KAL Energy: Avoid This Stock At All Costs

| About: KAL Energy, (KALG)

Important note from SA Editors: Seeking Alpha received a letter from KAL Energy's lawyers alleging that the article below, originally published June 12th, "is replete with false and misleading statements", expressing concern that the purpose of the article was "to manipulate the Company's stock price", claiming that "the falsehoods in the article are in fact defamatory and libelous", and demanding that Seeking Alpha immediately remove the article under threat that "KAL will vigorously pursue claims for defamation and liable (sic) and the Company's rights under the federal and state securities laws". A separate letter to Mr Turner, forwarded to us, outlined the alleged inaccuracies.

Mr Turner, who is not a Seeking Alpha employee and whose opinions are not those of Seeking Alpha, assured us that "neither myself or any other member of Hallgarten and Company... directly nor indirectly, has benefitted financially in any way from our coverage of KAL Energy... when we were first falsely accused of having a short position in the company by KAL we immediately sent a mail to KAL Energy HQ explaining that this was not true". Mr Turner adds that he "stands by every word" in the article.

Seeking Alpha is committed to open discussion of stocks that adheres to honesty and full disclosure. We have therefore asked KAL Energy's lawyers for permission to publish the section of their letter to Mr Turner outlining the alleged inaccuracies immediately below the article on this page, so that readers may judge the issues for themselves. When we receive their permission, we will publish that letter. We would also welcome a submission from KAL Energy itself clarifying the issues discussed.

We believe that KAL's counsel's demand that Mr Turner "cease and desist from making any further statement regarding KAL and investments in KAL" does not further the cause of open and honest discussion for the benefit of investors.

Our request to KAL Energy's lawyers to publish their discussion of the alleged inaccuracies in the article has not yet been answered.

First, Wikipedia gives us the background on the Portuguese fable “Stone Soup”:

According to the story, some travellers come to a village, carrying nothing more than an empty pot. Upon their arrival, the villagers are unwilling to share any of their food stores with the hungry travellers. The travellers fill the pot with water, drop a large stone in it, and place it over a fire in the village square. One of the villagers becomes curious and asks what they are doing. The travellers answer that they are making "stone soup", which tastes wonderful, although it still needs a little bit of garnish to improve the flavor, which they are missing. The villager doesn't mind parting with just a little bit to help them out, so it gets added to the soup. Another villager walks by, inquiring about the pot, and the travellers again mention their stone soup which hasn't reached its full potential yet. The villager hands them a little bit of seasoning to help them out. More and more villagers walk by, each adding another ingredient. Finally, a delicious and nourishing pot of soup is enjoyed by the travellers.

Kal Energy Inc (OTCPK:KALG) is a modern day version of stone soup.

Late last year, a London-based private equity group called Mining House Ltd took over a virtually untraded Nasdaq listed company with a market cap of just under U$6m and previously run by a Brooklyn real estate businessman. Once in charge, the first thing they did was change the name of the company to KAL Energy Inc and then quadruple the number of fully diluted shares to 47.3 million. A little later they reverse-mergered privately owned Thatcher Mining of Singapore into the newly named KAL Energy Inc and paid off the previous owners of Thatcher with a small cash sum and 32 million shares of newly created shares. Our eyebrows raised when we found out the Thatcher Mining began life as a company as late as June 2006 and that at least one of the shareholders of Thatcher, David Pope, is also a member of the key management group at Mining House Ltd.

So from seemingly nothing they found themselves with a NASDAQ listed company and managed to quickly fill it with a tasty ingredient, namely the main assets of Thatcher; two large unexplored coal mining properties in Indonesia that seem to hold around 192million tonnes of thermal coal. A neat trick, but it was just the start of it all.

Next, they needed some working capital. So they ran a private placement in February this year, selling 17.6m shares to floor-level investors for 20 cents a share (which must have been a popular offering to those lucky enough to get on, as shares in KALG.OB were trading at around 80 cents at the time. Why pay 80 when you can pay 20?). After commission costs and such, they were left with about U$3.4m. So the stock dilution had gone from under 12m shares to over 97m in a single quarter, but they now had a company, an asset and some working capital. Not bad for three months’ work!

With that capital, they started a drilling program at the site to find out exactly what they had under the ground. The problem was that although a promising site, it had never been professionally surveyed to Canadian 43-101 or Australian JORC standards. That is something that costs money. So KALG laid down the lion’s share of their U$3.4m to drill and explore at the site.

Meanwhile, they were not averse to spending cash in other places. They had a company, an asset and working capital, but they still needed to “get known”. So KALG went on the publicity trail and paid several different research analysis companies between $6500 and $10,000 a piece to publish positive reports on the company (all of which can be found on the KAL website). KAL also received excellent publicity from Bob Moriarty of 321gold.com and 321energy.com fame. Mr. Moriarty, as a friend of one of the original investment group, was invited to buy part of the original 20 cent placement. He was taken on the grand tour of the property in Indonesia. Then on April 17th he published a wonderfully positive report on KALG for all to see in his own inimitable style. He did mention that he was a shareholder in KALG and advised readers to do their own due diligence into the company before making any decisions, but all the same it would seem that a lot of people took him at his word. KALG.OB moved from 0.98c to over $1.40 soon after publication of Moriarty’s note, all on much improved volumes.


So what now for KALG? We are told by the company that while the necessary drilling program is going on, KALG will be able to sell 200,000T of bulk sample to be mined this year on the open market. This will provide cash flow for the future, and the company plans to ramp production to 5MT per annum by 2010. The bulk sample certainly will help, but if the approximate $2m profit they bring in from 2007 bulk samples sales is enough to cover expenses going forward we would be extremely surprised. As for the future production plans, maybe the company is jumping the gun slightly as it does not have the necessary work contracts or environmental permits to allow it into commercial production as yet.

Mr. Moriarty, in his glowing note, said he didn’t see any large dilution in the future. This could have been one of the main attractions for those who bought KALG after reading his article. Of course Moriarty is entitled to his opinion, especially as he is a shareholder in KALG (we presume that he has not sold out as yet, of course), but we certainly beg to differ on this point. It is estimated by one published report available on their website that KALG will need at least U$100m to ramp the project in the next four years, and with the lack of cash at bank they are almost certain to use heavy dilution for financing. It has therefore certainly benefited the company to have a share price lifted by “third party reports” and favourable articles by website owners with large retail followings, as raising U$100m in share dilution is far easier when your stock is worth $1.38 and not half that amount, or even a quarter of it.

So if we assume for argument’s sake that the company is fortunate enough to place new shares at $1 each on average, this means there would be at least 200 million shares in existence by full production time (quite possibly a lot more). If we use the company report’s own estimated net profit margins of U$10 per ton of coal, this would give us an estimated net profit of U$50m, or an EPS of U$0.25 per share, for the year 2010.

Today, KALG.OB stands at U$1.37. Those that buy the stock today are looking at a company with an estimated forward PE of 5.5X on 2010 earnings.

A company that has gone from a $6m market cap to a $130m market cap in just 6 months without producing or selling anything.

A company that still does not have the necessary permits to operate their mine.

A company whose asset is still non-industry standard compliant.

A company with little cash at bank and whose board expects shareholders to pay for the necessary working capital and pay their salaries for the next years.

A company that keeps very quiet about the significant amount of dilution it will need to do to go into full production.

A company that has already earmarked 1,750,000 as yet un-issued options to two of its executive members, and has approved a plan to give away a maximum of 12 million options to directors and management of KALG in 2007 alone.

A company that offers cheap shares and guided tours to influential website owners who then write glowing reviews on the stock (with all the necessary caveats at the end of the note, of course).

A company that pays thousands of dollars to research houses in return for reports recommending KALG to one and all.

Not surprisingly, we take a different view. Avoid this stock at all costs.

Disclosure: none