China looms large on AIM

There are now 26 Chinese-based or Chinese-focused companies on AIM with a combined value of £1.2 billion. Those leading them are trying to gain an economic footprint in what has been touted (almost everywhere) as the most exciting growth market the world has ever seen.

China is the fourth largest economy on the globe, with just Germany, Japan and the United States now bigger in gross domestic product (GDP) terms. It overtook the UK last year and France some time ago and many expect it to vault to the top of the league within our lifetime.

The financial excitement it is generating around the world is not just about its rapid adoption of a version of free market trade, but also about its huge population (1.3 billion and counting) and the fact that its Communist Party-controlled government is embarking on some of the largest infrastructure and economic projects ever undertaken.

The movement of 100 million farmers to cities over the past couple of decades has led to the creation of vast new mega-cities. A typical example is Shenzen, which used to be a sleepy fishing village near Hong Kong two decades ago and is now a shimmering metropolis that rivals London in size and importance.

Current estimates suggest that another 400 million people could follow from the countryside to the cities over the next few decades.

This rapid urbanization has led to huge building programmes, water projects (think of the gargantuan Three Gorges Dam) and immense transport developments (modern roads are springing up everywhere, the world’s largest airports are being built and the world’s highest railway between China and Tibet has just been completed). All of this, obviously, has increased demand for every type of essential raw material and type of energy available.

There are of course many risks to continuing Chinese development – from inflation, internal political divisions and widespread poverty, to currency wrangles and regional political instability. There is also the added difficulty of doing business in a country whose system of contract law is not something many Westerners would recognize. But with the economy steaming ahead and the government’s fixed-asset investment going up by $1.5 trillion a year, all the world continues to beat a path to the investment door, downplaying the worries in the hope of turning a profit in the short term at least.

AIM’s Chinese mining minnows
As you might expect, mining plays a big part in this resources-hungry, still-developing economy. But of the cluster of China resource plays on AIM, five out of the six are concentrating on gold and, of these, only gold and zinc developer Griffin Mining actually managed to deliver a profit in its last full year results.

Chaired by Australian former financier Mladen Ninkov, the group made a £172,500 pre-tax profit on maiden revenues of £3.4 million in calendar 2005 from its Caijiaying zinc and gold mine. That this profit arrived was thanks in part to a strong zinc price, which has since fallen to below $3,450 a tonne, although Ninkov recalls that Griffin’s feasibility study assumed a zinc price of just $760 a tonne.

With year-end cash of £3.7 million, Ninkov intends to expand operations on the hope of building a second mine at Caijiaying. Griffin is expected to grow quickly now and is forecast to make a £7.5 million profit and 8.5p of earnings in 2006, putting the 88.25p shares on a prospective p/e of 10.4.

Generating an equal amount of excitement is South China Resources, a venture drilling for copper, iron and molybdenum at its Danfeng project in the province of Shaanxi. Thanks to three ‘significant’ discoveries at the start of the year, the company now believes the high-grade underground molybdenum veins at Danfeng 'may extend over a much larger area than first thought'. £5.5 million was raised at 13.5p in February to accelerate development. This price skipped higher to the present 22p on the April news of an agreement with the state-owned Xi'an Institute for Geology and Mineral Resources to evaluate four ‘significant’ copper-molybdenum systems recently discovered by the Institute around 40 km from Danfeng. Worth a punt.

Energy needs
China is the second largest consumer of crude in the world and imports 40 per cent of this, so the government is extremely keen on developing alternatives. A potentially exciting play on one aspect of this insatiable thirst is waste oil re-processor China Biodiesel. Total Chinese diesel consumption was more than 90 million tonnes in 2005, of which CB produced 17,000 tonnes. The proprietary technology at its first plant in Fujian province allows it to use waste oil to produce biodiesel that can be sold at five per cent below the normal diesel price and still maintain its impressive 40 per cent margins. CB believes almost five million tonnes of waste animal, vegetable or palm oil is available from cooking oil and industrial sources per year in China alone, and this costs ‘around half’ the price of the pure virgin oil that virtually all competitors have to use.

There’s easily enough demand in China alone to soak up the further 80,000 tonnes a year to which it is increasing its capacity with a second and third factory. For this purpose £8 million was raised at 85p, capitalising the company at £38.6 million and leaving it with net cash. And because CB has pulled in money from foreign investors, it gets zero tax on the new plants it opens this year and next. Furthermore, Chinese renewable energy laws officially came into effect in January, meaning subsidies on fossil fuels will be reduced and tax concessions on biodiesel introduced. Furthermore petrol stations will be obligedto use biodiesel if it is available (biodiesel can be mixed with fossil-fuel diesel, so there are no storage or petrol-pump issues). CB intends to pay a dividend in April 2007 and house broker Evolution forecasts a 34 per cent increase in profits to £2.6m. With its high margins, profits, vast potential growth, a ravenous market and green tinge, this is a strong buy.

Financial counters to consider
Previously a dismal AIM performer, Asia-focused merchant bank London Asia Capital has turned things around recently, trebling pre-tax profits to £900,000 in 2005 after floating six Chinese companies on OFEX. It has strong institutional backing itself, having attracted such investors as Merrill Lynch, Schroders and New Star for its new £50 million London Asia Chinese Private Equity Fund, floated at 100p and now trading at 108.5p. This fund, says chairman Jack Wrigglesworth, tackles the problem of finding 'significantly more opportunities than we can currently take advantage of' on China's surging corporate scene. The shares have had a volatile history and are only for the steely nerved. Managed by London Asia chief executive Simon Littlewood, the fund has made five investments to date, recently pouring £9.4 million into such ventures as a business school, a maker of ethanol production technology and a health foods company.

Lossmaking investment vehicle EnterpriseAsia manages a tiny portfolio that is principally made up of a 9.7 per cent share of a waste incineration plant in Dongguan City and small investments in similar impending plants. Chairman Davie Auyeung imagines these projects are ‘the tip of the iceberg’ and is raising £1 million to up the pace. Its fledgling status, however, makes it a stock to avoid for now.

Similarly, AIM’s diminutive clique of China-focused cash shells is having difficulty locating suitable acquisitions. The gang has been reduced to just two and may soon be a solitary one.

Bossed by Chris Cleverly, Sweet China recently delisted as delays in completing the acquisition of a confectionary company meant that its listing was cancelled under AIM’s new rules. And Strategic Global Investment was suspended in April under the same rules and has until October to complete a deal before it too is given the boot.

The third shell, Asia Capital, has had a ‘frustrating’ year, having lost £300,000, leaving just £13,000 left on its balance sheet. If a deal is not completed before September, it is likely to fall off the market. (For more on cash shells, see page 24.)

Unlike the small, unhappy band of finance sector ventures above, equity finance house SovGEM is having a whale of a time. Maiden results for 2005 showed it boosting NAV per share to 18.42p after its four successful investments delivered a £1.3 million gain and a retained profit of £275,966. SovGEM had £1.5 million of cash left at year end and boasts a further improved network of investment introducers. Chairman Garth Milne stresses that the company’s investment strategy reflects ‘a strong and simple belief that companies servicing Chinese domestic demand will continue to prosper’.

SovGEM’s investments include Tynda Forest, a sustainable timber merchant operating just over the Russian border whose chairman Peter Hambro and his son Leo, the managing director, plan to float on AIM later this year. Another is Bodisen Biotech, a newly AIM-listed organic fertilizer and pesticide manufacturer.

Bodisen is led by former China businesswoman of the year Karen Qiong Wang and is listed on the American Stock Exchange. It arrived in London in February after a £12 million fundraising at 730p. It made net income of $7.4 million from $31 million revenue in 2005 and was identified in 2006 by Forbes as the 16th fastest growing company in China. The shares have since been higher than £10 and as low as 450p but have come back to 730p now with recent deals confirming a supply contract for 200,000 metric tons of fertilizer for 2007 (which the company estimates is worth $45 million) with a Xinjiang city council. With plans this year to continue to expand, the shares look a decent bet for considerable further growth.

Betting on the best of the rest
The Chinese love a wager – the late Singaporean Prime Minister Lee Kuan Yew called them ‘congenital gamblers’ – but gambling is illegal on the mainland and only lotteries provide an outlet for this pent up yearning. The arrival of the formerly Ofex-quoted lottery and gaming business Betex on AIM in March opened up access to this market.

Betex is run by the well-connected Dr Johnny Hon, the Cambridge psychiatry graduate-turned financier, who has won consultancy agreements involving China’s Sports Lottery in two provinces, Hebei and Guizhou. Between them, the two provinces have more than 100 million inhabitants and represent about 5.2 per cent of the £4.4 billion of sports lottery sales in China. The prospect of winning further sports lottery deals in other provinces provides potential excitement. Betex lost £3.6 million on £133 million sales in 2005 and has plenty of cash left from its £12.5 million fundraising to support expansion.

It looks a very decent bet.
Another worthy of attention is China Shoto, the profitable producer of industrial batteries for the fast growing telecoms sector. The company floated in December and in April posted a pre-tax profit of £3.8 million on £28.4 million revenues. £5 million was recently raised at 160p to increase battery production capacity and invest in widening the product portfolio. At the present price of 193p China Shoto is trading on 8.9 times 2006 forecast earnings. Buy.

Equally alluring is EBT Mobile China, which has the qualities to become the Carphone Warehouse of China, with all the implications that China’s massive population provides.