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Oxford Catalysts: The Next Big Thing?

|Includes: Velocys PLC (OXFCF)

Oxford Catalysts is a stock which seems perfectly placed to 'go all the way'. The start up launched in 2004 began from the University of Oxford and four years later merged with Velocys in order to create one of the world's first modular Gas to Liquid plant manufacturers in the world.

Gas to Liquid is the process used to turn cheap and hard to transport gas into a form of synthetic crude, which in turn can be used to make high quality diesel and jet fuel. This is the closest you can get from turning coal into diamond from a financial standpoint and in the current climate where Natural Gas trades at sub $4 in the US while Brent Crud trades a $108.

If you look at it from an energy standpoint, the current price of gas ($3.69) gives you 1m British Thermal Units while one barrel of oil gives 5.8m BTU. Using this calculation, $3.69 in gas gets you the same power as $18.62 of oil.

The Gulf In Prices

This occurs because of a number of geographic, physical, and demand based problems. Because of the boom in natural gas powered by the economic viability of shale, supply has outpaced gas usage and gas storage. If you can't pump gas directly into the grid, the gas must be transported and stored, which requires liquefaction, followed by transportation in specially designed trucks and tankers, ending with storage. This costly process means that the harvesting of gas becomes economically unviable and as a result, gas is flared at source (burnt for a cost) or re injected when government policy doesn't allow flaring.

To add to the problems, demand doesn't seem to be ticking up all that quickly. The car industry has shown little interest in promoting LNG or CNG (compressed natural gas) as an alternative means of power because the economics are unviable at a consumer level. If you wanted to pick up the CNG version of your favourite car, the average increase in price is around $10,000, which takes 6 - 8 years to provide a return. Furthermore, even if you did decided on purchasing these cars, you would have only a handful of places to fill it up.

In the near future, the car industry is focusing on hybrids and battery powered cars and aside from a huge technology breakthrough, gas powered cars will not become mainstream in at least the next ten years and probably not even for a long period after that.

Gas to Liquid

According to Oxford Catalysts and assuming a $4 price of gas, the cost to a firm of producing synthetic crude is around $65 per barrel, where the equivalent market price works out at something North of $125 a barrel. Using GTL technology, it is therefore possible that oil companies can actually make $60 per barrel of diesel or jet fuel that they can make from their previously useless natural gas.

This technology is definitely not something on the fringes of widespread use. Two years ago, shell completed the world's largest GTL plant in Qatar. The cost of development was a whopping $18bn and has the capacity to produce 140,000 barrels per day! To put that into perspective, the project equates to just under 10% of Shell's market Cap and is equivalent to all the company's current cash on the balance sheet.

Not only are Shell getting involved, but Sasol are also looking to build a plant with a 100,000 bpd capacity. The technology itself is therefore considered a serious way of decreasing wastage and squeezing margin out of decrepid oil fields.

The Unique Selling Point

I'm sure it hasn't escaped you that I am concentrating on a company with a Market Cap of £182m when there are much bigger fish making this technology on a much larger scale. There is good reason.

If you look at the two projects I mentioned you will initially notice the sizeable daily output. Of course, only a few gas producing assets around the world can even come close to providing the amount of product needed to make the huge investment worthwhile. Furthermore, only a few of those have the available land space and only a few of those are adjacent to water (the only way the materials can be transported). Finally, if the asset is off-shore, then there is definitely no where to build these hulking great plants.

The Modular Solution

Oxford Catalysts have developed a micro-solution for all of the above. By using microchannel technology, they can create the same bpd output in only 10% of the space needed for the current technology! What's more, the product is completely scalable allowing business to set up plants as small as a two metres cubed with an output of 50bpd. The factories are also prefabricated in partner factories meaning that once ordered, the completed factory can be flown, driven or boated to your destination where it will be assembled. The company also believe that from the initial order, they can have your asset producing synthetic crude in 18 months.

The Economics

A modular GTL plant costs around $100k up front per barrel a day of production (assuming max capacity. Smaller ones will cost a little more) and assuming we order a 1,000 BPD plant, we are looking at a cost of $100m. If we assume that the $60 per barrel gross profit (mentioned above) is correct while assuming 365 days per year operation with 10% downtime, the annual gross profit is $19.71m. I have also assumed that we employ ten staff at $50k per year, bringing the operating profit to $19.21m.

On a 20 year life, with a 10% discount rate, the project NPV is $82.75m and the IRR is 23.5%. The economics are sound. Furthermore, if the customer is flaring gas then his revenue is more or less 100% profit. Increasingly sound.

Before I look into the financials in any more detail, it is also worth nothing that Rosneft ordered a 100 bpd plant and following on from this, their owner, the esteemed Roman Abramovitch invested £4.3m into the company.

Why Now

The company are on their first steps towards commercialisation. They have two customers in final stages checks before ordering (the company expect both orders to be confirmed at some point this year). The first potential order is from Culmet and is for a 1500bpd plant. The company believes this equates to $10m over two years and $30m over the next 20 years in catalyst replacement.

The second order is from Greensky London for a 1000bpd plant producing $30m over 3 years and $50m in replacement catalyst revenues over the next 15.

The company current takes revenue from three streams and these payments are stepped meaning that the company receive half upon the order and half upon project completion. The three revenue streams are as follows:

Reactors: I assume this is for the physical machines and OCG's gross margin is pretty Small (5- 10%).

License: This is the fee for allowing the customer to use the firm's patent portfolio and is more or less 100% Gross Margin.

Catalysts: The final payment is for catalysts which are used in the Fischer Tropsch process, giving OCG a 60% margin.

Of importance is the heavy skew towards catalyst revenue as this is the recurring revenue from which the company derives the bulk of the contract's total revenue. It is important to note that it is very difficult, if not impossible to go behind the firm's back and use a cheaper catalyst. Firstly, you are contractually bound to the company upon order, while the catalysts are unique in that they are optimised for the machinery and patent protected. Furthermore, in the grand scheme of things, the catalyst cost is actually significant when compared to syn-crude revenue, and so it isn't in the customer's interest to pollute the reactor's with foreign chemicals.

A 2000 bpd plant generates $20m in revenue of which the weighted Gross Margin is 49%. so this order will generate $4.9m per year for the first two years with a $6m payment every two years after that. Converting to GBP this is roughly £3.5m per year for the first two years and then £4m every other two years.

This year, the company took in revenues of £7.63m which included government grants (That have since finished), milestone payments and feasibility studies. All in all, the net profit was an £11.67m loss for the year. The 1 percent assume that the company will seal these orders along with a Rosneft order (they have bought 3% of the company, this assumes they have a vested interested in seeing good performance), two more milestone payments and some dribs and drabs, giving a 2013 revenue estimate of £18.4m vs this year's £7.6m. Gross profit will be £9m vs this years £2.8m.

Unfortunately, the company intends to ramp up commercialisation and sales force which costs money in the short term and the firm has indicated a £15m cash burn for the coming year. Despite a huge ramp up, it is therefore likely that 2013 will also be a loss-making year to the tune of £6m.

Is this a worry? Not immediately. The company has already done an equity raising (days after the closing of accounts and so the most recent FY will not show the excess cash) and will have roughly £39m cash in hand to keep them through to profitability. Furthermore, the company has 100k bpd of deals in the pipeline although these aren't particularly close to being wrapped up.

The bottom line is that this technology is new. It takes a little bit of time to find the customer who is willing to spend a significant amount of money on an only recently proven technology and OCG expects that once one customer pulls the trigger, it should open the door for many others.

There is really no point valuing this company financially as the date of profitability could be next year or it could be three years away. This is what you should be considering...

1. Do you like the technology

2. Do you see the technology as economical from a customer point of view

3. Does the company have a unique and protected product

4. Does the company have enough cash to see it through to profitability

5. Does the company have strategic investors who can impact the bottom line and have a vested interest to do so

For us @ the 1 percent, the answer is yes. I have added it to our top stop picks and hey, if you don't take our word for itm take Roman Abramovitches instead