Gulf Resources An Acquisition Target?

Includes: ALB, CAF, FXI, GURE, HAO
by: Emerging Markets Investor
Bromine is a scarce resource in China; the country is a net importer of it. Bromine reserves are found in the Shandong province of China, the U.S. and the Dead Sea. Gulf Resources has one of six bromine exploration licenses granted in Shandong. In July 2006, the Shandong Provincial Government issued a decree which stated no additional bromine exploration licenses will be issued going forward. Since the decree, the Chinese government has shut down unlicensed bromine production facilities, creating a oligopoly in China for a few chosen companies. These companies have been buying up the remaining unlicensed bromine facilities, since they are worthless without a license. Due to the scarce supply of bromine in China and annual bromine consumption from 2000 to 2009 growing at an annual compound growth rate of 8.7%, the price of bromine has increased substantially from $813 per metric ton in 2000 to $2,850 per metric ton in March 2010. Click here for the company presentation to learn more.

Currently, there are at least 7 to 10 unlicensed bromine facilities that Gulf Resources is considering acquiring. So far, they have made 9 acquisitions for $76.9 million since April 2007, which increased their capacity from 12,000 metric tons to 46,300 metric tons. However, at some point, as in most roll-up industries, after the small players get gobbled up, the mid-sized players get acquired as well. (I know this from experience as my last start-up was acquired in a consolidating industry and I worked in mergers & acquisitions for five years on Wall Street.)

On July 29, 2010, Gulf Resources filed a S-3 with the SEC for up to $120 million in a mixed shelf offering for either a mix of equity, debt, or preferred securities. Given that Gulf Resources only produces 19% of the bromine produced in China, there are larger players in the market. It would be plausible to consider that Gulf Resources' competitors saw the mixed shelf offering and knew that Gulf Resources was serious about acquiring as many of the 7-10 other unlicensed players in Shandong. In order to take out a competitor, it is possible that ICL Group from Israel, Albemarle (NYSE:ALB), Shandong Haihua, or another player with deep pockets decided to make an acquisition offer for Gulf Resources last week. This could explain why the 2nd quarter conference call was delayed from Monday, August 9th to Tuesday, August 17th. The CEO, CFO and Board of Directors would need the extra time in order to consider an acquisition offer.

On Monday, August 9th, Gulf Resources pre-announced Q2 revenues of up to $46 million (beating consensus by over 20%), which is exactly what I predicted two weeks ago in my article Gulf Resources Q2 Revenue Preview: An Opportunity to Beat Consensus. It is clear that bromine prices and utilization are high. Gulf Resources is trading at less than 6x 2010 earnings. Israel Chemicals (ICL Group) trades at 18.8x earnings, which would make an acquisition of Gulf Resources highly accretive. A 40% premium to its current price would still make Gulf Resources only worth 8x 2010 earnings. Other than a strategic buyer, private equity firms are still flush with cash and Gulf Resources is a LBO target given its cash flow, growth opportunities, and no debt load. While an acquisition announcement might not happen next week, it is clear to me that Gulf Resources will keep rolling up smaller competitors until a large chemicals company finds Gulf Resources' low valuation, bromine reserves and license, too good to pass up.

Disclosure: Long GFRE at the time of this writing