pierponts view

The resources market is having its greatest boom in history, West Texas Intermediate went briefly through $US70 a barrel last week and anyone invested in oil and gas shares should be pouring Bollinger over their cornflakes every morning.

Unless, of course, they're shareholders in Sydney Gas, whose share price has halved from $1 to 50¢ over the past year.

Sydney Gas has a little problem. Unless it starts generating a lot of gas within the next two years, it's going to have either a lot of debt or a lot of shares.

The latest June quarter was the best ever for Sydney Gas, with $2million in sales. But expenses ran to more than $7million so operating cash flow was negative by $5.6million.

The company is at the critical point where the cost of developing its methane fields is running much higher than its income from selling the gas. To bridge this gap, Sydney Gas has arranged to raise up to $50million in committed underwriting bonds (CUBs), of which it has so far drawn $15million.

Part of that money has been used to repay an interest-free loan from Sydney Gas's main customer, AGL, and the rest is being ploughed into working capital.

That leaves open the question of how Sydney Gas is going to repay the CUBs, which mature two years after being issued. At that date, they can be redeemed by Sydney Gas buying them back or by the sale of Sydney Gas shares issued to the Chimaera CUB Trust, which issued the CUBs.

CUBs are issued by Chimaera at a margin of 4.25per cent above the Reserve Bank of Australia target rate, which now means they are on a coupon of 9.75per cent. If they are converted into shares, Sydney Gas has to issue enough scrip to cover unpaid interest and a 5per cent premium. CUBs were supposed to be listed on the ASX after issue, but for some reason that hasn't happened yet.

On top of the CUBs, Sydney Gas has nearly $30million in convertible notes due to mature next April and June. The note holders can either take cash or convert at 60¢. If Sydney Gas shares are still 50¢ by then, the note holders will go for cash, which would mean the company would have to issue enough shares to pay them out.

So between CUBs and convertible notes, Sydney Gas shareholders stand to be massively diluted some time over the next couple of years. The alternative would be for Sydney Gas to suddenly find a whole lot more methane, but Pierpont hopes that doesn't happen either, because when you strike a whole lot of methane all at once it has a nasty habit of exploding.

If any Sydney Gas shareholders are at all nervous about the CUBs being issued by Chimaera, Pierpont recommends they should not spend any time studying the recent performance of Luminus Systems Ltd.

Luminus was formerly a US company named Digital Now Inc, which sought bankruptcy protection in Chapter 11. A couple of chaps named Sal Catalano and Ian Pattison brought it out of Chapter 11 and transformed Digital Now into the Australian listed company Luminus Systems.

Luminus has a system that scans old-fashioned photos and turns them into digital images. The most luminous aspect of the company was its information memorandum issued in May last year, which positively glowed with optimism.

The document said Luminus was "a leading developer of digital imaging technology and application service solutions for the photofinishing industry". The memorandum said Luminus offered a comprehensive breadth of solutions and was a clear leader in the design and development of high-performance software and high-speed, high-resolution scanners.

It had European operating subsidiaries, a large, diversified customer base, an established distribution network and an experienced management team.

Subscribers who bought shares after reading all that may have been somewhat jarred, therefore, when Luminus reported a loss of $3.6million for calendar 2004. Revenues of $2million had been easily outstripped by costs. The balance sheet looked even worse, showing a deficiency on assets of $6.3million. The shares, which had looked tragic enough in October 2004 at 2¢, were down to 1¢ by early this year.

The Luminus board resolved to overcome these problems by a $10million equity raising. Innocent readers may wonder how a company can raise $10 million when its shares are only 1¢. The answer is easy: just issue more shares.

Luminus had some 350million shares on issue at the time. To raise the $10 million, it issued a further 2billion at half a cent each.

This brilliant manoeuvre has been something less than a resounding success. In calendar 2004, Luminus lost $3.6million and in the half-year to June 2005 it lost a further $1.8 million.

Revenue has been shrinking. In the half-year to June 2005 it was $850,000 - barely half the level of the previous corresponding period. The subscribers who pumped $10 million into Luminus a year ago are now looking at a company with net assets of less than $1.8 million.

The shares they bought at half a cent are now down to one-fifth of a cent, so they've taken a 60per cent loss. And if Luminus keeps losing money at its present rate, it will hit the wall somewhere around Christmas.

The directors, including Sal and Ian, say it's not possible to provide a reliable sales forecast from here, so they haven't.

Harking back to the start of today's column, poor puzzled readers must be wondering what the misfortunes of Luminus have to do with Sydney Gas. The answer is that they're both being financed by Chimaera.

Sal and Ian are directors of Chimaera Capital Ltd, which is providing the CUBs for Sydney Gas and which will be responsible for raising the money for their redemption. What recourse Sydney Gas shareholders will have if Chimaera fails to deliver is an open question, because according to the Australian Securities and Investments Commission's database, Chimaera Capital has a paid capital of only $73,000.

Chimaera must have access to more capital than that because it appears to have stumped up some three-quarters of the $10 million raised by Luminus. But Luminus proves that Chimaera's backing is no guarantee of success for either a company or its shares.

What Pierpont doesn't know - and what is by no means evident from such documents as have been made public - is where Chimaera gets its funding from. Chimaera made a quick million dollars recently from Harvey World Travel, but it looks to be down the hole for $7million in Luminus so far and has the job of recycling maybe $50million or more of Sydney Gas shares in the next year or two. Pierpont rang Chimaera this week to ask, but they couldn't talk to him, so Pierpont will just have to die wondering.

Following last week's column on Knights Insolvency Administration, Pierpont received an email from the company's founder, Des Knight. In part, it read: "Thank you for a well-researched article. I sold the practice to [John] Schmierer on 5 March 1994 and have absolutely no connection with him or it.


"As you point out, the work in progress figures were not correct and could not be turned into collectible billings. The punters never had a chance."