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Wednesday, January 25, 2006

What can go wrong

With Strathmore, ETLT, and CXTI all with rising stock prices, now is the time to remind myself what can go wrong with each of these. Each one of these issues has an answer, but I'm not focusing on answers right now, just issues.

Technology for mining has improved over the years and may speed up the process for getting uranium out of the ground as well as minimizing the advantages of experience/skill/knowledge in uranium mining. This allows competitors to add to the global supply quickly.

The price is rising very fast and possibly too soon. It would be better if the price stayed low while Strathmore continued work on the various properties. A high price is bringing everyone out of the woodwork and into the mining business.

It seems like Strathmore will probably end up giving up a lot in order to monetize the uranium in the ground. I'm assuming that for every 2 pounds in the ground, it will cost them 1 just to do joint ventures. And the other pound will probably still have the cost of extraction. Considering the Church Rock results into this, I figure Strathmore has the equivalent of about 1 pound of uranium in the ground for each share.

The U3O8 price could have been artificially driven up too soon due to speculation and investment such as Uranium Participation. What happens if the rapid rise is due to short term accumulation and not to the long term imbalance in supply/demand?

Eternal Technologies (ETLT)
They're planning a gigantic $37 million investment in a new area. This is more money than their entire market cap. This represents a large startup-risk.

E-Sea is not really related to what the company does.

There are some unusual "basic business" red flags.

It seems like the whole Inner Mongolia farm was a mistake.

China could go through some sort of revolution where they could be tempted to trample of the property rights of investors, especially us foreign investors. I'm hearing about a lot of protests and friction (the repeal of the agriculture tax is actually suspicious).

Cash flow could be a real problem for them with new contracts.

The market went wild about the new contract but might have missed two securities offerings (one for 1.2 million shares for contract service and sourcing by Expert Network, one for 800K shares for compensation) that for obvious reasons weren't publicized. This adds dilution.

The financing they got recently wasn't such a good deal for the company.

Contracts run out and need to be replaced with new contracts.

26 million shares were outstanding on Dec 27, 2005. This offering added another 14 million shares (2 million shares were already outstanding). The two offerings above added another 2 million. The results would be 42 million shares. They'll probably earn $12 million or 29 cents per share. Tack on a P/E of 15 and you get a share price of $4.35. But if you figure on more dilution in the future, with some various adjustments for totally vague factors, it would make a value of about $3.75 per share which includes some benefit of being invested in a desirable currency.

Their costs could go up at the end of the contracts due to higher than expected costs of maintenance and bug fixing.

They're capital intensive because they get paid over a long time period and the costs are more front loaded.

UPDATE next day:
OK, so what can go right?

Strathmore: You end up with 1 pound of U3O8 per share which (after accounting for the pound we already gave up to monetize the uranium) might cost another $20 to pull out of the ground. U3O8 currently has a spot price of $37 per pound (it remained the same this week) and will probably go up to say $40. So you end up with each share being worth US$20 ($40 minus $20) when they're selling for US$2. Ten-bagger.

ETLT: On a regular basis in the not-too-distant-future, they'll likely earn $4 million from their legacy operations, another $1.5 million from these clinics they plan to open up, another $1.5 million from the original E-Sea operations. The $37 million investment will likely end up earning them a routine $5 million per year. The result is $12 million in earnings per year (remembering this is as a reasonably competant business in an economy growing at around 10% per year). With 40 million shares, that results in earnings of 30 cents per share. Give them a P/E of 15 and the stock is worth $4.50 per share. Ten-bagger.

UPDATE Jan 29, 2006: In the ETLT quick valuation above, I only added $1.5 million in earnings for E-Sea when they had $1.8 million net earnings after taxes in the 6 months ended June 2005. Given the additional new business model, I'll use $5 million for E-Sea total. This ends up with $14 million in earnings per year, and a stock worth $5.25.

UPDATE Feb 1, 2006: Uranium spot prices ratcheted up 50 cents this week after taking a breather last week. The price is now $37.50. Based on my current estimates, changes in the spot price match 1-for-1 changes in the value of Strathmore. As usual, the industry news includes a few expansionary items and nothing indicating any contraction in long term demand.

UPDATE Feb 2, 2006: See this post for why the ETLT valuation was too high here. It's currently $3.00.

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