Gulf Resources Gets Financially Comfortable

Mar. 7.08 | About: GULF RESOURCES (GURE)

In May last year, when the share price of Gulf Resources (GFRE.OB) was trading at around $1, the company entered into a standby equity distribution agreement with several private investors to sell up to 60 million shares at $1 each. Announcement came Thursday that this agreement, which has never been put in effect, has now been scrapped. The reason is obvious - GFRE's share price is now trading at above $2.50, and a $1 offering would represent a criminal 60% discount. So this is good news.

The real question is, why not vary the agreement and change the price to, say, $2.50? I like the idea of a standby agreement because it is a ready-made mechanism for the company to tap into, as and when cash is needed. In fact, Thursday's press release did mention that the company "has decided to pursue more cost efficient funding sources". But isn't varying the strike price the simplest and most cost effective way? In fact, the price doesn't even need to be fixed, but could be based on a formula that is related to the market price.

The fact that the agreement was not varied led me to ask: why would these investors agree to a $1 price (which was equal to market price in May 2007) but not agree to the current market price? Does that mean the current price is too high? After all, it has appreciated by more than 150% in less than 10 months.

I suspect GFRE may be referring to debt when it mentioned "cost efficient funding sources". After all, the company is now the #1 bromine producer in China, with a 20% share, and doing well in its oil & gas chemicals, all of which are generating tons of cash. Indeed, GFRE's NET cash inflow was well over $5 million for the first nine months of 2007. Ultimately, I think it is a sign of confidence that GFRE is so ready to dismantle this financial safety net, simply because it will have many more funding options from here on out.

My Position: None.