China- shut-down or slowdown?

When Xstrata's Mick Davis said China's extraordinary growth would be "stronger for longer" it was a phrase that stuck.  It matched a constant flow of economic data which grew more powerful as the mid decade years sped on. Capital inflow, retail sales, building construction, steel and cement production increased year by year, sometimes by extraordinary amounts. China's rural poor were heading to the cities and as we heard repeatedly, this alone meant China had to build "a Brisbane a month".

If anything the data may have been understated, but sceptics looked on concerned at both the pace and the quality of this roaring environment.  Beijing clearly revelled in the statistics as China's power and influence grew. The world was flocking to China it seemed but very often the factories were simply outsourced production divisions for US, European and Asian markets.  the US marketsof e y have been deliberately misleading and in fact the growth may have been understated at times, the cautious China observers were warning that this was all too aggressive and too much designed to boost China's national image.  It was also a period when the entrepreneur often had open slather.  

sion of housing were the property entrepreneurs who were targeting high national savings with up-market and even luxurious  apartments. 

Those were the policies, but the right investment question is not what is happening now, but what will happen. The future is rarely a lineal copy of the present. 

BHP and Rio were alsofirm proponents of the "stronger for longer" view.  Were it coming just from Hegarty and Fortescue's Andrew Forest, many may have resisted,but with these corporations and all their presumed market intelligence, it was largely taken on faith that they really did understand the dynamics of China' materials demand.

This is what was actually happening - we have seen it first hand - but once in China, the observer is at once both impressed and distressed. The development seems manic and all enveloped in a haze that reduces visibility to three to four kilometres or less. At times the countryside seems worse. We never heard these executives say the obvious and right thing: this cannot continue.

Neither gave the slightest indication of slowing iron output as China's steel production raced past 450,000 tonnes pa as 2008 began. Now that the massive Chinese economy has temporarily stalled, at least as a metals importer, it will be interesting to see how two iron giants reconsider their supply ambitions and intepret these new levels of demand. 

At first blush it seems inconceivable that BHP and Rio (and Vale) could have misundetood the true depth of Chinese metals demand. Perhaps we should not be surprised. Large scale corporate misjudgements are actually very common. (We only have to look back at the ASX Top 50 of 1988 to see how many large companies have fallen by the wayside). Could this be another colossal corporate mistake like Kodak's unwilling to accept the demise of film or GM's addiction to heavy, energy inefficient vehicles? 

Currently BHP executives are dispersing around China to try to get an accurate picture of the true state of demand. We confess immediately that we are perplexed by the speed of the slow down. There have been sharp dips in the import data for the last decade, but they were soon followed by a reversion to the previous trend.  But the figures were massive. China's steel demand rose from just half of Japan's in ...... to three times Japan's  moved from being swings in the import figures of . After each return to China the impression one has is of restless new development. Apparently this has slowed or even stopped abruptly in Guangzhou. This should not surprise. Our property crash in Australia in the early nineties was also an abrupt affair.  The cranes themselves made it look top- heavy at the time and so it proved to be.  The property recession lasted for at least four years.

We have to ask how long this interruption will be and whether it becomes a recession or as some are arguing, a deep global depression. There are a number of points to make.

First, it is mistake to confuse China's large exports with the Chinese economy and to confuse its US exports with its Asian and European exports. In fact China's exports to Europe are slightly higher than exports to the US.is may seem obvious, but we are fed our news through a filter of US . China is partly reliant on exports to the USA, The exports, particularly from the Pearl River Delta region are very important. We gather that thousands of consumer goods plants are closing.  



reet with no vested interest , the people in the street wondered. ties, particularly Beijing.  After 20-25 years of high speed development, there is little of old Bejing left.  We hear that cranes and scaffolding are Guang
mplied that some didn't agree or at least some didn't believe the China story or at least qualified view pushed by Oxiana, BHP and Rio over the last two to three years and enthusiastically supported by the likes of Southern Crosss Equities, it was difficult not to concede that by 2008 China was perhaps only half way or even a third into its re-birth as a modern industrial power.  One could quibble that many did not seem to understand that China still retained its centricst political structure, even if it was experimenting with free-markets devolution on the outer skin.

On the analogy with the USA 's industrial expansion 1870-1929, it seemed fair to argue that perhaps half way into its t was always intended as a longer range forecast. Most commentators added the caveat that there would be bumps on the way, although they may not have envisaged a bump like the present one where many Chinese companies are asking for contracts to be reviewed.

Who has cash? - October 12

Now that the government will guarantee all bank deposits - no matter how large - attention turns to the companies with  cash. The more the better. We identify several large, mid and small cap companies with ample fire power for acquisitions once the banking systems stablises.

At the big end of the market Seven Network is one one of the most liquid relative to its size with $1.16 billion in cash forming 98% of its current market value. This represents a breathtaking revaluation of the business assets which until two weeks ago were worth at least $300m but are now effectvely zero.

At the centre is the 50% stake in the television network and the seven magazines which it shares with Wall Street  leveraged buy-out firm KKR. Then. orbiting this core holding, are various media and other assets consisting principally of a 22% holding in WA News, 4.58% of Consolidate Media, owenership of the "under development" wireless business Unwired and effective control of Engin, a internet and VOP service provider making painful losses.  Unrelated to this collection is a stake in GRD, the mineral and waste processing design engineers which has a solid pipeline of projects, but which has also slumped..

A buy-back at current levels will be highly accretive as Kerry Stokes makes up for buying into media assets at the top; he can now have a second go at the bottom paying as little as $240m for eliminating 20% of the shareson issue. This will leave Seven with about $900m and a mixed collection of media assets: two cash-cows in Seven Media Group and WAN and the two fairly expensive experiments in engin and Unwired. "The Wimax" technology has its sceptics, but does have the great advanatge of relatively low cost roll-out.  The obvious query hanging over this lot is whether the Seven team and Stokes have the capacity to second guess where broadcast technology will go and the uptake in a more subdued, dollar conscious environment. The "products" touted by the new media crowd tend to be faddish and trivial; restaurants and cricket scores. But we should show some rspect; Kerry Stokes did not make his multimillions by day-dreaming.

He now has one of the biggest war chests on the scene; it will be difficult not to buy well.

Others with significantly high cash balances include Origin aat the big end of town and IMF, Ipernica and Oncard at the micro end of the market.  For Oncard's situation see our report blwo, but don't ignore the litigation businesses IMF and Ipernica with $83m and $32m each.  For IMF this represents 95% of the market cap and for Ipernica it is also roughly 100%. As with Seven the market's pricing of these ones is wildly awry, typical of times of stress.

In both almost all future growth is discounetd out of contention, whereas the informed observer, or perhaps we should see the unstressed observer can fairly predict that both will have a fair share of settlements from cases in progress and more to be joined. It is also likely that broadly both are in a better position to bring cases and manage cases, being well cashed up. Ring for more detailed reports.

The market efficiency hypthosis is a typical example of our academic thinking seeks to create laws and models of aspects of human behaviour like economics where there is only complexity and impermenance.

Blue Energy (BUL) - October 10

Blue Energy's review of its position has an upbeat note. It should. Wih cash of $20m, an off-take ageement with Stanwell Power (see below September) which supplies 30% of Queensland's energy and the sight of Shell sniffing around the great coal plains of central west Queensland it senses strong potential. Recent drilling is confirming the gas content expected which is lending early stage support to BUL's 10-30TCF estimate.

An immediate market hurdle is the clearance of shares held by the receiver of Opes Prime. Sad to say, one of the company's founder's used his BUL shares as collateral with that abysmally incompetent share financier and lost the lot as ANZ scrambled to retrieve its funds from Opes Prime.  The receiver has held on as the market crumbled; instead of considering our offer at 23-24c, he is now dealing with a market at 16-17c. But this is not Blue's problem. .

It owns 100% of its ground 10-11 leases covering 30,000 sq kilometres, the second largest acreage of all the coal seam stocks. This means BUL can slice and dice these leases several times and still retain possibly as much as $25% free carried. 

What would that be worth?  Conoco-Philips has set the base price  at $1.80 per unit, but with a return to normal markets and the amount of interest being shown by off-shore majors locked out of oil and gas resouces, we can expect prices considerably higher. It will be an interesting few months. Stanwell paid 40c without a quibble, obviously aware that the shares will be eventually worth far more than that.  We destest the expression "ten banger" as it conveys all of that puff chested grossnes than has undone America, but if ever there was a "ten banger" in the making, this is one.
 

Oncard: cash positive - October 9

We confess we are a neighbour of Oncard. It helps to be able to duck next door to grasp another piece of the jig-saw which, it tuns out, is as simpler business than it seems at first sight.

Oncard deals in cash and like Scrooge McDuck is dedicated to the stuff. It has $15m in the bank which covers listing fees and the salary and travel of a small Australian management team, but the rest of the company is off-stage in Asia, principally China where 400 or so employees in 100% owned companies or joint ventures promote the concept of convenient, secure, fraud-free payment technology.. Who uses it? At this point about 7000 organisations which either want to reward employees with a tax free component of salary, or track spending with reward and loyalty points or who simply want to use a debit card as a promotional tool. In Singapore Oncard manages a diners cards.. In New Zealand it operates a popular fuel card..

Intersting perhaps, but there are plenty of cards operators around like American Express and Diners. There are, but they have focussed on selling debt, not on facilitating payments. They are the mirror image of a debit operation which earns lower interest, but rather than advance capital, they receive it until drawn down.

After two and a half years the business is gathering pace. It has 16 million cards on issue, well up on last year's 8 million.  Income comes from the merchant fee, the interest on the total pool of funds advanced on trust to Oncard (now "over" $100m*) and from part of the unspent residual on the cards.

Perhaps the most significant aspect is an agreement with a subsidiary of the Bank of China, Beijing All-Payments. Surprising as it may seem, the central bank has sought Oncard's expertise to assist in the roll out of a national on-line payments system. China does have cheques, but is basically leap-frogging this expensive, risk prone method of organising bearer payments. After all, cash or debit cards are an electronic form of bearer cheques, but with an inbult electronic clearance. It takes a moment to absorb the significance of this step. China's commercial presence will percolate through Asia. Guiding aspects of this will be Oncard's Executive Chairman's with the experience of twenty five years in the electronic payments division of ANZ, a facility for languages and an upbeat personality.

As a package Oncard passes our cred test in several respects. It has some well known names on the registry, it has no debt; cash representing three fifths of its market cap; and it is doing business in high growth, high savings economies. In all of them wads of cash are still the basic payment system. In time it will be largely electronic.

* We've tackled Peter Abotomey a few times about what "over" means. The answer is always the same: "It means over"

Conoco supports coal seam gas - September 10

Down south we don't get it. Victorians are stuck with low energy brown coal for most of their power supply,but up north iits all go for gas.  ConocoPhillips has just confirmed how valuable Queensland's vast resource of coal seam gas are when considered soberly and globally. By laying down almost seven billion, some immediately, Conoco has gazumped BG which thought it had the measure of the parochial locals. For a moment BG had the market's attention. By laying out some $13 billion for all of Orgin - resources, power generation and distribution - the bid could down-play the real target, its still to be fully quantified coal seam gas assets in Queensland. Origin almost took the bait as this was almost double the what Sydney and Melbourne fund managers were prepared to pay. Fortunately on the same weekend as its Board was deliberating, Santos announced a deal with Petronas (see below) which valued its neighbouring coal seam gas at twice the price. 

Origin opened its eyes and quickly rejected the bid. Its coal seam gas leases were still largely in the resource category and not certified as "proven". Once precisely defined, they could be worth $13-20 billion alone, quite apart from all the other Origin assets. This is what ConocoPhillips obviously believes. When offered a half share in Origin's leases, apparently its technical people nearly wet themselves. Not only did they have scale; they had consistency. Now that the technology and know-how has arrived which can tap this type of gas, these coal measures are one of the great energy resources of the world. They are also located in Australia where official corruption, at least in this sphere is unknown.  Just as importantly, they are Pacific rim assets, a diversification from middle east gas reserves.

And even more importantly they are marvellously cheap. Conoco's home market is paying between A$10-11 for the same volume of gas as of mid September. In Australia it has just bought into what could become a half share of much more than the 4 trillion cubic feet of proven and probable gas. When these reliable coal measures are drilled into better definition, Conoco may have dealt itself into 10 TCF or possibly even 15, all for under A$2.  Add one dollar for liquifaction and Conoco has a deal to dream on.

It gets better. Like all energy companies Conoco has been monitoring the climate change debate. As oil and coal carry an increasing impost for their carbon emissions, gas will be seen as the clean or at least "cleaner" fuel and grow in demand. This is already occurring in the UK where the policy is to phase out coal as much as possible in favour of gas fired power generation.  The upshot is a win-win. Origin keeps itself intact and has a huge partner to turn its gas into saleable LNG for Asia. It also has cash - massive amounts of it.  The market remains still doesn't get it, but in time will.  The underlining point is that proven, probable and possible in this context is qualtatively different than conventional oil field gas. That gas can escape along cracks and faults. It is corectly called "possible".  In this case the better term is "contingent". The coal is known to be there: the question becomes how well the gas it contains flows, not whether it is there at all.

Blue Energy (BUL) - September 11

Blue Energy has done an early stage estimate of its gas reserves which it puts at 21 Trillion cubic feet of gas, If this resource can be converted into a reserve of even 10 TCF, this will be a very serious asset. Recent deals done by Santos and Petronas valued proven gas at just under $5 a GJ so if an independent geologist confirms Blue Energy's mid-case estimate of 21TCF shareholders are looking at values of $40 billion or more.  

That's a serious number for a company trading at 28c for a cap of $124 million. Stanwell Power must have accepted the story to some degree as it paid 40c in early August as part of a strategic partnership supply arrangement which guaranteed the power station 1% of this resource over 20 years. From a glass half empty perspective Blue Energy now needs to sign up contracts for the remaining 99% of its self-estimated resource, or from a half full perspective it may be able to sell gas to the world markets over the next decade at far higher prices than are prevailing in Queensland at the moment. The market price remains paralysed by the large volume of Blue Energy shares which fell into the hands of ANZ following the collapse of a margin lender associated with ANZ.  While this had nothing to do with Blue Energy. the shares were held by one of its founders who mortgaged his shares. The legailities of the issue are contentious. The fine print may not be, but when the surrounding circumastances are admitted, it seems that ANZ and its associates may have said one thing and meant another. The only relevance of this side issue is that it put BUL's shares under the cloud of a large possible sale by the receiver.  Once they are sold and locked away, there is every reason for Blue Energy shares to trade closer to the 40c that Stanwell thought it could easily justify..

Can Blue Energy reflect its inherent value? As we note above, these coal seams are far more predictable than oil gas structures.  In these reservoirs seimic can indicate hyrdocarbons, but it may have migrated or leaked in past eons. Coal seams are different.  The do vary in their capacity to hold and release gas, even over relatively short distances, but there is a far greater degree of predictability. The coal is there stretching for thousands of kilometres north south along the inland eastern coast. In a relatively short time we expect BUL to reveal is value.

ESI  -September 10

It would be difficult to find a share performance worse than ESI's over the last three years.  As the Chairman frankly said today, almost every governance aspect of this energy company went awry since listing. It was undercapitalised, management was not ready, major shareholders had too large a say...he went on. But when he turned to the actual business the message was far more positive. ESI was getting there. It had formed firm commercial partnerships and had viable plans and projections. It is a good idea.

Ideas, however, don't spin cash. We should explain that ESI holds the rights to a patented method of drying lignite or brown coal. It is simple enough even if it took a decade to fully develop.  Brown coal, a very soft material, is crushed to powder form. Water is added to form what looks like black dough. It is stirred (attritoned to be technical) and extruded like pasta wich forms pellets about the size of a thumb. With the surface area greatly expanded the internal heat generated by attrition is given a further evaporative assistance with warm air drawn from nearby power stations. A furher period of drying ( 48 hours is plenty) reduces the water content from 60-62% to 12%. The result is a highy reactive, low sulphur coal which can be used as direct power station feed or as a steel coal. When mixed with low grade iron ore (high grade works well but costs more) it ignites well in a retort and produces high quality, low carbon steel.  It can also be used to produce gas or oil by the same proces used by Sasol in South Africa.  More importantly in the short term, the net greenhouse emissions of of dried coal are far less than wet coal, for the simple reason that the energy content of the coal rises almost threefold. The less coal used, the less emissions.

The concept has commercial potential for several reasons.

1) Market size: about 40% of the world's coal is lignite and 90% of Victoria's power is generated by brown coal. 

2) lignite poses a high risk for power stations as they face rising carbon imposts either as permits or taxes.

3) the related steel proces (Matmor) is proven. While a boutique process for the time being, it has flexibility. Coke ovens can be by-passed and a range of steels can be prodcued with simple retorts which use the high volatility of the coal's gas to create the temperatures required.

4) lignite is a cheap fuel, far cheaper than power coal. This process produces an energy equivalent coal for $25-30, offering scope for very high margins.

That's the positives. One considerable draw-back is the Australian market's entrenched hostility to technology and to improvement and change. Americans once prided themselves on a "can do" culture; ours is so often a defensive "can't do" society which many investment professionals, almost entirely unqualified in hard sciences, prefer for its lack of technical challenge. To many Coca Cola is the quintessential and  ideal stock. There is nothing to make or improve or enhance in value. Buy water, add sugar and advertise. Margins are good, stress is low. If it contributes to an obese, lethargic society so be it. Let the masses drink coke; the main concern is relative investment performance and maintenance of fees. Why make life difficult?

Will ESI succeed?  We're hopeful, not certain. There is now a process design, temporary funding is in place and we believe there are some reasonably sized players who are happy to be associated with the construction of a plant in the La Trobe Valley. The risks are falling but not removed. Still lacking is publicly stated support from a power generator. An MOU from one expressing interest is something, but not much in this climate. However, we are reassured by the Chairman's firm words. The Board certainly understands what it has to do. What ESI needs now is an engineer partner of scale. A Transfield would be good, a Worley Parsons or Tata would be even better.  Stranger things have happened. Small Jervois has China Rail, one of the world's Top 300 companies, as its development partner for its Young nickel project. 

Maybe ESI will think outside the square.  One thing is certain: Victoria's power stations will have to reduce their CO2 emissions fairly soon. Once the Tibetan glaciers have melted completely (about 25% gone now) the great rivers of Asia will only run in the wet season. Not good, but maybe they could drink coke instead. 

Silex Systems - solar project still coming -August 2008

The latest operational update says the solar cell project is "well advanced" but still coming. November 2007 was to be the completion date and now it appears that "mid year" 2008 will stetch to November or December. Nevertheless, a completed thin-film multi-junction photovoltaic collector doped with rare earth oxides should be worth the wait. 

The objective is a relatively low cost, robust sheet of silicon film which can be laid on glass and able to capture most of the sun's radiant energy from dawn to dusk regardless of light conditions.

The immediate objective is third party ratification so that mass production can begin next year. In previous updates the photonic processor project was slated for a late 2008 release, but we are unclear whther this too will be delayed as Silex is not given to plain English announcements.

Still, the market has taken the delay of the silicon project with remarkable equanimity. There was slight dip, but during turbulent week, the market has held around $6.90- 7.00 perhaps because the nuclear enrichment project now funded by the GE-Hitachi consortium seemed to be going as planned or even ahead of shedule.  .   

The photonic processor project seems to also be on track with some advances made in materials. Silex followers tend to become befogged by the opaque language of these releases, but as we understand Silex through its Californian subsidiary and some collaborator laboraties is within a short distance of the holy grail of data processing: the use of light (photons) to drive micro-circuits, so producing a step up in speed and a sudden shrinkage in size as the cicruits will be much cooler. With heat dispersal no longer required it is a case of "Honey, I shrank the chip"

We hesitate to guess the commercial value of a both projects if succesfully commercialised,but clearly the global potential is large.  Europe is already preparing for a de-carbonised world with the French led Euopean-North African energy grid. Solar,wind and geo-thermal resources from the Sahara to Denmark are united in one system.