Silex: carbon free investing BY THE SOUTHERN CROSS EQUITIES TEAM AS EDITED BY CHARLIE AITKEN | PRINT THIS STORY The acquisition of the Sydney Olympic Park (SOP) solar manufacturing plant, formerly operated by BP's Australian solar business, will potentially transform market perceptions of Silex (SLX) and could make it our first billion dollar plus market cap carbon free company (current market capitalisation $883 million). The purchase of the facility (with a replacement value estimated to be around $70 million) for $7 million with the company testing what it feels could be game changing technology has been barely recognised by the market. Given the dearth of carbon free energy plays in Australia this would be a companymaking event. The fact it comes in a week when the multi-national group seeking to commercialise Silex's laser enrichment technology has formally sought a licence application and US Government loan guarantees ahead of this month's start of the test loop only strengthens the story. The platform for Silex's future has been based on the perpetual revenue based royalty which the GLE consortium (GE 51%,Hitachi 25%, Cameco 24%) has been willing to negotiate for a technology which promises to restructure the $US6 billion a year (and growing) uranium enrichment market. Under the deal GLE would pay 7 cents of each dollar of revenue generated by SILEX enrichment technology which could rise up to 12 cents depending on the efficiencies generated by the process. Until recently Silex believers have relied on the fact the GLE consortium capitalised the Silex venture at pushing a billion dollars as evidence their patience would be rewarded starting from 2013 when commercial operations are anticipated to commence. Now although confident that a decision to commercialise Silex will be made by year end, after meeting management in London this week we believe the solar story will take centre stage. In a deal reminiscent of Incitec Pivot's transformational purchase of the Southern Cross fertiliser plant from a disinterested seller, WMC, Silex has bought a solar plant which until recently produced 50 megawatts annual output in a facility which can see it more than triple output in a deal which, according to an article in the Financial Times this week, more reflects BP’s strategic designs rather than any inherent commercial logic. Silex believes it will able to generate 10 to 15MW of sales in 2010 (25% of the current Australian market) and if BP pulls its marketing operations in Australia (as suggested by the FT's report), then 30MW in the first year of operation is not out of the question. To put this into context 15MW roughly equals $45 million in revenue with margins for typical solar operations estimated to be at 20 to 30+% margins (50% of the cost base is in Silicon which looks to be in adequate supply for many years to come). Publicly BP plans to import solar panels from mega plants in China however given these are bulky to shift and the world price of silicon wafers is low it is hard to see how the oil giant competes with a local plant carrying no depreciation. The FT suggests solar would be buried as the Beyond Petroleum strategy is dumped as the company goes back to basics. Given SLX has very little capex and no amortisation, after the current qualification period which ends in fourth quarter, next year could see very real cashflow for the group. They feel that they have the expertise to get to 20% efficiency with advanced mono-silicon product (currently 17%) in the next couple of years, which would potentially rank with the world's best. Then there is Transluscent.... a process to improve the efficiency of solar panels which is being tested by the certification authorities in Boulder, Colorado, and Heriot Watt University, in Scotland. A progress report is expected in August and it is hoped the company has cracked the issues with the electrical properties which were a feature of the last update. Silex raised $50 million aid in 2007 to develop a pilot plant for the process ... on the basis it would cost an estimated $35 million aid to build a mono silicon pilot plant. At Homebush as part of the SOP deal, the company has picked up that pilot line as part of the purchase price. Now the company is able to generate revenues from the balance of the plant while hopefully testing its Transluscent technology. If the company believes it can better typical industry returns, this would suggest the opportunity to get to 30+% in a few years time although that at the very least is probably a 2012 outcome. The SOP deal gives Silex two to three year’s head start in commercial manufacturing, and the stock some real earnings to be valued, before we get to the possibility of the Wilmington royalty. The commercial plant start-up for the laser enrichment process is due 2013, when the royalty (somewhere between 7% to 12%) will start to kick in and could be as much as $US100 million per annum by 2015. Industry sources reckon that by that stage adding up the new centrifuge plants, less the diffusion plants that are being de-commissioned, the shortfall in the market will be about 6 million units. GE has stated its targeted production by that point will be 3.5 million to 6 million units. The test loop is scheduled to start up shortly and will operate for the next three to six months as the GLE partners of GE/Hitachi/Cameco evaluate the project. At this point there has been no indication other than of confidence in the outcome. Talking to Silex the issue is not whether the process works - that has been demonstrated in earlier activities - it is the capex, and operating/reliability cost issues. The process is a pioneering third generation one involving equipment including lasers engineered to extremely high standards. The royalties are based on the capex and revenues generated by SILEX technology. The cost of a SILEX plant is thought to be in the order of half of that of an equivalent centrifuge plant but the unknown is the detailed capex and this will determine Silex's returns. If one assumes the uranium enrichment market is worth $US6 billion annually and should grow as Russian weapons material and gas diffusion plants disappear let alone the growth in nuclear reactors and GLE can capture 20% of the market by 2015, a 10% royalty to SLX would earn it a $120 million payment. SCE could argue given the risks, $6 is a fair valuation but put in solar and SLX could easily move into double figures. For a technology company Silex has raised $90 million in its career and still has $60 million in the bank. SCE believes it has the potential to be Australia's first billion dollar market cap carbon free energy company and a poster child for Kevin Rudd's desire to show his green credentials. The stock Under remains a "buy" and our core large cap alternative energy play.
SLX Price at posting:
$6.71 Sentiment: Buy Disclosure: Held
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