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Tuesday, January 30, 2007

MAE Engg @ 23.5 cts ( Alternative energy / Singapore ) 0 comments

Final Poll Results: 4:2

(P.S: Sorry for any disturbances the advertisements above may have caused you)

Main issues

1.Concept stock with no track record

2. Acquisition goodwill is staggering at current price

3. Dangerous to hold when market sentiment peaks

How does one analyse the valuation of a concept stock?

What is a concept stock? The best and most recent examples would be dot-com stocks, with no concrete earnings but armed with a blinding idea that captures popular imagination. These ideas tend to sound extremely plausible and promising, of course; the investors are not fools in the conventional, IQ aspect of the term.

What is the danger of a concept stock? Consider a company making losses and with negative equity. It then acquires a new business with a hot concept, pays for the acquisition with new shares, and then voila! Two things are achieved:
1) The negative equity on the balance sheet is wiped out, because "new equity" is injected, via the new shares issued to pay for the acquisition.
2) The new business, which might still be losing money, gets a high valuation and obtains exposure to the capital market
Who really cares how good the acquired business is? Well the original shareholders might care because they will be diluted .... but if the acquiree has a "hot" concept that captures market imagination, it inevitably will raise share price post-acquisition. And so everybody leaves happy.

This is just the danger of a concept stock I am describing of course, and MAE Engineering and its new biodiesel business may well turn out to be the best thing since sliced bread. But let's lay down the case for MAE Engineering:
1) Negative equity of -1.2 cents/share pre-acquisition (would have been even more negative before the rights issue that doubled MAE's shares outstanding)
2) Market turnaround was entirely on the basis of the new upcoming acquisition of a 38% stake in Lereno, a Malaysian specialist biodiesel manufacturer, which owns a proprietary winterised biodiesel technology that allows biodiesel to be used in temperate climates. Plans to build biodiesel plants in Malaysia (licence was available) and also Singapore (talks with EDB) further ignited market excitement.
3) Lereno is loss-making. According to filings, MAE's equity-accounted share (38%) of Lereno's results for the year ending March 2006 is negative S$0.5M, meaning Lereno lost about S$1.3M in the year. Lereno's NTA (net tangible assets) at the end of this period was S$1.4M, which means MAE's notional acquisition value of S$17.5M (paid in new shares valued at $0.05/share) factored in enormous goodwill. Current market valuation of 23.5 cents/share, of course, values the goodwill even higher. Incidentally, this goodwill need not be recognised on MAE's balance sheets because equity, rather than consolidation accounting, will be undertaken as share of Lereno is only 38%. Those hoping for more insight into Lereno's assets and liabilities will be disappointed.

How to value concept stocks properly? I don't know, and will not attempt to estimate anything for MAE's future prospects here. Processing the palm oil, in abundant supply from Malaysia and Indonesia (see "The coming biodiesel boom in Malaysia and Indonesia"), and then selling it as biodiesel in Europe where there is growing political will to diversify fuel sources away from Russia (see Russia's dominance in energy supply to Europe, and associated problems, in "Russia as an energy superpower"), sounds like a viable idea, but totally unquantifiable given the lack of industry and company track record. One thing to note about the proprietary winterised biodiesel technology though --- it is hardly as exclusive as they claim, because using additives to make winterised biodiesel has long been known (see link for example). Note that the claim made by Lereno is that the technology is "patentable", not "patented". That makes a lot of difference; it's probably one big step to heaven from earth that has to be taken.

The other thing of course, is that for those who are concerned about the market peaking, concept stocks with no real earnings are the exact ones to avoid. Market timing through complete sellout of one's portfolio may be unwise (might be too early), yet a heavier allocation to quality businesses may be prudent when top volume counters are mostly pennies day after day.

Poll(please vote)
I agree that MAE Engineering is a hot-stock-not: Agree/Disagree




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