavily to fund production and now faces a $1.5 billion loan refinancing by next March.

It racked up net debts of $4.06 billion, only to find itself sitting on a glut of diamonds at the height of the credit crisis when sales collapsed catastrophically.

Sales now appear to be picking up -- moving back toward their average levels at the diamond auctions, known in the arcane world of diamonds as "Sights," which take place 10 times a year. By cutting back dramatically on costs and getting a grip on production -- which will be down by 50 percent for the year -- De Beers is now hoping it can get itself back on track.

It certainly needs to. First-half net profit fell a disastrous 99 percent to just $3 million, with debt costs wiping out profit before finance charges and taxation of $140 million.

While slow off the mark initially, the vigor with which De Beers, under managing director Gareth Penny, has addressed the problems is good news for Carroll who needs to convince her own investors that she is tackling underperformance within her own Anglo empire as she attempts to see off Xstrata's approach.

For getting things done in the labyrinthine De Beers "family of companies" -- a complex matrix involved in controlling everything from mining to sales -- is by no means simple. Even though Anglo owns 45 percent of De Beers, the management contract sits with the Oppenheimer family company Central Holdings.

These complexities are no less of a factor in sorting out De Beers' debt, which has risen from $3.8 billion at the end of 2008. Anglo, along with the other shareholders, has already lent De Beers money -- some $368 million in interest free loans in Anglo's case.

De Beers says it has not yet drawn on a $500 million loan from its shareholders during the first half, but with the $1.5 billion bank loan to refinance by March of next year, it may yet have to. De Beers thinks it will be able to get the refinancing done in time -- albeit at a higher cost.

The recovery in the diamond market and its cost cutting should ensure that De Beers gets back on an even keel, but it will still take some time for the company to get anywhere near repaying its debts.

Analysts at RBC Capital Markets reckon De Beers won't be able to pay a dividend for at least two years, which begs serious questions about the capital Anglo has employed there.

Anglo rejected Xstrata's nil-premium merger proposal partly because it would dilute its exposure to diamonds, so it needs to show that De Beers really is going to sort the business out and make a decent return on the capital it has tied up there. After all, even if it were to have a change of heart and try to get out of diamonds, now is hardly the best time to be selling.

Carroll's priority must be to ensure it does a deal with its banks, and fast, otherwise De Beers' stated purpose of turning "diamond dreams into lasting reality" will come too late for Anglo in the debate with Xstrata.

And if Anglo does need to stump up any more loans or even take part in a rights issue, this must be in exchange for greater control at De Beers.

-- Alexander Smith is a Reuters columnist. The opinions expressed are his own. At the time of publication Alexander Smith did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. --

(By Alexander Smith. Editing by David Evans)