Holding the Ivanhoe Bag?

What's the hottest notion on the street? Demand for resources, and the ascendancy of China. If you could figure out how to play both in an emerging company, it may be reasonable to expect that you're going to do very, very well.

One of the biggest risers in the stock market this year, returning more than 900% in the last 52 weeks, is just one of those plays -- Canadian energy company Ivanhoe Energy (Nasdaq: IVAN  ) . The company has had the press release machine fired up this year, bubbling with reports of its relationships in China as well as in other potentially lucrative markets. Two weeks ago the company mentioned that it had engaged top officials in Iraq about projects in that country and the company's stock leapt. Clearly company founder Robert Friedland's reputation for going to places others are unwilling to go has given Ivanhoe the aura of being on the cutting edge for getting into troubled but lucrative markets.

Ivanhoe Energy should not be confused with sister company Ivanhoe Mining, which has had the same PR machine going over its massive potential copper project in Mongolia. Ivanhoe mines is expected to begin trading in the U.S. as soon as tomorrow. The PR, at least, has paid off -- Ivanhoe energy has gone from being an obscure company with minimal interest to being one of the most heavily traded companies on the Nasdaq, with more than 11 million shares -- $66 million worth -- trading daily. That's nearly 7% of the company's float changing hands each day, for those of you playing the home game.

In Ivanhoe's most recent 10-Q, the company showed a 21% growth in revenues for the first nine months of 2003 as compared to 2002, and a net loss of a penny a share. I'd love to talk about the past nine months' results more, but frankly, for the bull case for Ivanhoe, they don't matter.

CBSMarketwatch's (Nasdaq: MKTW  ) Thom Calandra's exhortations that this is the next big thing notwithstanding, what you're dealing with in Ivanhoe is a company that is currently trading at 93 times revenues. That is absurdly high. Ah, but there is the matter of all of these potential projects and their untold billions of potential value. Here's what investors in this company need to ask themselves -- with what assets would such projects be developed?

According to Ivanhoe's unaudited financials, it has $7.6 million in cash and equivalents at present. In order to develop just one gas project, the LAK Ranch field in Wyoming, Ivanhoe would need to invest as much as $5 million, or most of the liquid resources it had on hand as of September 30. For other potential projects, certainly Ivanhoe's potential partners aren't simply going to give the company a stake -- it will have to commit financial resources, which it has to get from somewhere. Continuing operations that barely clear $10 million gross and are unprofitable aren't substantial enough to generate funding. Ivanhoe could, of course, tap the debt markets, but it is just as likely going to issue additional equity. This, of course, would make a high stock price very, very useful.

But useful for whom? Existing shareholders are going to have to hope that they're not only making correct assumptions that the company can deliver on its promise of tapping natural gas and oil development projects, but it can get good enough terms for funding so that they aren't diluted substantially.

Recent actions show that the company is willing to sell its own stock well below where it is currently priced. On November 5, Ivanhoe announced that it had arranged $12.5 million in financing for operations (which you can add to the amount disclosed in the 10-Q) through the sale of 3.1 million unregistered special warrants at $4 apiece. Each warrant entitles the undisclosed buyer to a share of Ivanhoe, plus 0.4 of a special purchase warrant, each whole special warrant entitling it to buy one more share at $4. This means, simply, that less than two weeks ago the company valued its own equity at substantially below $4 per share, meaning its $6-plus market price at present is a premium of more than 50%. One would expect the company to attempt to get full value for its own shares, so were I a shareholder I would take the sale price of this warrant quite seriously.

Robert Friedland has attracted his share of controversy over the years, most recently in an upcoming issue of Forbes Magazine. That the market seems to be throwing caution to the wind with a company that has as of yet produced very little is disturbing.

Disagree or want to pile on? Take it to theIvanhoe discussion board.


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