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  • HOL: This Chinese SPAC has at least 50% upside, and the warrants have 300% upside
     China Holdings Acquisition Corp (ticker HOL on the NYSE Amex) is a Special Purpose Acquisition Company (SPAC) that is purchasing a Chinese ceramic tile manufacturer known as JinJiang Hengda Ceramics Co ("Hengda").  On 11/20/09, this deal was approved by shareholders, and typically these deals close within a day or two of a successful shareholder vote.  Like most SPACs, the stock has zero Wall Street coverage, which helps explain its significant discount to intrinsic value.  At $9.75, the stock trades at a P/E (2009E) of 6.5X ($1.50 in EPS).  Comparable stocks in the Chinese building materials industry trade in the 15-30X range, and with Hengda's targeted 15-20% EPS growth rate, this range seems more reasonable.  To be conservative, I'm using a 10X multiple to get a price target of $15.00, for 54% upside. 
     
    For those with a higher risk appetite, the warrants (ticker HOL.WS on the NYSE Amex) at $1.50 trade at a 33% discount to parity (strike price is $7.50, and with the underlying stock at $9.75, parity is $2.25).  The warrants expire on 11/16/12, and assuming an implied volatility of 30%, intrinsic value for the warrants is currently $3.30, for 120% upside.  At a target price of $15.00 for the underlying stock, the warrants would be worth about $8.00, but given that the warrants are callable by the company when the stock hits $13.50, upside on the warrants is limited to $6.00 for 300% upside.  Note that the warrants will not be exerciseable until after the stock is registered.
     
    Hengda, founded in 1993, has a nearly 4% market share in the $5 billion ceramic tile industry in China.  The company generates about 95% of its revenues from the domestic Chinese market, and its products are available in over 2,000 styles, colors and size combinations, and are used for exterior siding and for interior flooring and design in residential and commercial buildings.  Hengda's products are known for their high quality and innovation.  New products, such as the ultra-thin tile, have approximately 50% higher gross margins than the industry average.
     
    Hengda's manufacturing facility is located in JinJiang city, Fujian province, with an aggregate annual production capacity of 28 million square meters.  Hengda is in the process of building a second production facility, which will increase capacity by 42 million square meters by 2012.  The company has maintained long-term relationships with its customers, with 9 of its top 10 clients having purchased its products over the past 10 years. 
     
    The ceramic tiles industry in China has grown at a 20% rate (by revenue) over the past 3 years and is expected to grow 10-15% per year over the next 5 years.  The industry is fragmented, with the top 10 manufacturers accounting for just 20% of total revenues, the remaining 80% is spread among hundreds of small mom and pop factories.  Clearly this is a great platform for both organic growth and market share gains.
     
    To get a sense for timing, 2 Chinese SPACs that have recently completed their acquisitions: footwear maker Exceed Co (ticker EDS on the Nasdaq), and advertising company China MediaExpress Holdings (ticker TMI on the NYSE Amex) were up 54% and 48%, respectively, within 6 trading days of their shareholder votes.  Due to limited floats, the upside volatility can be significant in the short term.
     
    Disclosure: Author is long HOL stock and warrants
    Tags: HOL, TTY, TMI, HOL, Hengda, TTY, EDS, Exceed, TMI, MediaExpress, Chinese SPACs, ceramic tiles, warrants, arbitrage, SPAC, China
    Nov 22 05:34 pm | Link | Comment!
  • Is Iraqi Kurdistan The Next Saudi Arabia?

    The Kurdistan region of Iraq is a geological extension of the world’s richest petroleum fairway, which extends from Saudi Arabia to Syria. It is estimated to have around 45 billion barrels of oil reserves making it sixth largest in the world, mostly recently discovered (even excluding Kirkuk and Mosul which are essentially controlled by the federal government). Due to geo-political conflicts, the resources in Kurdistan have been essentially untapped. Upon the overthrow of Saddam Hussein’s regime in Iraq, however, Kurdistan began to open itself to foreign investment (the tapping of the Kurdistan keg). Currently about 25 companies have been granted the Profits Sharing Contracts (PSC) from the Kurdistan Regional Government (KRG). Some of the publicly traded companies are listed below.

     

    Chart 1 PSC Blocks in Kurdistan

    Source: WZR company presentation.

     

     

    Companies that have made discoveries and/or are producing

    ·       Addax Petroleum Corporation (AXC CN): Addax has a 45% working interest in Taq Taq, a currently producing oil field, and another 26.67% interest in the Sangaw North PSC. Starting June 1st, 2009, Addax began exporting oil from Taq Taq, a historic event for Kurdistan.

    ·      DNO (DNO NO): DNO entered into a PSC with the KRG as early as 2004.  It has a 55% working interest in the producing Tawke field. Just like Addax, DNO was also granted permission to export oil from its Kurdistan oilfield.

    ·      Heritage Oil (HOIL LN):  The company announced a major oil discovery in early May 2009 with an estimated oil-in-place of 2.3-4.2 billion barrels.

     

    Pre-production: Large International E&P Companies

    ·      Talisman Energy (TLM)

    ·      Niko Resources (NKO CN)

    ·      OMV Aktiengesellschaft (OMVKY)

    ·      MOL Magyar Olaj-es Gazipari NyRt (MOL, listed in Hungary)

    ·      TNK-BP (TNBP, listed in Russia)

    ·      Reliance Industries (500325, listed in India)

     

    Pre-production: Junior E&P Companies

    ·      Gulf Keystone (GKP LN or GUKYF)

    ·      Sterling Energy (SEY LN)

    ·      HKN Inc. (HKN)

    ·      WesternZagros (WZR CN or WZGRF)

    ·      Vast Exploration (VST CN or VSTFF)

     

    Investment Theme I: M&A

    M&A activities involving Kurdistan-related E&P companies have been heating up over the past several weeks. After a rumored bidding war among Chinese, Korean and Indian companies, Addax was acquired by Sinopec on June 13th with a price tag of around $8.5 billion (including debt), implying a $6.3/boe or CAD 7.3/boe (3P).  On June 9th, Heritage Oil announced its acquisition of Turkish oil company Genel for $5.5 billion. Genel is the working partner of both Addax and DNO in Kurdistan. Last time we heard any meaningful M&A news about Kurdistan assets was back in 2Q07 when DNO received and subsequently rejected an unsolicited offer ($700 million) for its Kurdistan assets from an unidentified international oil company.  Based on DNO’s reserve data as of 2Q07, the offer represented a valuation of $7.3/boe or CAD 8.3/boe (3P).

     

    The biggest X factor in Kurdistan is actually China.  Recently, China has been very vocal regarding its concerns of the safety of the US dollar and its holdings of US treasuries. There are a lot of signs that China is channeling its gigantic foreign currency reserves into commodities through overseas acquisitions. China has a decent track record of acquiring assets in South America, Africa and the Middle East where political sensitivity is less of a barrier than in the developed countries such as Australia. Additionally, after China was outmaneuvered and walked away from Rio Tinto deal, China was left with a $19 billion additional war chest for overseas acquisitions (assuming the money is still earmarked for the original purpose). China is no stranger to Iraqi oilfields: China National Petroleum Company set its foot on Iraq in 1997 and has just signed a development  service contract of Al-Ahdab oilfield.  Kurdistan oil assets could be an ideal target for China though it has shied away from them to avoid offending Baghdad. Sinopec’s aquisition of Addax provides anecdotal evidence of a possible strategy shift.  Besides Addax, Niko Resources could also make an ideal acquisition target for Chinese oil companies. NKO has a market cap of CAD 3.8 billion, large enough to be on China’s radar screen, and a portfolio of assets primarily located in the developing countries where China seems to have a diplomatic edge.

     

    Investment Theme II: Kurdistan Pure Plays

    There are only two Kurdistan pure plays in the Kurdistan universe: WesternZagros and its “mini” neighbor Vast Exploration. They share many of the same attractive investment characteristics.

     

    Highly attractive risk/reward profile.  We believe that the fair value of WZR (click here for valuation details) is conservatively about C$3.60, or roughly 2.5X its current price.  There are many cheap lottery tickets in the E&P universe, but what makes this one unique is its high likelihood of success.  It is hard to make a forecast of VST’s NAV due to the earlier stage in its exploration efforts. However, NKO, one of the larger E&P companies in Canada with a market cap of CAD 3.6 billion,  is not only VST’s business partner (36% working interest) in the PSC block, but also VST’s largest shareholder (17% ownership). Combining both, NKO’s actual working interest in the block is over 42% (36%+36%*17%). Therefore, buying VST stock is essentially buying a call option on NKO’s Kurdistan business or the eventual consolidation into NKO.

     

    High scarcity value. Kurdistan holds one of the world’s most coveted oil fields, which up until recently was off limits, protected from foreign ownership. WZR and VST were among the first movers, and because they took large risks as foreign investors at such an early stage, their potential reward is sky high.

     

    Kurdistan is actually safe. Kurdistan is no tropical island for the long distance traveler, but it is arguably a true “security oasis” within the war-battered Iraq, and it is ranked “secure” by the US military.  Over 20 E&P companies have been operating in the region over the past several years with no major interruptions, which makes this a safe haven among prospective untapped oil reservoirs. Click here for detailed blog on geo-political issues in Kurdistan region.

     

    “Elephant” potential.  An “elephant” oil field is one whose recoverable reserves are at least 100 million barrels.  According to the well respected oil and gas consultancy Sproule and Associates, as of March 31, 2009, WZR’s exploration block has P90 prospective resources of 1.6 billion barrels.  P90, for those unfamiliar with the industry jargon, refers to reserves that have a 90% certainty of actually being produced.  WZR’s find, if “proved” would count among the 100 largest producing oil fields in the world. VST’s block is bordering both the WesternZagros block and the Heritage Oil (HOIL LN) block, which are considered among the 2 most promising blocks in Kurdistan (and in the world for that matter). Heritage Oil announced a major oil discovery in its Miran West-1 well early May with estimated oil-in-place of between 2.3 to 4.2 billion barrels. In early February 2009, VST started a seismic acquisition program for a minimum of 350 km of 2D seismic data. The process will take 4-5 months, and at its conclusion, VST will be able to generate an initial reserve estimate for its block – this creates potentially very market moving news flow this summer.

     

    Terrific takeout potential.  WZR, although well capitalized for a “junior” oil exploration company, with $130 million in cash and no debt, is extremely unlikely to remain independent long term.  Its exploration partner, Talisman Energy (TLM CN), with $8 billion of revenue and a $16 billion market cap, is better suited to take on this elephant, and may wish to increase its stake by acquiring WZR itself.  Other large oil companies who either have been waiting on the sidelines due to lack of a clear regulatory framework or who already have small stakes, are undoubtedly eying WZR’s prized oil fields hungrily.  NKO is VST’s exploration partner and  its largest shareholder. The likelihood that NKO eventually acquires VST in whole is arguably quite high, which provides another very direct catalyst.

     

    Disclaimer: The author is long WesternZagros and Vast Exploration. 

     

    Tags: ADXTF.PK, TLM, NKRSF.PK, SNP, kurdistan oil, Iraq, WesternZagros, Vast Exploration, Heritage Oil, Niko Resources, Gulf Keystone, Sterling Energy, DNO, China, SNP, PTR, CEO, China acquisition, Oil Reserves
    Jun 25 02:36 am | Link | Comment!
  • APWR: Headwind or Tailwind?

     APWR is a provider of distributed power generation systems (DG) in China and is in the process of launching a wind power business. Its stock price has more than tripled this year as investors considered the company a proxy for the fast-growing alternative energy sector in China, especially the wind power market.  Additionally, most of the major Chinese wind power players are listed either in mainland China or Hong Kong, APWR enjoyed an extra tailwind due to its perceived scarcity value. However, a reality check of the wind power market in China suggested that APWR might be facing significant headwinds as it tries to jump-start its wind turbine business. Its current stock price has simply priced in too much of a blue sky scenario and significantly underestimates a wind chill factor of the execution risk in the current market environment.

     

    Reality Check

    Supply deficit of wind turbine market in China has given way to manufacturing overcapacity in 2009. Since 2005, the wind power installed capacity in China has experienced a triple digit growth rate. However, this explosive growth has quickly been surpassed by the manufacturing capacity as more and more companies jumped on the wind power bandwagon. Going forward, the demand growth is expected to gradually slow down.  According to the Global Wind 2008 Report prepared by the Global Wind Energy Council, “demand in the decade between 2011-2020 is forecasted to be 80 GW, or about 8 GW per year”.  This will be more than met by the existing manufacturing capacity in China – according to Chinese Wind Energy Association, the top four Chinese turbine manufacturers (Sinovel, Goldwind, Dongfang and Shanghai Electric) already have a combined capacity of 12GW now. APWR stated that it has the largest wind turbine production facility in China with 1125 MW capacity (according to its press release on January 11, 2009), however, in an industry with growing overcapacity, the utilization rate matters more than size.

     

    Wind turbine market in China is highly concentrated with limited incremental market share for new entrants.  There are currently 70 wind turbine manufacturers in China, but the top 10 accounted for a staggering 90% market share by the end of 2008. There is little market share left for new entrants such as APWR unless the demand grows significantly more than expected or the new entrants focus on the international market.  APWR may be able to mitigate some of this risk by selling 2.7 MW turbines as most of its competitors are selling 0.75MW, 1.5 MW and 2.0MW models. However, Sinovel, the largest wind turbine in China, has just started to manufacture 3.0MW (for offshore wind farm) in 2009 and other top manufacturers are also eyeing the high capacity turbine market. Direct exports may not be a solution for APWR as its technologies are all licensed from European companies which may have rigid geographic limits on the licensed products.  

     

    Table 1 Wind Turbine Market Share in China

     

     Manufacturers2008
    1Sinovel22%
    2Goldwind18%
    3Dongfang17%
    4Vestas10%
    5Gamesa8%
    6Windey4%
    7SHE3%
    8Mingyang3%
    9Hang Tian2%
    10GE2%
    11Nordex2%
    12Suzlon2%

     

    Wind turbine manufacturing is not the sweet spot in the wind power value chain. A typical wind power value chain in China includes wind farm operators (usually the government owned utilities), wind turbine manufacturers, wind turbine components providers, and raw material providers. Wind turbine manufacturers have the least bargaining power along the chain and are potentially squeezed from both upstream and downstream participants.  The overcapacity has led to increased competition and price wars among turbine manufacturers, which has eroded their bargaining power against wind farm operators and weighed on the top line. On the other hand, there is a significant supply deficit for key turbine components as the explosive growth of manufacturing capacity has not been matched by the similar growth of qualified component providers in China. Consequently the pricing and delivery terms are more dictated by the component suppliers, which will eventually weigh on the cost structure of turbine manufacturers. APWR will have to face similar challenges, though its joint venture with GE will mitigate these pressures with respect to one component: gearboxes.

     

    Wind power business is very capital intensive. To build a wind power turbine business from scratch, it takes significant upfront capital outlays to acquire land, equipment, technology licenses and other necessary manufacturing facilities.  For example, Beijing-based wind turbine new entrant Shengguo Tongyuan recently invested RMB 460 million ($65million) in the first phase of a wind turbine project with annual output of 1,000 units of 1.5MW wind turbines. The second phase will cost an additional $90 million. After the business is up and running, the ongoing working capital need is also high as there is a natural funding gap between current assets and current liabilities. For example, Goldwind Technology, the 2nd largest wind turbine manufacturer in China, has accounts receivable days of 96 and inventory days of 116 while the accounts payable days are 58.  For some small players with less bargaining leverage, the accounts payable days could be as low as 30.  APWR’s existing DG business has relatively low working capital requirements: both receivables and inventory requirements are minimal - its A/R days are 20 and inventory days are only 7. With the ramping up of its wind power business, its working capital needs will have to increase significantly to be more in line with the industry norm and its cash balance is likely to go down significantly.

     

    Valuation

    Buying APWR now is essentially buying its DG business and a call option on its new wind turbine business and its JV with GE.  It will make a great investment if its DG business is traded at a discount and the call option is free. Current valuation does not present a good entry point, however.

    ·      Distributed generation business. DG is APWR’s bread and butter business, where it has a good track record. Though it has a high growth rate, the business has relatively low operating margins (~10.6%) and is quite sensitive to the macro economic cycle (evidenced by its downward revision of 4Q08 earnings). We find it hard to apply a higher than 10x P/E on the company (that is assuming no discount factor for an emerging market small cap stock). Management’s earnings guidance for 2009 is $32 million, implying a market cap of $320 million vs its $430 million market cap on 6/15/09.

    ·      Wind turbine business. We are hesitant to assign any value to its wind power business as at this point as it is still in a very early stage and it is hard to forecast “normalized earnings” for that division. The company stated before that it has signed a letter of intent for 380 units of 2.7 MW, but during the first quarter earnings call on 6/16/09, it said it will only deliver 2 units by the end of July and potentially another 30 units of 2.7 MW (300 manufacturing capacity) as well as 40 units of 750 kw (420 manufacturing capacity) by the end of 2009. As we point out in the reality check section, APWR has not picked the best timing in launching its wind power business. It needs to prove that it has a viable business model and the capital sources to compete and grow this business in the increasingly challenging market dynamics. 2010 is more likely a make-or-break year for APWR. Until then, there should be no tail wind for its valuation.

    ·      GE JV – the JV makes long term sense for APWR.  As we mentioned in the reality check section, component providers are the sweet spot in the wind power value chain. Additionally GE will use the JV as a potential supplier for its business in Southeast Asia. 

     

    Near Term Catalysts

    ·      6/16/09 earnings release: as expected, not a lot of new information to support its current valuation, especially in regard to the order book for its winder power business and how APWR would fend off its more established competitors.  Current 2009 guidance does not include contribution from wind power business as the company is still working with its customers on pricing terms which for competitive reasons could not be disclosed.

    ·      20F filing possibly by the end of June 

    ·      July 2009: the deadline to deliver 2 units of 2.7 MW wind turbines

     

    Disclaimer: the author has no exposure to APWR.

    Tags: APWR, Wind Power, China, Alternative Energy, Wind Turbine, China Wind Power, Green
    Jun 16 01:32 pm | Link | Comment!
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