China Clean Energy: Biodiesel Production Expansion Reassures Investors

Finally, news from China Clean Energy (CCGY.OB). Investors have been anxiously waiting for an announcement from the company since its Q3 earnings release and now we can all let out a sigh of relief. The company has found money for its new biodiesel plant, which will up its production capacity from the current 10,000 ton to 110,000 ton per annum, positioning CCGY as a significant biodiesel player in China.

But "found" is perhaps not quite the right word. In a PIPE deal, the company offered 10 million shares at $1.50 apiece to raise $15m. In addition, 5 million warrants were issued at an exercise price of $2.00. Some shareholders are moaning about dilution (approx. 32% without warrants), but at an approx. 25% discount, this is very respectable indeed. I have seen 40%, 50% discounts, and one has to realize that this is a OTCBB traded company with a current market cap (pre-PIPE) of only $43m.

Perhaps the following is a simplistic way of looking at it, but whenever the discount is less than the dilution, one cannot complain. Further, this could have been a convertible deal, loading the company up with debt and interest liability. The fact that it is 100% equity shows a long-term view taken by the new investors. This is a great transaction for CCGY.

But biodiesel is not without risks. With fast-rising commodity prices, raw material costs are sky-rocketing. Just two days ago, U.S.-based Bioenergy (USBE) filed for Chapter 11 amid a 50% rise in soy oil prices. However, as previously discussed, China's agricultural policies make it a very different game for biodiesel producers there, plus, CCGY uses waste palm oil as feedstock, not soy.

While there is no way for the company to control commodity prices, the Make Good provisions of the offering will ensure management steps up to the plate. Essentially, insiders have set aside 1.5 million shares in escrow, to be distributed to the investors should (i) the company fail to begin production at the new plant before 1/1/2009, or (ii) if it doesn't meet a FY2009 net income target of $14m. Note that on a fully-diluted basis, this net income figure represents a EPS of $0.38, which at the current price of $2.00, works out to a P/E of just 5.3x!

It remains to be seen if CCGY will meet this target. But judging from the last few conference calls the company had, I dare say that this is one of the better management teams I've encountered.

My Position: None.