Synthesis Energy Systems Full of Hot Gas

The Company: Synthesis Energy Systems, which builds and operates integrated coal-to-methanol gasification plants.

The Filing: A Form 8-K filed with the SEC on June 23, 2008.

The Finding: Synthesis Energy is using the proceeds from a $93 million equity offering to finance its 50 percent joint interest in the Golden Concord project, a 100-megawatt gasification plant under construction in Inner Mongolia, which the company expects to come online in the first half of 2010. The Company sold investors on its second round of equity financing (in less than a year) by touting its alleged first-mover advantages, combined with its inability ability to leverage unique technology into attractive financial returns.

The Upshot: In February 2008, Synthesis Energy commenced initial synthesis gasoline (syngas) sales at its first coal-to-methanol gasification plant in Shandong Province, China. Management's first-mover advantage claim, however, is somewhat precarious, for its relationship with Shenhua Group, the state-owned coal company-and parent company of Synthesis Energy's partner in its Shandong venture--is not exclusive. Shenhua Group is free to date others, and is allegedly in talks to build other coal-to-liquid fuels projects with global players, such as BP, ConocoPhillips, General Electric, and Siemens.

Given cheap labor and minimal environmental regulations in China, the time it takes to go from the planning board to operations is 18-24 months.

At present, there are 20 coal gasification plants located throughout China, but the majority of these campuses convert the coal to non-fuel downstream products, ranging from formaldehyde for use in the construction industry, acetic acid for use in producing plastics, and other methanol derivatives (used to manufacture a wide range of products including plywood, particleboard, foams, resins and silicon). As such, a key element of the company's business strategy is to steer clear of competitors, instead executing its efforts on transportation fuels, such as DME and syngas.

The company believes its licensed U-GAS fluidized bed gasification technology offers an environmental friendly option to conventional fuels, saying U-GAS plants "cleanly unlock the value of coal," converting low-quality, high-ash coals into higher value energy products, such as transportation fuels and downstream chemical products, such as ammonia and urea (fertilizer).

Critics rightfully dismiss the company's claim as oxymoronic, for no matter the quality of the coal, its extraction leaves behind an environmental footprint; and, there are leakage concerns regarding the storage and transfer of carbon dioxide captured during the separation process from waste ash.

At a CleanTech Energy conference last month, management said scalability was a unique advantage offered by the U-GAS technology, too, allowing for faster construction at lower capital costs than competing technologies, such as entrained flow and fixed bed over. Permit me room for skepticism. If this were the case, why is the company planning more ambitious projects with each round of financing? The 100-megawatt Golden Concord project is expected to become operational in the first quarter of 2010, at a total cost of $130 million, whereas its third Chinese facility, the Yima Joint Venture (Hunan Province), is forecast to be commissioned in the fourth quarter of 2010, at a total cost of $300 million.

As far as confidence in management goes--material weaknesses in its internal accounting controls are an ongoing concern. In November 2007, KPMG, its accounting firm, found an erroneous invoice for a $940,040 payment on behalf of a five-percent or greater stockholder.

Last month, in the registration filing for this latest equity offering, the company admitted it still did not have a sufficient number of accounting professionals who had familiarity with its operations and the requisite knowledge of generally accepted accounting principles to prepare its financial statements and related disclosures on a timely basis!

As of the third-quarter ended March 31, the Shandong Province plant produced nominal revenue of $39,879. Management would not commit to break-even marginal revenue numbers needed to prove the commercial acceptability of its U-GAS technology as a low cost energy alternative.

The Question: Is it just me--or does anyone else see more debt and 'less-than-attractive' financial returns in store for Synthesis Energy Systems?