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Sunday, February 25, 2007

What is Strathmore Minerals (STHJF) worth... according to Sprott?

Sprott Asset Management owns about 19% of Strathmore Minerals (combined links). On Feb 14, 2007, Sprott Securities (see comment) put out this report on uranium.

Big important points they are are:
1) The basket approach is no longer valid. 2007 is the time to pick specific stocks. Stock gains were big in 2006, but will be less so going forward.
2) They believe the spot price of uranium will go beyond $100 per pound.
3) They believe the good investments will be in three categories: producers, imminent producers, and "development stories with fundamentally solid assets aggressively moving towards production."

They list the stocks that they're following, including their target price. I prefer the term value instead of target price for various reasons, but we'll leave that alone for now. None of the stocks are particularly cheap based on their table in Figure 1.

Short term, they see $100 per pound of uranium. Long term, they believe it will fall to $50 based on fundamental economics principles (makes good sense to use that for the long term). Obviously, it's difficult to predict the short term prices. But they note that the utilities are maintaining inventories at historically low levels.

About 80% of production between 2008 and 2012 is already under contract. So buyers are scrambling to locate supply. The Cigar Lake mine flood adds a lot of uncertainty. Hedge funds have driven up prices, which I believe is a good thing since it causes producers to increase supply (basic economics).

Sprott believes supply will catch up with demand in 5-7 years. At that point, they expect uranium to sell for $45 to $60. Now they obviously they know the industry and I don't. But based on what everyone is saying, including Sprott, it seems like it would take much longer for supply to catch up to demand.

Based on the fact that this is the second mine flood at Cigar Lake, and trying to understand the difficulties in that particular mine, it seems to me that it's very likely for them to have yet another flood after they do whatever it takes to fix this one. Sprott is saying that opinions in the industry range from there being a 1-year delay to being indefinite. The difficulties with the water are "a monumental task." Sprott believes it will eventually be mined, one way or another. They believe a best-case scenario is production in 3 to 4 years.

A lot of utilities are losing contracted uranium due to this flood. I recall that Cameco said a while ago that many of the contracts they have allow them to decrease the amount they sell.

Sprott notes that the spot market is small and volume is actually decreasing, so those utilities that need uranium are in trouble.

In December 2006 there were 435 reactors worldwide, with 28 under construction, 64 planned, and 158 proposed (and this keeps increasing). There are predictions by the World Nuclear Association (WNA) that nuclear power generated will increase 45% by 2030, or maybe a lot more than that. Sprott goes into detail with the predictions.

My own opinion (which is worth very little), is that it seems like supply is going to have a very difficult time catching up with the increasing demand in addition to the huge gap already present.

The current reactors require 180 million pounds of uranium (U3O8). Mining only produces 110 million pounds. The rest is made up by MOX (mixed oxide fuel), various national and utilities inventories, Russian LEU (non-weapons related uranium), recycling, tail assays, DOE sales, and HEU (downblended weapons grade uranium). There are lots of issues and limitations in using MOX. But it can be used in up to 30% of the fuel elements of existing reactors without any modifications. But handling the MOX fuel is a big problem. Right now MOX is a small part of the fuel business. I don't know the details of the limitations, but it seems like this could eventually be trouble for anyone speculating in uranium.

The WNA assumes that all the sources of nuclear fuel will just barely be enough until 2012 when there will be a significant supply shortfall, and that's assume everything goes according to plan. Sprott thinks they're overly optimistic. Utilities and speculators are going to be trying to buy more than the amount needed for production. Sprott's supply-demand scenario is in Figure 6 on page 9. But this conflicts with what they said earlier about the price dropping around this time frame.

Sprott believes that investment funds have taken perhaps 12 to 15 million pounds off the market in the last 2 years (most sourced from inventories).

There's also the initial core effect that I had read about in one of the StockInterview articles (I think). Cameco presented a paper at the recent WNA conference (was that the one in Quebec City?). Starting in 2010, ten new reactors will be coming online each year. To start up a new reactor, you need to fill the entire core plus stockpile a supply of inventory. A typical reactor would need roughly 1 million pounds for the core and perhaps another million for inventory. So this would add roughly 20 million pounds of demand each year. And they don't wait until the plant starts up to buy the uranium. Fuel rods need to be fabricated and tooled and the uranium needs to be purchased, mined, converted, enriched before that. All this might take 2.5 to 3 years. So that means perhaps 20 million pounds of additional demand might start showing up in 2007.

In addition, the top producers have been short by abount 10 million pounds due to many different factors. This could mean that production levels are already stressed.

Sprott believes consolidation will be happening in 2007. They list the various stocks they follow and the expected price appreciation. None of them are drastically cheap in their view. Right now, Strathmore is selling for more than their target price.

Sprott then goes into detail about each company they follow.

Aurora Energy (AXU on TSX, AUEGF on Pink Sheets): aggressive explorer. On the Michelin property, 100% of the drill holes have intersected uranium. The stock has gone from US$4 to around US$16 this year. Sprott's target is around US$20 (C$24).

Cameco (CCJ): Sprott goes into some detail about Cigar Lake and other properties.

Denison Mines, Energy Metals, SXR, etc.

Strathmore Minerals (starts on page 56): This details the stuff that's become well-known about Strathmore (it's good to have it all in one place). Sprott is valuing Strathmore strictly on the near-term projects in New Mexico and Wyoming. Their target price is C$4.70. The stock closed at C$4.94. Based on comparables, Sprott estimates the value of the Canadian spin-off of Strathmore to be worth only 60 to 85 cents (not sure if it's Canadian or US, but does it matter?).

They consider most of the value of the Canadian properties to be in the Waterbury Project's 100K acres. Denison struck it very big nearby and that might extend over to Strathmore's property which essentially nearly surrounds Denison's property. The other properties are very deep, far from needed infrastructure, and/or just plain non-core. Strathmore's Dieter Lake has too little infrastructure.

There are still hurdles for Strathmore in New Mexico due to the Navajo's anti-mining stance.

Overall, there are a lot of opportunities for spin-offs and joint ventures for Strathmore.

For the various properties, Sprott assigns $3.50 to $5.50 of value per pound of uranium in the properties they're looking at. This strikes me as extremely pessimistic, especially since these properties were cherry picked and we know that the early ones will have costs of $20 or so per pound.

So here you have Sprott, which owns about 19% of Strathmore giving a target price that Strathmore has exceeded. Strathmore is a Canadian stock and I don't know the reporting rules: when/if Sprott would need to report on stock sales. If they really mean it, then they should be selling now (roughly 14 million shares?). I really don't know if they are or not, but I'm not.

UPDATE next day:
Seeking Alpha has an interesting brief article about uranium investors by Kevin Chan. Someone whispers in your ear, you-ray-nee-um.

UPDATE April 3, 2007:
senor_blanco wrote an important comment about Sprott Asset Management being separate from Sprott Securities. This analysis is not from the same people who own a big chunk of Strathmore. That makes a lot more sense.

Wednesday, February 21, 2007

Uranium spot price hits $85

The long awaited auction produced a spot price increase of $10 per pound to $85, details later.

UPDATE same day:
UxC is now showing the $85 spot price here.

This is a huge jump and it's no doubt due to the nature of auctions when people are nervous. People let their emotions run wild. I wouldn't have been surprised if the auction price was even higher.

Also in other news, nuclear power plants are running at a very high production rate.
Electricity production at nuclear power plants has increased 36 percent since 1990....
All that does is burn up more uranium and make the supply/demand imbalance even worse.

Here's another blogger's view.
Here's another.

My own sense is that uranium investing is starting to get a bit frothy. It has a long way to go. It wouldn't surprise me to see Strathmore Minerals as high as $25 per share. I intend to sell it before that.

UPDATE Feb 22, 2007:
Here's a press release on the subject from U308.biz.

Sunday, February 18, 2007

Wisc Elect pfd, Westfield Group (WFGPY), Winner Medical (WMDG)

WELPM, WISCONSIN ELECTRIC POWER CO., website, sec, yahoo, chart, Pfd 6% Cum ($100)
WELPP, WISCONSIN ELECTRIC POWER CO., website, sec, yahoo, chart, Pfd 3.60% Cum ($100)

Determining the value of these preferred shares is outside of my area of competence. I could gain that competence with perhaps 15+ hours of work, but I don't expect it to yield much in the future. Therefore, I'm discarding this. If the price goes up say 30% within the next year or two, then I would be deemed wrong.

23.8% of their electricity is generated from nuclear (page 7).
2003: 25.0%
2004: 24.4%
2005: 20.3%
2006 (est): 23.8%
I'm also tossing out some other similar listings on the pink sheets.

WFGPY, WESTFIELD GROUP, website, no useful sec, yahoo, chart, Sponsored Amer Dep Rec; (representing 2 Ord shs)

Their website has the financials. World's largest retail property group, based in Australia, listed in Australia. They're the result of a merger (in 2004?).
Australia: 44 shopping centers
US: 59 (US$440 million large redevelopment in San Fran)
New Zealand: 11
UK: 7
Total: 121 shopping centers
21 projects under construction (A$8 billion cost).
Is this bigger than Simon Property Group (SPG) at $26 billion? Seems hard to believe.
They have Trumbull CT, Connecticut Post, Garden State Plaza, Topanga, Old Orchard, etc. Lots and lots of malls with > 1 million sq ft.

Half year review for 6 months ending June 30, 2006:
"close to 100% occupancy in AU, NZ, UK. 93.5% leased in US. Acquired 16 Federated stores in US.
About A$46 billion in assets, half equity. A$3.4 billion net income for 6 months (a 5% boost from mark-to-market derivatives). That would be about 14.6% return on assets! Very good (is it sustainable?). A bit less than 1/3 of profits are distributed as dividends.
Cash flow looks reasonable, but let me look at the 2005 annual....

Full year 2005:
One thing I notice here is that part of their revenues is due to revaluation of properties. This is tricky and it would be easy to end up double-counting parts of the value of the business. Cash flow from operations is A$2.3 billion and capex is A$1.2 billion (not sure how much is recurring, but this doesn't include acquisition of properties). But they expect earnings to grow at around 6% going forward, so let's say the free cash flow is A$1.1 billion growing at 6%. Given the expected growth rate of the global middle class, that growth could continue for a long time. Note that share count grew by 2.3% year over year to around 1.73 billion shares.

If I understand correctly, my estimate of free cash flow is around 64 Aust cents per share. I could be wrong as Australian GAAP seems a lot different and they are often not clear about the currency they're talking about (A$, US$, and just plain $ which I assume are A$). I figure each share is probably worth about A$18 or US$14. Since each ADR consists of 2 shares, I'd guess a value of US$28 per ADR. The ADRs are selling for around US$38.
Don't follow this one.

WMDG, WINNER MEDICAL GROUP, INC., website, sec, yahoo, chart, Com ($0.001)

Chinese reverse merger making various medical products (wipes, bandages, dressing). Cotton grown in China has a low sugar content and moderate fiber content making it good for medical use. Textile quotas were lifted Jan 1, 2005. They have Chinese patents granted and under application. Also a mostly worldwide patent applied for relating to spunlace non-woven cloth with x-ray detectable element.

10-K for period ending Sept 30, 2006:
Customers in 80 countries.Sakai Shoten Co. (Japanese purchasing agent) accounted for 21.6% and 24.5% of revenue in 2006 and 2005 resp.
Lower cost, lower quality competitors in China.
5,400 employees.
CEO Jianquan Li of Shenzen owns 80.77% of the company.
Pinnacle China Fund owns another 9.39%.

Europe is 38% of revenues
Japan is 26% of revenues
North Am is 13% of revenues
China is only 12% of revenues
All regions are growing significantly

BDO McCabe auditors (I looked at them before)
Unqualified opinion

Current assets are mostly inventories, AR, and prepaid, with significant cash.
Assets are very roughly half PP&E, half current assets.
Some bank loans, AP, other accrued liabilities.
Current ratio is about 2.
Capital is mostly equity.

9.4% revenue growth in 2006.
32% revenue growth in 2005.

28% gross margins (and have been increasing somewhat)
13.5% net margins
SG&A has been expanding rapidly: 15% of revenue in 2004, 15% in 2005, 18% in 2006

44.7 million shares on Dec 19, 2006. 5 million options reserved, but only 41K issued. Only 8K outstanding.

Cash flow from operations across 3 years has matched earnings.
Capex has been enormous every year, more than operating cash flow every year!
Some of the negative operating cash flow has been shifted to investing.

The business might be worth $2.00 per share. But the red flags are a big issue. If capex has been so large, why haven't revenues been growing more??? Stock is selling for $4.75.
No thanks
why Milton Friedman was important

Saturday, February 17, 2007


WBRBY, WIENERBERGER BAUSTOFFINDUSTRIE AG, website, sec, yahoo, chart, Sponsored Amer Dep Rec; (representing 1/5th Ord sh)

Wienerberger bricks, roofing tiles, pavers. #1 worldwide in hollow bricks, #1 in facing bricks in Europe, #2 in facing bricks in US, etc. They sell to Western and Eastern Europe and the US. Revenues have been increasing fairly consistently. Roughly 10% net margins. Reasonable return on assets for that size company.
Balance sheet is about half equity. Earning roughly 73 cents per ADR. The ADRs are selling at around $12.50. Probably under full value, but I have no idea about how sustainable their growth is.
will probably never be cheap enough (but who knows?)

WCSTF, WESCAST INDUSTRIES, INC., website, sec, yahoo, chart, Class A Com (No Par)

Westcast, the exhaust manifold leader. I had followed them years ago. If there's a really bad automotive downturn, this might get interesting.

WEBC, WEBCO INDUSTRIES, INC., website, sec, yahoo, chart, Com (1 Cent)

Went dark June 2005. Website has financials. Steel tubing and other industrial stuff. Q1 ending Oct 2006: Low gross margins, but reasonable operating margins. Earned $2.91 diluted in Q1. Full year: Earned $7.53. Revenue up 4%. Dependent on the cost of steel. 12% gross margin, down due to higher steel costs and competitive pressures. Prior year they earned nearly $25 per share. Big capex. Stock price is under $80.
Worth following

Thursday, February 15, 2007

Points of Inflection

I spend a lot of time trying to figure out big, long term trends that might be happening. In general, they're hard to detect at the time because they occur so slowly. I also like to go back and find out where I was right and where I was wrong.

I've been consistently wrong by overestimating economic downturns in otherwise successful economies. 1990 and 2002 both seemed a lot more serious at the time than in hindsight. It amazed me that 1987 was just a blip in the stock market. The S&L crisis is a forgotten memory. The long term trend in reasonably free markets is up. And the long term trend in places that have been economically screwed up and suddenly fixed is seriously up.

Neanderthals and Cro Magnons overlap
It was January 1982 when I entered the workforce. We had a typing pool where you'd handwrite a document and then bring it upstairs to the typing pool of secretaries with typewriters. They'd type what you wrote, getting all sorts of things wrong and drop it into your designated corporate mailbox tray. You'd write corrections and walk it back up. Eventually you'd have a finished memo with a list of names at the top to be handed to your own secretary who would then make copies and use a yellow highlighter to indicate one of the addressee names on each copy, which would then be distributed in each person's mailbox tray. The typing pool typists got very disturbed by the fact that I started giving them computer printouts containing the text that I wanted typed up. They were mostly gone within a year or so.

That seemed like a time of great change. Most people thought of computers as giant mainframes guarded in bright rooms while simultaneously a whole unseen wave of people were using small personal computers and word processors. Charlie Chaplin broke the news to the masses. Japanese cars were getting serious and seriously noticed. The US economy finally started getting fixed. The long dead stock market started going up for a change. "High tech" started getting the spotlight. I view that early 1980s period as a point of inflection, a sharp turn. Things are always changing, but it seems like there are points in time when the prevailing view breaks and re-forms to something different as a result of a particularly high gradient between the old and new.

It seems to me like 1995 was also like that. Most of the world had never heard of the Internet and it seemed like a secret world and you were either in it or totally unaware of it. The time of DOOM and the World Wide Web. It was also the time of Yahoo (which would go public a year later) and the dot coms. It was the year that you might suddenly realize, "Hey, the economy isn't all that bad anymore."

Is 2007 another one of those points? I'm increasingly getting the sense that it is.

UPDATE Feb 21, 2007:
This seems like the future of the personal loan industry: www.prosper.com. Real "Army of Davids" type stuff.

Wednesday, February 14, 2007

Strathmore Minerals (STHJF) exclusive negotiation

Strathmore (combined links) issued this press release today.

Here's how I interpret this: A company like Cameco or Cogema ("Cogeco") paid Strathmore $100K to sit down and discuss the terms for a joint venture exclusively for 90 days. Cogeco didn't want Strathmore playing them off "Camema" or anyone else while doing the negotiations. But regardless, thanks to the work that they've done before everyone got the uranium bug, Strathmore has some good low production-cost properties based on the huge Kerr McGee database that can go into production reasonably soon while there are more than one uranium mining companies to compete for them. I would expect Strathmore to be in a fairly good negotiating position right now.

If this deal is anything like the last one we saw, the terms are probably going to be pretty good for Strathmore. Any uranium that can go into production in the next 8 years is going to pay off well.

Roca Honda is on the order of 30 million pounds of uranium plus what I understand would be the only uranium mill in the Grants region. Based on the presentation by Strathmore (page 9), Roca Honda would be going into production at the start of 2013. While this is a long way out, they're actually pretty early compared to most other uranium mines that aren't even close to permitting yet. Cigar Lake will go online within a year or two (or three or...), so will some others. But those will only make a moderate dent in the demand/supply imbalance based on the numbers that are out there.

Looking at that presentation, here's what Strathmore is hoping for in terms of production (assuming they get the permits). The early stuff has a low cost of production. They show Roca Honda cost of production being $20 per pound or less (not sure if that includes milling). The profits from the uranium would probably be split with the operations company, perhaps 50/50, perhaps better.
This is in pounds of U3O8.

2010: 500K
2011: 500K
2012: 1 million (what happens if uranium spikes at $150/lb at this point?)
2013: 1.5 million
2014: 2 million
2015: 3 million
2016: 4 million (uranium prices will probably settle back around $65 at this point)
2017: 5 million
and so forth

With a comodity in an equalibrium situation, the selling price is generally at around the marginal incremental cost of production, which industry people seem to think is around $65 for the long term equalibrium at the expected future demand.

UPDATE Feb 15:
A new interview with a Strathmore VP shows that neither Church Rock nor Roca Honda is affected by the ruling on Native American land vs uranium mining.

DeJoia also explained, “We are not on any Native American lands and there are no Native American lands adjacent to us. We have private property in the area, ranch lands, and other mineral holders. There is no checkerboard Indian ownership in the area. The community is predominantly non Native American.”

DeJoia told StockInterview, “This ruling basically doesn’t affect our schedule at Church Rock or at Roca Honda. We will currently do all the work we had originally planned to move our projects toward permitting.” He added, “We’ve started activities toward a mill design for the area.” According to DeJoia, Strathmore Minerals plans to start drilling to obtain background water data and complete a ‘radiation walk-over’ survey this spring.

Tuesday, February 13, 2007

Re-examining BakBone Software (BKBO)

Recent comments in the last post about BKBO (combined links, sec) provide a good wakeup call to go back and take a closer look at the company. While the decrease in cash is accounted for by expenses, a good question is why cash hasn't actually increased if things are going so well. Also, have we been in the dark about any additional dilution beyond the 18 million preferred shares that were outstanding back in 2004? These are damn good questions and it's one reason I put everything out here in public.

The last financial statement was this 10-Q for the period ending June 30, 2004. There were 64.5 million shares outstanding on July 31, 2004. There were 18 million shares of preferred stock outstanding on June 30, 2004. All of them had been released from lockup by August 2004. There were also 7.2 million anti-dilutive stock options. There were a total of 24.2 million anti-dilutive potential shares from options and convertible preferred. The weighted average common shares is listed as 64.5 million which is the same as the undiluted count. So the fully diluted share count on June 30, 2004 is 88.7 million shares.

Now let's walk through the 8-K statements after this point.

8/31/04: Restated 2003 reports.

10/12/04: Auditor resigned, letter, press release

10/25/04: New auditors D&T

Halloween 2004: CEO resigned, agreement, new CEO agreement, press release

Dec 7, 2004: Canadian trading halt awaiting new financial statements (that still haven't happened)

Dec 23, 2004: 2004 statements will need to be restated
The restatement is due to an error in the calculation of a non-cash beneficial conversion feature related to the Company’s shares of Series A Convertible Preferred Stock sold in July 2003 at a price that was less than the market value of the Company’s underlying common stock
Jan 31, 2005: Open letter $19.2 million in cash, positive operating cash flow
25 percent of the total value of new bookings in NA was derived from repeat customers with 75 percent coming from new customers – this compares to 10 percent from repeat customers and 90 percent from new customers just one year ago – a clear indicator that current customers are continuing to buy BakBone products. Specific to the competitive landscape in NA, the majority of all transactions continue to be Veritas replacements.
Feb 11, 2005: Kicked off the OTC BB and onto the Pink Sheets

May 3, 2005: Open letter $19.5 million cash, operating cash flow positive

June 23, 2005: Open letter Full year bookings were $37.5 million for the year ending March 31, 2005. Cash dropped to $18.0 million due to D&O liability insurance renewal, capex, and SOX expenses.

Nov 18, 2005: BakBone acquires Constant Data privately held. Paid $5 million, total of $5.5 million including assumed assets/liabilities. No financial statements shown. Here's the contract.

Jan 18, 2006: TSX delisting imminent

Jan 23, 2006: golden parachutes

April 27, 2006: new CFO, employment agreement
$275K per year plus TBD bonus plus $50K signing bonus. But wait! You also get 300K restricted stock units (one share each), vesting 50% after 2 years, etc.

May 9, 2006: Open letter
Fiscal year bookings (ending Mar 31, 2006) were $45.2 million (both SW sales and maintenance contracts). This was a 20.5% increase from $37.5 million for the prior year 2005.
Q3 2006 bookings were $13.3 million (both SW and maint), a 21.6% increase from prior year.
Q4 2006 bookings were $11.5 million (both), a 7.5% increase from prior year.
cash $9.8 million (vs $14.7 million at end of Sept 2006), due to acquisition.

The acquisition became "NetVault: Replicator"

Q&A Session on same day. All the questions are about the delisting in Canada.

June 28, 2006: Press release. More accounting problems

July 19, 2006: More golden parachutes sample here

August 8, 2006: More bad accounting, numbers in rear view mirror are not as they appear (in other words, just more of the same stuff).

August 8, 2006: Open letter, dated July 27, 2006, my sister's birthday.
Q1 bookings: $11.5 million, up 28% from the $9 million the year before.
Cash is $9.1 million down $716K due to severance payments to former executives (CFO?)... and capex.
Doing well with Apple customers.

Nov 20, 2006: Open letter, dated Nov 14, 2006.
Q2 bookings $12.4 million, 9% increase from $11.4 million in the prior year.
Cash is $8.2 million due to internal review costs of $1.6 million... and because the sun rises in the east.

Dec 21, 2006: worldwide agreement with Sun Microsystems.

and finally, we have this:
Feb 8, 2007: Press release.
Q3 bookings $17.2 million, 27% increase from the prior year.
Cash is down yet again to $5.9 million due to $1.5 million internal investigation and $443K payment related to the acquisition above... also because Charlie left the window open and a bunch of cash just flew out the window [not really].

For all those millions of dollars of constantly increasing bookings, when exactly does the cash flow back in?

They were pretty close to break-even back in 2004. Cash flow from operations seemed to be getting reasonably close. Assuming that all these excuses are correct/accurate, then they'd be well into positive free cash flow territory.


I ask myself if this is another Epolin or Liveworld or one of many other solid, but somewhat anemic small companies that I seem to buy into. Maybe. At least that's not a dangerous thing to have happen.

I continue to own the stock.

UPDATE same day:
I added a comment to this post about BakBone. Also, it's time for another pointless off-topic link:
tilt shift photos are for real?

Monday, February 12, 2007

Nothing New

I spent most of the weekend reading the book Deep Survival, which is outstanding. Particularly interesting are the qualities of people who survive disasterous situations as well as the internal factors which often cause people to get into them by their own doing.

I did some work on BakBone Software based on a comment containing good questions, but didn't make much progress.

Thursday, February 08, 2007

BakBone Software (BKBO) update

BakBone Software (combined links) issued a press release today.

Third quarter results for the period ending Dec 31, 2006. Bookings were $17.2 million, up 39% from the 2nd quarter and up 27% from the prior year. Strong demand from Linux environments.

Cash was down to $5.9 million vs $8.2 million at the end of Q2. $1.5 million costs for the continuing investigation to figure out the accounting issues they've been stuck in nearly forever. But I'm patient. $443K payment under the Constant Data purchase agreement.

The SEC has allowed them to file only a 10-K statement and not all the quarterlies that they've missed. The 10-K will cover the period ending March 31, 2006 and the prior year. The results for the three quarters beyond this will be available at roughly the same time. After all the filings, there will be a conference call.

It will take about 90 days to finish the 10-K, so this will all play out in May 2007?

China Natural Gas (CHNG)

CHNG, CHINA NATURAL GAS, INC., website, sec, yahoo, chart, Com ($0.0001)

LNG gas with a 120km pipeline serving Xi'an, Shaanxi, China. Probably worth more than $3.00, selling for $2.82. Big agreement with PetroChina. Earned 9 cents for the quarter.

Q3 10-Q quick check:
period ending Sept 30, 2006
24.2 million shares on Nov 13, 2006. 1.14 million warrants outstanding on Sept 30, 2006 (2.28 years, $3.60 strike... not bad). Assume 27 million totally diluted shares.

period ending Dec 31, 2005
incorp in Delaware
offices in Xi'an, Shaanxi, PRC (same city as CHNG)
24 million shares on Mar 17, 2006

Reverse merger of Xian Xilan Natural Gas Co. and Bullet Environmental Systems and Liquidpure Corp. Some indirect connection with Bodisen Biotech and Amaranth Advisors.
Until late May, Amaranth was also a controlling 5.6 percent shareholder in an affiliated Bodisen company called China Natural Gas Inc., which trades at about $3 per share on the Over The Counter market.

The Chinese company began life as a Canadian penny stock called Bullet Environmental Systems, headed by a man named Ross Wilmot, a longtime investment world associate of a notorious one-time European boiler room operator named Altaf Nazerali.

10-Q Detective notes that Bodisen owns a chunk of CHNG stock.

And 10-Q Detective did a great writeup of CHNG.

CHNG has three main segments.

1) End user residential delivery (50,000 residential customers). CHNG connects to a Shaanxi Natural Gas Company (government operated) high pressure pipeline. This is delivered at lower pressure to residential/commercial/industrial customers [green, purple, and yellow respectively for those familiar with Sim City].

CHNG owns 120 kilometers of high pressure gas pipeline (Their website explains that it's a direct link to a gas field in northern Shaanxi). They're the only private company in Shaanxi to have this type of pipeline. Northern Shaanxi has one of the largest natural gas fields in China.

The natural gas is sourced and transported through 120 Km of proprietary high pressure gas pipelines which are spurred off of the intrastate transport pipeline owned and operated by the state-owned Shaanxi Natural Gas Company. This pipeline supplies natural gas directly from a gas field in the northern region of the province through to the high pressure pipes that then feed into the citygate "let-down" stations at Hongqing and Lantian County. At HongQing and LanTian the pressure is reduced and transported througn a network of low pressure distribution pipes to supply the residential, commercial and industrial customers in Lantian County, Lintong and Baqiao Districts. The spur also feeds a compressor station at Hongqing where compressed natural gas (CNG) is collected by tankers to supply autogas stations.

CHNG is trying to expand into Shangluo and Ankang areas of Shaanxi, attempting government approval to provide gas to residential and commercial. CHNG submitted a project feasibility proposal. Takes 4-6 months for approval/rejection.

2) Wholesale to filling stations. These sell to taxis and buses in Xian (approx 5,000 buses and 20,000 taxis in Xian use natural gas). Note that this is very clean technology. The Chinese government emphasized it in the most recent five year plan.

July 2005, CHNG bought a compressor station near the pipeline to fill gas tanker trucks which then deliver to the filling stations.

CHNG is doing a feasibility study to expand into LNG production (due June 2006): this would require $19 million, to be completed in 2006 and testing in Oct 2007, production Dec 2007. Needs financing and approvals.

3) Retail filling stations. There were an estimated 31 filling stations in Xian. Feb 2006, CHNG finished construction of two filling stations in Xian (each cost about $600K). They purchase gas for 1.16 RMB and sell it for a net of 1.90 RMB. March 2006, constructing a 3rd station. [after the 10-K, they created a lot of these retail filling stations]

For retail filling stations, advertising is focused on taxi drivers. Discount loyalty card. Radio/newspaper ads, etc.

Only one supplier: the government owned Shaanxi Natural Gas Co. Ltd. They've gone from 1 year contracts to 6 month contracts, subject to review prior to renewal, also with a minimum required purchase of natural gas (2.36 million cubic meters for 2005). Prices are strictly controlled by the government and have been stable for three years. What this tells me is that China views Shaanxi Natural Gas Co as a utility, with the usual regulation.

50,000 residential customers (apartment blocks, small estates), commercial customers are small businesses such as restaurants and office buildings. Industrial customers include Xiwei Aluminum Company.

Natural gas consumption will increase rapidly in China (expected to double in 5 years). Shaanxi itself has large natural gas reserves.

Several licenses needed: CHNG has them. CHNG includes the license numbers in the 10-K.

Two private competitors. Xinjiang Guanghui LNG Development Corporation (tanker truck transport). Xin'Ao Gas Field Ltd (pipelines in 13 provinces) None of these are currently directly competing with CHNG.

Of the 31 filling stations: 13 state owned. 18 privately owned (mostly single station operators).

243 employees: 6 management, 16 admin, 87 operations, 5 sales, 38 R&D, 16 finance, 75 retail filling station employees.

Jan 2006, CHNG raised $2.8 million by selling PIPE units. 1 million shares plus 275K warrants (3 years, $3.60 strike, with a 10% ownership limitation).

Jan 2006, CHNG raised another $2.2 million by selling PIPE units. 784K shares plus 213K warrants (3 years, $3.60 strike, 10% ownership limitation).

Jan 2006, CHNG raised yet another $5.4 million by selling PIPE units. 1.9 million shares plus 523K warrants, same terms and restrictions.

AR includes reserves based on historic bad debts, customer concentration, etc. recorded mostly on a specific identification basis.

Inventory is FIFO, with allowances for writedowns if prices drop. "Inventory consists of material used in the construction of pipelines." Wouldn't it also be natural gas itself? [no, also construction, see below]

Depreciation schedule is good. Cars are 5 years, buildings 30 years.

Contracts in progress relates to constructing and selling pipelines (typically 2 month duration).

Revenue recognition is as expected with sufficient detail.

Tax rate is only 15% (instead of 33%) due to being in a favored industry (natural gas industry).

The huge increase in revenues is due to one-time construction and installation as well as increased sales of natural gas. It's not clear to me what the sustainable revenues are. Construction revenues have high gross margins. Natural gas sales increased by 396% over the prior year.

Skipping ahead to the numbers...

Natural gas revenue: $1.69 million (recurring) 23% gross margins
Construction/installation revenue: $3.16 million (one-time) 65% gross margins

Natural gas revenue: $306K (recurring) 26% gross margins
Construction/installation revenue: $578K (one-time) 50% gross margins

Looking at the amended Q3 2006 10-Q:
Natural gas revenue Q3 2006: $5.21 million (recurring) 47% gross margins
Construction/installation revenue Q3 2006: $1.30 million (one-time) 60% gross margins

One customer accounted for 36.1% of revenue for Q1-Q3 of 2006 (87.0% for 2005!).

As CHNG keeps doing construction, it results in a one-time big profit, but adds to a recurring smaller profit. You can see that the recurring revenues are ramping up very fast. Let's say that quarterly gas revenues ramp up to around $8 million (I tend to think it will be more than that) and construction/installation falls off to a steady $300K. Assume the same gross margins. This would result in a gross quarterly profit of $3.94 million. We'll say that operating expenses increase to $800K (which seems pessimistic since they're scaling slowly). We would then see a quarterly net income of $2.67 million and the stock might be worth $5.93, assuming no seasonality [see below]. It's currently trading around $2.80, which would be an acceptable discount for an investment.

From Q1:
New households pay approximately 60% of the construction costs of the pipeline
that supplies their homes with natural gas up front and the balance is paid as
part of the monthly natural gas bill.
Ok then, let's say they hit-the-wall right now and stop growing as of Q3 2006. What would that look like in terms of free cash flow? Revenues for a typical Q3 would be $5.2 million and gross profit would be around $2.46 million. Operating income might be $1.82 million and net income $1.55 million for a typical Q3.

As far as seaonality goes, I have no idea. CHNG has been growing too fast to see any seasonality in the results. According to TravelChinaGuide, average high / low temperatures are:
Jan: 39 / 22 degrees F
Mar: 56 / 36 degrees F
May: 78 / 55 degrees F
July: 89 /70 degrees F
Sept: 75 / 58 degrees F
Nov: 52 / 35 degrees F
Q3 goes from July to Sept. Between the two of them, I have to think that natural gas is going to be used more for heating than air conditioning.

Looking at 2005 and 2006 results for each quarter:
Q1 05 gas/construction revenue: $233K / $10K
Q2 05 gas/construction revenue: $426K / $653K
Q3 05 gas/construction revenue: $406K / $986K
Q4 05 gas/construction revenue: $620K / $1.51 million
Q1 06 gas/construction revenue: $865K / $922K
Q2 06 gas/construction revenue: $2.50 million / $1.22 million
Q3 06 gas/construction revenue: $5.21 million / $1.30 million
Far from being an abnormally high revenue quarter, Q3 2005 was the only time in the last 6 quarters that gas revenue actually declined.

A big important question is whether the 40% portion of the construction that is not paid up front is lumped in with the construction revenues (as it should) or gas revenues (which would be very wrong). The revenue recognition section says:
Revenue from construction and installation of pipelines is recorded when the contract is completed and accepted by the customers. The construction contracts are usually completed within one to two months time.
So if I understand this correctly, they recognize the full revenue when construction is done (and accepted) and the 40% paid along with the gas bill is essentially accounts receivable and already recognized as revenue. This would be good from the standpoint of making sense of the gas vs construction numbers above.

Ok, I now go back to the 10-K again...

The increased operating expenses are due to increased sales and marketing costs to sign up new customers during 2005. Also, they entered the filling station segment. They mentioned applying for permits and such. Kickbacks? This is China, after all.

Liquidity: They raised all that money in Jan 2006 to start up the filling stations. They ended up starting up a lot of them (four in Q3 of 2006 alone). There were 17 filling stations on Nov 10, 2006 and they planned to build or buy at least 4 more (Q3). They then built two stations in Henan Province (population 100 million) and ended the year with 23 stations (ten in Henan).

Auditors are Kabani & Company. I've run into them before. Kabani had what appeared to be a fraud perpetrated against them by Genex who posted a fake letter supposedly from Kabani on Kabani letterhead in an SEC filing! Kabani audited Harbin Electric, a fine upstanding company that recently switched to NASDAQ. I had noted here that Kabani handled 28 accounts in 2005. From their website:
Member: American Institute of Certified Public Accountants, California Society of CPAs , MEMBER AICPA Center for Public Company Audit Firms (formerly, SEC practice Section ), Registered with PCAOB.
Kabani gave CHNG an unqualified opinion for 2004 and 2005.

Visual display of financial statements:

Balance Sheet:
Current assets
Cash *
All other stuff *
Total current assets **

Property, Plant, Equip ****************
Construction in progress ***
Total assets *********************

Liabilities (all current) ***

Equity ******************

Income Statement:
Natural gas revenue        ********
Cost of natural gas -------

Construct/Install revenue ****************
Cost of construct revenue ------

Total revenue ************************
Cost of revenue ------------

Selling expenses --
G&A expenses ---

Operating income *******
Tax -
Net income ******

Cash Flow Statement:
Net income ******
Depreciation ++
Contract in progress ++
Other payables +++
Unearned revenue ---

Property & equipment ----------------
Construction ---------

Stock issued for cash *****************

Net increase in cash ***

"Insignificant" allowance for uncollectable accounts.
Interest-free advances to suppliers.
FIFO inventory.
Reasonable depreciation schedule (cars are 5 years).

PP&E is nearly all operating equipment, as expected, with some buildings, cars. Modest depreciation at this point.

Construction costs are material, labor, overhead.
Construction projects normally completed in 1 to 2 months.

Revenue from gas sales is recognized when gas is pumped through pipelines to end users.

"Insignificant" advertising costs for 2005 and 2004.

Taxes are low because of the 15% tax incentives for natural gas.

The usual PRC welfare stuff is in there.

All natural gas is purchased from one vendor (see above), with a required minimum purchase (2.36 million cubic meters for 2005, 1.6 million for 2004).


Two suppliers accounted for 51.5% and 13.3% of equipment purchased.

Customer Concentration:
Customer 1:  ***********
Customer 2: *******
Customer 3: *****
Customer 4: ***
All others: ******
Total: ********************************
Customer concentration is very high, but will decrease going forward. By now, I expected it to be more diversified from the filling stations.

The customer concentration is high in construction/installation (40%, 17%, 17%).
In 2004, construction concentration was 36% and 37% (seems like the same customers).

Jumping ahead to Q3, for 9 months: supplier concentration was 42.2% and 17%. Customer concentration was 36.1% of total revenues.

$350K payable to a stockholder.

Management / Insiders

company website

Qinan Ji, 48, Chairman. Founded Anxian Hotel in Weinan City, Shaanxi. Formed Xian Sunway Technology and Industry Co. Founded Sunway Technology Industries (which now owns a big chunk of CHNG stock). 1990 represented Weinan City at the People's Political Consultative Conference. Chairman of Weinan Anxian Petrolium and Chemical Co. Long ago founded and ran Weinan Anxian Trade & Industry Co. BS in economic mgmt, Northwest U (Shaanxi).

Bo Chen, Vice Chairman (Oct 2005). President and a founder of Bodisen Biotech (BBC). 1997-2001 COO and CTO of Shaanxi Bodisen Chemical Co (which is essentially Bodisen Biotech). 1994-1997 CEO of Yang Ling Shikanglu Chemical Technology Development Co (nothing googles). BS Shaanxi Normal College 1984.

Patrick McManus (board member) has ties to Bodisen Biotech. Bad news. Possible fraud. Herb Greenberg has been all over them, mentioning the investment in CHNG.

Bodisen Biotech sec page.

Yangling Bodisen Biotech Development Co. owns 516K shares.
Minqing Lu, 43, CEO.

People selling shares in the recent prospectus (3 amendments)
Amaranth LLC 1,363,096
SovGem Limited (Peter Charles St. George) 454,365
MidSouth Investor Fund LP (Lyman O. Heidtke) 181,889
Jayhawk China Fund (Kent C. McCarthy) 445,278
T2 Capital Management (Richard Taney) 36,349
Broadlawn Master Fund (Jon Bloom) 22,718
Jon D. Gruber and Linda Gruber Trust 68,152
Gruber & McBaine International 77,243
J. Patterson McBaine 22,721
Lagunitas Partners (McBaine) 286,250
Primarius China Fund (Patrick Lin) 227,182
Nite Capital (Keith Goodman) 68,154
Antoine de Sejournet 63,611
Philippe de Cock de Rameye 11,450
Vision Opportunity Master Fund (Adam Benowtiz) 90,874
Citizens Security Life Insurance (Darrell Wells) 22,718
Peijian Sun 636,111
Jiakuan Wang 647,379
New York Global Securities (Scott Morrison) 420,843


I really hate to rule out a company because it has links to what might be a fraud (Bodisen Biotech), but I just can't invest in this company. It's too bad because the price has been getting better and better.

Tuesday, February 06, 2007

New uranium website

www.U3O8.biz just started up this week. The uranium investment area is starting to get a bit frothy.

Phase 1) "Uranium?!?!?! You're crazy to invest in uranium!"
Phase 2) "Uranium? What do you mean? I didn't know you could invest in it."
Phase 3) A small group of people find uranium to be a good investment. It shows up on websites, the best newsletters (remember those?).
Phase 4) The investing world starts to take notice. More newsletters, more websites.
Phase 5) The investing world goes wild. The non-investing world starts to take notice.
Phase 6) Uranium becomes Time Magazine "person of the year" or else just shows up on the covers of Business Week and Money Magazine.

It's pretty much common knowledge that by the time you reach Phase 6, the price is going down, probably soon. Also, typically the best time to invest is somewhere between Phase 1 and Phase 2, although in the case of uranium, Phase 2 was decades long.

I'd say Phase 4 started when the Cigar Lake mine flooded in October.

Conforce International (CFRI) new VP

Conforce International (covered here) hired a new VP of operations. Since the company is going to be ramping up very fast, this particular individual is very important to the business.
Mr. Tonon joins Conforce after working with Royal Group Technologies (now Georgia Gulf) for over 19 years. Mr. Tonon began with the Royal organization in 1986 as a Manager for Jovien Associates, a division of Royal Plastics Group, where he was responsible for the construction of the company's numerous manufacturing facilities. From 1991 to 1996, Mr. Tonon traveled extensively around the world in order to assist in the design, development and global marketing of revolutionary plastic based modular housing systems. In 1996, Mr. Tonon was asked to relocate to Argentina where he was promoted to the position of Director of Operations for Royal Mercosur Argentina Ltda. S.A., a division of Royal Group Technologies. While there, his responsibilities included the setup of the manufacturing operations and the training of the facility's personnel for the assembly of the company's complete line of PVC and composite products for sale in Brazil, Paraguay, Uruguay, Chile and Argentina. The company received numerous awards in the manufacturing sector from the Government of Argentina.

In 2000, Mr. Tonon returned to Canada where he was promoted to the position of President for Prince Plastics, a division of Royal Group Technologies. During his six years with Prince, the division experienced triple-digit growth and was responsible for the design and manufacture of PVC fence boards, deck boards and railings for distribution to big box outlets such as Home Depot Canada, Home Depot USA and Lowes USA.
Prince Plastics seems to be in India (not the same area of products), while Royal Group still has plastic fencing. In Aug 2005, they introduced a composite building material, Celucor.
Until Celucor™, market choices were limited to soft and hard woods, vinyl, and first-generation composite materials.
Sound familiar?

This guy will work on developing manufacturing around the world, ealing with all the usual supply chain issues.

Seems like a good choice from what they say.

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