Arabian American Development C ARSD
June 30, 2006 - 10:46am EST by
2006 2007
Price: 1.67 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 38 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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The lowest priced petrochemical company in North American & potential for a long lived highly profitable base metal mine.

All amounts are quoted in U.S. dollars

Microcap value investors may find Arabian American Development Co. (listed on the pink sheets) to be of interest. In 2005, this microcap petrochemical firm generated record profits, closed out virtually all outstanding litigation claims against the company, expanded an existing plant and sold an unprofitable facility for a gain of $5.82 million.

In 2006, there are two distinct sets of catalysts which will drive the stock foward. These include the following.

Petrochemical division.

1. The spread between the cost of feedstock (natural gasoline) and the finished product may result in record EBITDA throughout 2006. This is due to the low price of natural gas, which natural gasoline is derived from, and the high price of crude oil, which petrochemicals are typically priced off.

2. A 31% overall plant expansion has been completed in late 2005 and is now on stream.

3. Bank of America has entered into a new banking relationship, replacing a factor bank and a small Texas bank. The interest savings on $12 million of debts looks to be in the range of $250,000 per year.

4. Record EBITDA and low sustaining capital expenditures appear such that all interest bearing debts may be eliminated by year end 2007.

5. A recent purchase of Huntsmans petrochemical division by TXPI in Texas took place for a price of almost 12X EBITDA. This provides clarity as to potential prices for petrochemical assets.

Mining Exploration division.

1. Base metal prices have increased to the level that the mining exploration project should be highly profitable if developed. I estimate that a successful mine would generate peak EBITDA of $101 million and net earnings before U.S. taxes in excess of $65 million per year. Although it will take until 2010 (at the earliest) to develop a mine, one could look at current pricing as peak, and estimate EBITDA to determine potential valuations.

2. Arabian American appears to have improved financial capability to take the mining exploration project to the next level. The appointment of a major bank to manage the debts and credit lines affords management the time to canvass for experienced joint venture partners in 2006.

BALANCE SHEET DEVELOPMENTS. There are approximately 23 million shares outstanding on a fully diluted basis. On March 31st. 2006, ARSD had total debts - cash of roughly $25.67 million. ARSD has an enterprise value of $64.08 million. Debts include an interest free $11 million loan. Subsequent to March 31st, the company announced full retirement of an additional $2 million of loans.

COMPANY DESCRIPTION. Arabian American (ARSD) owns and operates a specialty petrochemical facility near Silsbee, Texas. The company manufactures pentanes and benzene solvents used in the plastics and foam industries. Chemicals are produced for ARSD's account and on a toll basis for two contract customers. Arabian American purports to be the second largest manufacturer of these highly specialized petrochemicals in the U.S. The absence of significant competition allows for price increases in feedstock to be quickly passed on to purchasers, usually within one fiscal quarter. In 2005, revenues totaled $80.368 million.

PROCESSING FOR OWN ACCOUNT. Until mid 2005, Arabian American had the ability to process about 3650 barrels per day of natural gasoline feedstock for its own account. In 2005, the company expanded its pentane facility by 16.4%, or 600 barrels per day. Revenues were $76.26 million in 2005.

PROCESSING FOR OTHERS. Arabian American produces chemicals (principally mineral oil) on a toll basis for two long term customers under contract. The mineral oil facility was expanded in October 2005 to process a minimum of 2000 bpd of feedstock, up from 1000 bpd. This was due to increased customer demand. Actual processing capacity tested in the range of 3000 barrels per day of feedstock.

In 2005, Arabian American generated toll revenues of $4.1 million.

ENVIRONMENTAL ISSUES. ARSD has identified two areas of hydrocarbon contamination at its plants. The major area of contamination is a contained pools of hydrocarbons (estimated to hold roughly 18,000 barrels of feedstock) sit at 25 feet below ground level, and are not migrating. ARSD has sunk hydrocarbon recovery wells to clean up the pool, and uses the product as feedstock for its plant. The wells presently recover 400 to 500 barrels of high quality light hydrocarbons per year and represent an innovative solution. The Texas Commission on Environmental Quality (TCEQ) considers this to be an acceptable method to remediate the property.

The second area of contamination is a surface spill which is quite small. Natural attenuation is the chosen method to remediate this spill, and TCEQ also considers this to be acceptable.

SAUDI ARABIA BASE METAL EXPLORATION PROJECT. Arabian American has been exploring for minerals in Saudi Arabia since 1971. In the past decade, ARSD has been funding development of a base metal project (Al Masane) in Saudi Arabia. Arabian American expended $586,000 on Al Masane in 2005. Total capitalized costs are close to $37 million at Al Masane.

The Al Masane project consists of a 44 sq. km exploration claim. The project can be accessed year round via roads suitable for heavy trucks. The deposits contain 7 million + tonnes of ore grading an average of 1.4% copper, 5% zinc, 1.1 grams of gold per tonne and 40 grams of silver per tonne. The reserves are open to depth.

SNC Lavalin updated a feasibility study in August 2005. SNC estimates that a 700,000 tonne per year mine could be built for capital costs of about $120 million. Annual output would be in the range of 17.5 million pounds of copper, 62.6 million pounds of zinc, 22,000 ounces of gold and 800,000 ounces of silver per year. Mining costs are estimated to be $60.01 per tonne. Saudi taxes on mining profits are 20%. The mine would have a minimum 10 year life based upon present reserves.

Using gold prices at $450 per ounce, silver at $7 per ounce, copper at $1.4 per pound, and zinc at $.54 per pound, the mine could generate EBITDA of about $20 million.

At current metal prices for gold of $600 per ounce, silver at $11 per ounce, copper at $3.39 per lb. and zinc at $1.45 per lb., I forecast that a mine at Al Masane may generate peak EBITDA of about $101 million and net earnings of $65 million. Sadly, Arabian American lacks the technical capability to take this project to production and needs to find a suitable partner.

In prior filings, ARSD indicated that up to $51 million of debt funding from Saudi banks and agencies could be made available. Assuming that a experienced partner could be found to buy in for a 49% interest, I estimate that ARSD would need to commit a minimum of $35 million of equity, so as to advance the project to production.

As with most exploration properties, there are risks too numerous to count. I consider the greatest risk (but by no means the only risk) at present, to be that the government of Saudi Arabia has not granted a mining lease on this property. This is due, in part, to the fact that an $11 million interest free loan issued to ARSD by the Saudi government & secured by the mining claims has not yet been repaid. According to SEC filings, Arabian American indicates that the government of Saudi Arabia has never formally requested repayment of the loan.

SEC filings indicate that Saudi ministers of finance recommend the outstanding loan be rolled into a larger, master loan with SIDF (Saudi Industrial Development fund). The proposed loan may cover up to 50% of the cost of the Al Masane project with a negotiated payment schedule. ARSD has requested formal negotiations to set terms.

In the interim, ARSD continues to spend funds with a view towards forwarding the mining project to a commercial operation. In the first quarter of 2006, Arabian American expended $172,000 on the Al Masane project. I would consider a material increase in spending on this project, in upcoming quarters, to be a positive sign.

ELY-PIOCHE MINES. Arabian American holds a 55% interest in a dormant silver, copper, zinc and gold mining company. There are 1500 acres of patented claims held in Lincoln County Nevada. At one time, this was the largest mine in Nevada. ARSD provides no value as to this asset on the balance sheet. I wouldn't go so far as to sugget that this is a hidden asset. However, I would note that Homestake mining took an option on this property some years ago. I would also note that the amount of 10-K space this dormant asset uses, has been increasing for several years.

2006 FORECAST: The trailing 4 quarters revenue and EBITDA were $87.3 million and $12.9 million respectively. As there was modest disruption to the toll revenues while the white oil expansion program was underway, 4th quarter toll revenues were somewhat below expectations

Assigning a simple midpoint between trailing revenues and forecast revenues as well as trailing EBITDA and forecast EBITDA results in a 2006 estimate of $92.28 million in revenues and $15.55 million EBITDA.

Should the 1st quarters performance be indicative of 2006, EBITDA could be as high as $18.2 million U.S with revenues surpassing $97 million.

When full toll plant capacity is utilized, EBITDA may exceed $20 million U.S on revenues above $103 million.

Sustaining capital expenditures are modest. In the past, Arabian American has consistently spent far less than $2 million per annum to maintain the facility. The 31% expansion which took place in 2005 cost less than $5 million in total. The company has the ability to add incremental expansions for nominal costs.

PEER GROUP COMPARISON. Due to the small market cap of ARSD, a directly comparable representative peer group was difficult to find. This peer group is comprised of either small cap chemical companies, or pure petrochemical competitors. Some trade on major exchanges, while TXPI is also listed over the counter. TXPI has recently purchased Huntsmans C4 business and also trades OTC.

Name Current 2006 est. 2007 est.

Texas Petrochemicals(TXPI) $25 11X 8.8X
Quaker Chemical (KWR) $17.90 12.8X 10.2X
Nevada Chemical (NCEM) $8.71 7.4X 6.0X
Nova Chemical (NCX) $27.91 6.7X 6.1X
Arabian American Development $1.67 4.1X 2.7X

SHAREHOLDERS. Insiders control approximately 33% of the total outstanding shares. 57% of the shares on December 31st, 2005 were Saudi citizens. Prince Talal Bin Abdul Aziz held 5.6% of the outstanding shares on that date.

CONCLUSION. Arabian American appears to be selling far below micro cap peers based upon the 2007 petrochemical EBITDA forecast. The low valuation may imply that investors are paying nothing for a potentially successful base metal mine. ARSD's balance sheet has greatly improved in the past 2 years. This (+ record base metal prices) may allow the Al Masane project to be funded to commercial success, without giving up total control.

Assuming that petrochemical prices remain strong into 2007, EBITDA in 2007 may surpass $20 million. Without factoring in any potential based on a successful mine, Arabian American could still be fairly valued at up to 5.7X est. 2007 EV/EBITDA, or about $4.95 per share.

One possible scenario with respect to Arabian American development would involve direct participation with the Saudi government as well as a partner. One could envision the Saudi government converting the $11 million loan to a 30% direct interest in Al Masane. This is based upon the $11 million loan expressed as a percentage of the historic $37 million capitalized expense at Al Masane. Another mining firm would then take a 51% stake in the mining project, leaving ARSD with a nominal 19% interest. Under this scenario, Arabian American would likely not need to add funds.

A worst case scenario would be for the government of Saudi Arabia to expropriate the entire Al Masane property without compensation. This would be based upon the fact that ARSD is in fact overdue on the principal amount of the $11 million loan. This possibility is what keeps investors from including a very material value into the price of Arabian American shares. The firm would be a pure petrochemical company. No debt covenants would be breached, as petrochemical assets are stand alone. The $11 million Saudi debts would likely be extinguished, and the $37 million of capitalized asset would also disappear. EBITDA at the corporate level would rise by the annual capex in Saudi Arabia. I would suggest at that time that the entire petrochemical firm would be sold.

A good case scenario would be for an experienced partner to fund a 49% interest in the mine. At a very modest valuation of 3X peak estimated EBITDA of $101 million, a productive Al Masane may add incremental value of up to $154.5 million net to Arabian American. Should the mine be a commercial success by 2010, fair value of the overall company at that time, may be as high as $11.67 per share.


Record EBITDA at petrochemical division from completed expansion. Lowered interest costs from debt refinancing. Record base metal prices now support highly profitable mine.
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