Company Report - VMBL · 1-Yr Target $5.25 Avg Daily Volume (K) 56.9 Dividend $0.00 Control Blocks:...

January 29, 2008

Industrial Products

Company Report

Zongshen PEM Power Systems Inc. Picking Up Speed

ZPP-V: $3.50Recommendation: Buy

Target price: $5.25

David Buma, CFA Mathieu Chevrier Industrial Products Analyst Associate (514) 350-2957 (514) 350-2949 [email protected] [email protected]

David Buma, CFA Industrial Products Analyst 514-350-2957 [email protected] January 29, 2008

Zongshen PEM Power Systems Inc. Picking Up Speed

Page

Investment Highlights ...................................................................................... 2

An Emerging E-Bike Manufacturer...................................................................... 3 Alternative-Energy Vision Receives Support......................................................... 5 Profile Of Management & Directors..................................................................... 6 Recent Results: E-Bike Production Ramping Up.................................................... 7 Positioned For Take-Off .................................................................................... 8 Company Well Funded.................................................................................... 10 Shares Have Considerable Upside .................................................................... 11 Key Risks: Legislation, Chinese GDP, Currency .................................................. 13 Financial Statements...................................................................................... 15 Appendix I – E-Bike Outlook............................................................................ 18 Appendix II – Important Disclosures ................................................................ 26

Company Report

Zongshen PEM Power Systems Inc.

2 David Buma, CFA Industrial Products Analyst 514-350-2957 [email protected] January 29, 2008

Investment Highlights

Zongshen PEM Power Systems Inc (ZPP-V)

Company Profile

Zongshen PEM Power Systems Inc. (ZPP) is a Chinese-based, early-stage designer and manufacturer of electric bikes. Although the primary market for these vehicles is China, the company is targeting international markets as well. ZPP is also involved in the development of alternative power systems including batteries, and fuel cells for a variety of consumer and industrial applications.

Source: BigCharts.com

Ticker ZPP-V Shares O/S (M) 48.9Rating Buy Market Cap (M) $171.3Risk High Float O/S (M) 29.4Price $3.50 Float Value (M) $102.81-Yr Target $5.25 Avg Daily Volume (K) 56.9Dividend $0.00 Control Blocks: Zongshen1-Yr ROR 50.0% Voting 40%52 Wk High-Low $4.14-$0.23 Equity 40%Valuation 20x P/E (2009E)

(December 31 Year End)Fully Diluted EPS Q1 Q2 Q3 Q4 Annual 2006 $0.00 A ($0.01) A ($0.01) A ($0.01) A ($0.02)2007 $0.00 A ($0.01) A ($0.01) A $0.00 ($0.01)2008 $0.02 $0.03 $0.04 $0.05 $0.132009 $0.27

EBITDA ($M) Q1 Q2 Q3 Q4 Annual 2006 ($0.1) A ($0.1) A ($0.1) A ($0.3) A ($0.7)2007 ($0.1) A ($0.3) A ($0.0) A $0.1 ($0.4)2008 $1.2 $2.1 $2.9 $3.6 $9.72009 $19.7

Source: Company reports; Thomson One; LBS estimates.

Market Data

Next Reporting March 2008

Buy – Target Price: $5.25

We are initiating coverage on Zongshen PEM Power Systems (ZPP) with a Buy rating and one-year share price target of $5.25, implying a total return of 50%. This target is based on a 20x forward P/E (2009E) multiple. We have a share risk rating of High.

We highlight the following:

♦ Strong Growth Profile: With e-bike production at ZPP just starting to ramp up, combined with very strong industry fundamentals, we expect a revenue CAGR of 223% from 2007-2009. Key drivers in the Chinese market include higher disposable income, increased demand for transportation as cities continue to grow, and the ban on gasoline motorcycles in a number of cities.

♦ Backed By Resources Of Chinese Parent: ZPP is fully supported by Zongshen Industrial Group (Zongshen), a major Chinese motorcycle and engine manufacturer. Through a master support agreement, ZPP has access to Zongshen’s resources at cost, including design, manufacturing, and distribution as well as use of the Zongshen brand in perpetuity.

♦ Insulated From North American Economy: Considering the primary market for e-bikes is China, ZPP is relatively insulated from a slowdown in the North American economy. Instead, the largest North American influence is likely to come from the translation of earnings from Chinese renminbi (RMB) to C$.

♦ Management & Directors Are Significant Owners: In addition to the 40% held by Zongshen, the company controlled by ZPP Chairman Zuo Zongshen, senior executives and other board members at ZPP hold 5% of ZPP shares outstanding.

♦ Call Option On Alternative Energy: Although we have focused on the e-bike business at ZPP, given this is currently the sole revenue generator for the company, ZPP has done extensive research on fuel-cell technology and continues to explore various applications of alternative energy. As this work progresses, ZPP shares could attract a premium valuation.

♦ Strong Balance Sheet: Following two equity issues in 2007, raising a total of $40 million, we estimate ZPP will have a net cash position of $38.4 million at the end of Q4/07. Although we expect the company to burn through a portion of that over the next 12 months, we estimate the company will be free cash flow positive as early as Q1/09.



Zongshen PEM Power Systems Inc

Buy, Target $5.25 We are initiating coverage on Zongshen PEM Power Systems (ZPP) with a Buy rating and one-year share target of $5.25, implying a total rate of return (ROR) of 50%. This target is based on a 20x forward P/E multiple. We have a share risk rating of High.

High Growth Potential ZPP is well positioned for growth. Backed by a 10-year agreement with a major Chinese motorcycle and engine manufacturer granting full access to its design, manufacturing, and distribution resources at cost as well as the use of its brand in perpetuity, ZPP is well positioned to benefit from the rapid growth of the highly fragmented e-bike business in China. Considering the company’s growth prospects, strong management, the relative insulation from a slowdown in the North American economy, solid balance sheet, and further potential upside from the company’s research and development of various applications of alternative energy, we rate ZPP shares a Buy with an ROR of 50%.

An Emerging E-Bike Manufacturer

Formed In 2004 Through RTO

ZPP was formed in 2004 through the reverse takeover of Norstar Ventures by PEM Technologies. PEM Technologies was a Vancouver-based fuel cell research and development company incorporated in 2001. In May 2004, PEM established a marketing alliance with Zongshen Industrial Group (Zongshen), one of largest manufacturers and distributors of motorcycles, engines, and power equipment in China. Through a subsequent equity issue, Zongshen acquired 34% of PEM Technologies. The common shares of ZPP began trading on the TSX Venture in March 2005.

For the purpose of this report, we view ZPP as an e-bike manufacturer supported by the design, production, and distribution expertise of Zongshen. Electric bicycles, or e-bikes, are broadly two-wheeled vehicles powered by an electric motor (Exhibit 1). Although the primary market for these low-cost, zero-emission vehicles is China, the company is targeting international markets as well. ZPP is also involved in the development of alternative power systems including batteries and fuel cells for a variety of consumer and industrial applications. It is Zongshen’s intention to develop alternative energy applications through ZPP, although we do not expect commercialization of those technologies in the near-term.

Source: Company reports.

Exhibit 1 - E-Bike ModelsBicycle Style Scooter Style



Targeting The High-End E-Bike Market

The company is currently focused on two e-bike lines:

♦ Red Sea – The company’s first e-bike, ZPP has positioned the Red Sea at the top end of the market. It has similar features to the higher-end lead-acid bikes currently in the market and has an above average range of up to 70-80km. The company expects to have an annual production capacity of 300,000 Red Sea bikes by 2009; ZPP sold 60,000 bikes in 2007. Red Sea bikes sell for an average price of $300 (2,300RMB).

♦ Blue Sea – Launched in early Q1/08, the Blue Sea is being marketed as a premium brand due to its superior battery technology, design, and two-wheel drive propulsion. ZPP charges a premium price as a result of the patented battery technology, which combines a lithium battery with the traditional lead-acid battery to extend the range by 40-50km, as well as increase the speed and convenience of recharging. ZPP expects to have an annual production capacity of at least 200,000 Blue Sea bikes in place by early 2009 with significant room to expand. Through the Blue Sea, ZPP intends to become a technology leader in the industry. Blue Sea bikes are expected to sell for an average price of $400 (3,000RMB).

Longer-term, the company is considering setting up an e-bike battery replacement club. Unique in China, this would allow the member to exchange a discharged battery for one fully charged across its network of stations. By enabling the user to change batteries mid-trip, the range of e-bikes would be improved significantly. This business is currently in a very preliminary stage of development; if launched, we would not expect it to make a meaningful contribution to the bottom line for a number of years.

Backed By Major Motorcycle & Engine Manufacturer

Given the influence of Zongshen in ZPP’s operations, we also provide a brief description of that company. Based in Chongqing, China, Zongshen has grown to assets of more than $500 million and 13,000 employees since its inception in 1992. One of Zongshen’s subsidiaries, Chongqing Zongshen Power Machinery Co., trades on the Shenzhen Stock Exchange with a market capitalization of $1.3 billion. Zongshen produces 2 million motorcycles, 4 million motorcycle engines, 5 million general-purpose engines, 50,000 mini-vans, 200,000 mini-van engines, and 100,000 car engines per year. Zongshen has a distribution network of 5,000 dealers, including 1,000 owned by the company, and has a joint venture with Harley-Davidson in China. Zongshen currently owns approximately 40% of ZPP.



Alternative-Energy Vision Receives Support

Building An Alternative Energy Product Portfolio

ZPP is focused on expanding its alternative energy-related product offering through research and development, licensing, and acquisitions. Although the focus is on e-bikes in the near-term, over the medium to long-term, ZPP intends to diversify its product line into additional battery technologies and solar power. ZPP continues to develop its fuel cell technology, currently aimed at indoor forklifts, which although operational, is still too costly to go commercial. Over time, ZPP hopes to sell fuel cells as an alternative source of home power.

Two Major Goals In 2008

ZPP has two major goals for 2008:

♦ Sell 260,000 electric bike and gas scooter units, up from an estimated 60,000 in 2007. ZPP currently produces its Red Sea bike at a leased facility in Wuxi, which can be easily expanded with only modest expenditures. ZPP intends to outsource production of the Blue Sea model to Zongshen in the near-term but should have its own plant in place in Chongqing by early 2009 with a production capacity of at least 200,000 units per year, with significant room to expand.

♦ Diversify its product offering from e-bikes to include additional battery technologies and solar power. The company intends to accomplish this through acquisitions, strategic partnerships, and continued research and development.

Zongshen intends to support the efforts of ZPP by providing access to its resources at cost. By leveraging Zongshen’s expertise in R&D, manufacturing, and marketing, ZPP has started well up the learning curve.

Master Support Agreement With Zongshen Signed

On January 7, 2008, ZPP and Zongshen signed a 10-year agreement covering the following:

♦ Zongshen agreed to conduct all alternative power source business through ZPP, including all products and services related to electric vehicles, fuel cells, solar power, and wind power. As part of this, Zongshen has agreed to not compete with ZPP in such businesses.

♦ Zongshen agreed to introduce ZPP to its network of distributors and dealers and provide certain services, including design, engineering, and production on a cost basis.

♦ ZPP may use the Zongshen brand with no license fees in perpetuity, provided Zongshen remains the company’s largest shareholder. This is significant given Zongshen is the third largest motorcycle manufacturer in China.

♦ Zongshen has the right to participate in all future equity offerings such that it can maintain a minimum 25% interest in ZPP.

Acquisitions Could Accelerate Product Development

Management intends to consider acquisitions in order to accelerate the growth of its product portfolio. We believe ZPP could acquire a more established e-bike player to accelerate the pace at which it distributes its Red Sea and Blue Sea models. We note the company could also acquire a solar-related and/or battery system company to accelerate the pace of its fuel-cell commercialization program. ZPP has adequate resources to make a reasonably-sized acquisition.



Profile Of Management & Directors

Zongshen Has Influence At Both Management, Board Levels

Reflecting the support Zongshen is giving to ZPP, Zongshen has significant influence at both the management and Board levels. We profile the management team below:

♦ Li Yao – President, CEO, and Director: Previously one of the top executives at Zongshen, Mr. Li has been given the mandate to grow ZPP. Mr. Li has held a number of positions at subsidiaries of Zongshen, including Director of Chongqing Zongshen Power Machinery, which trades on the Shenzhen Stock Exchange. Mr. Li has also served in a number of roles within the Sichuan provincial government.

♦ Simon Anderson – CFO: Mr. Anderson has extensive experience in senior roles at public companies, including those listed on the TSX, TSX Venture, and American Stock Exchange. For the past eleven years, Mr. Anderson has been a principal of MCSI Consulting Services, where he has specialized in developing financial strategies and operations of public companies.

♦ Ali Mahdavi – Vice President Corporate Finance: A managing director at Genoa Management, a Toronto-based investor relations and capital market advisory firm, Mr. Mahdavi has more than 10 years of experience in investor relations, investment counseling, financing, and mergers and acquisitions.

We also profile several key board members:

♦ Zuo Zongshen – Chairman: Mr. Zuo currently serves as President of Zongshen. He founded the company in 1992. Mr. Zuo was elected as the standing member for two sessions of CPPCC Chongqing Committee, standing member of the State Business Association, Vice Director of Chongqing Business Association, and Vice Chairman of Chongqing International Chamber of Commerce.

♦ Kim Oishi – Independent Director: Mr. Oishi has held senior management and Board of Director positions in a number of public and private companies, playing a key role more recently in helping China-based companies develop links with the North American capital markets. In addition to ZPP, companies in which Mr. Oishi has or continues to play a key role include Hanfeng Evergreen (HF-T), Hanwei Energy Services (HE-T), and Grand Power Logistics (GPW-V).

♦ Joanne Yan – Independent Director: Ms. Yan has extensive experience in advising and assisting in the financing and business development of venture and growth companies in both North America and China. Ms. Yan is President and Director of Red Dragon Resources, a junior mining company exploring in China, as well as director of a number of companies including Hanfeng Evergreen (HF-T), New Pacific Metals (NUX-V), and Virtual China Travel Services (CTX.H-NEX).

Insiders Own 45% Of ZPP

Insiders own 45% of the company. In addition to the 40% held by Zongshen, controlled in turn by ZPP Chairman Zuo Zongshen, senior executives and other board members at ZPP hold 5% of ZPP shares outstanding. Of note, as part of the Master Support Agreement, Zongshen has the right to maintain a minimum equity interest of 25% in ZPP.



Recent Results: E-Bike Production Ramping Up

Loss Reported As Production Still In Early Stage

The company’s Q3/07 results reflect the ramp up in e-bike production (Exhibit 2). We highlight the following:

♦ Revenue up 209% sequentially – The strong increase in revenue was the result of the ramp up in e-bike production. Of note, the company had no revenue in the same quarter last year. ZPP produced a total of 18,168 units in Q3/07, including 14,806 e-bikes and 3,362 small gasoline motorcycles, versus 5,896 units in Q2/07. The addition of 35 new dealers to the company’s previous network of 74 plus a surge in exports to Nigeria were key drivers behind the increase. All of the company’s revenue was generated by e-bike sales.

♦ EPS unchanged at ($0.01) – Despite the increase in production and the associated economies of scale, gross margin declined to 6.8% from 8.4% in Q2/07 due to the product mix more weighted to gasoline scooters. Although stock-based compensation was off somewhat from Q2/07 levels, it was significantly higher on a year-over-year basis, as was the foreign exchange loss. As a result, ZPP posted a loss of $0.01 per share.

♦ Free cash flow (FCF) of $0.6M – Although FCF was positive in the quarter, we note it was the result of the $0.8M contribution from working capital. We expect ZPP will be required to invest in working capital on an ongoing basis, but this should be more than offset by positive operating cash flow beyond Q4/08.

($M, except per share amounts) Q3/06 Q4/06 Q1/07 Q2/07 Q3/07Revenue 0.0 0.0 1.8 1.7 5.2

% Growth (YOY) nm nm nm nm nmEBITDA (0.1) (0.3) (0.1) (0.3) (0.0)

% Growth (YOY) nm nm nm nm nmEBITDA Margin nm nm -7.4% -19.5% -1.0%Earnings Before Spec Items (0.1) 4.1 (0.1) (0.4) (0.3)

% Growth (YOY) nm nm nm nm nm

EPS Before Spec Items ($0.01) ($0.01) $0.00 ($0.01) ($0.01)% Growth (YOY) nm nm nm nm nm

Shares Outstanding 31.4 33.5 39.7 39.8 41.7

E-bike Deliveries (K) 0.0 0.0 6.5 5.9 18.2% Growth (YOY) nm nm nm nm nm


Exhibit 2 - ZPP Recent Results

Well Funded Following Two Equity Issues

♦ Net cash position - The company is well funded, having done two equity issues in 2007. In July, the company raised $5 million through a private placement at $0.57 per unit, which included a share and a half-warrant carrying an exercise price of $0.89. Following strength in the share price in late October (Exhibit 3), ZPP raised an additional $35 million at $3.06 per share to be used for future expansion, marketing, and potential acquisitions. At the end of September, ZPP had a net cash position of $7.4 million.



Exhibit 3 - ZPP Performance (2006-Present)

$0

$1

$2

$3

$4

Jan Apr Jul Oct Jan Apr Jul Oct

Price

2006 2007Source: Bloomberg.

Positioned For Take-Off

Revenue CAGR Of 223% for 2007-09

We expect a revenue CAGR of 223% over the forecast horizon. From no revenue in 2006, we expect revenue to progress to $17.1 million in 2007E, $103.2 million in 2008E, and $178.1 million in 2009E. Of note, our revenue forecast is based solely on the e-bike business and does not include any contribution from the company’s fuel-cell research efforts, acquisitions, or the potential battery replacement network.

E-Bike Market In China Remains Strong

The popularity of e-bikes has surged in China since 2001 (Exhibit 4). Drivers for this growth include:

♦ Higher level of urbanization and suburbanization – As housing costs continue to rise in city centres, people are increasingly moving to the suburbs, making the commutes to work longer. With the bicycle becoming a less practical means of transportation given the growing distance travelled, the average urban Chinese commuter is being forced to consider alternatives. Given the relative cost and ease of e-bikes compared to almost all other forms of transportation in urban centres, their popularity is soaring.

♦ Growth in disposable income and transportation spending – As disposable incomes grow, there is a tendency to increase spending on transportation and communication at a disproportionate rate. With bicycles still the primary means of transportation in China, e-bikes represent the first step “up” in personal transportation for many.

♦ Many cities have moved to ban gasoline-powered motorcycles – More than 60 cities in China, including Shanghai, have banned gasoline-powered motorcycles for first time purchasers due to the environmental impact of those vehicles. Considering a car remains largely unaffordable, e-bikes have become increasingly attractive. In addition, the federal government has announced a five-year plan to cut carbon-based emissions significantly.

We profile the e-bike industry in China in Appendix I.



Exhibit 4 - Output of E-Bikes in China

0

10

20

30

40

50

2001 2002 2003 2004 2005 2006 2007e 2008e 2009e 2010e

Millio

n

Source: Horizon Research.

E-Bike Production Expected To Grow Rapidly

We have modelled an aggressive ramp up of e-bike deliveries at ZPP, with the lower-priced Red Sea model dominating in 2008 as initial production of the Blue Sea is expected to begin only in late Q1/08. We expect production of Blue Sea units could exceed that of Red Sea already in 2009. As Blue Sea production ramps up, ZPP’s average selling price should benefit. Considering the strength of the Zongshen brand in China, the extent of Zongshen’s distribution network, and strong industry growth expected over the forecast horizon, we believe e-bike sales at ZPP are poised for significant growth.

Margins To Improve With Scale

We expect rapid margin improvement as production ramps up. In the last nine months of 2007, ZPP produced approximately 60,000 bikes at its Wuxi facility, representing an estimated 40% capacity utilization. As production levels ramp up over the forecast horizon, we expect the operating leverage at the company to result in a significant improvement in gross margin. Product mix, given the higher margin associated with the Blue Sea line, should also contribute to margin gains. Of note, ZPP intends to outsource Blue Sea production to Zongshen until early 2009, when its Chongqing facility is scheduled for completion.

We expect EBITDA margin to improve rapidly over the next 12-18 months before stabilizing in the low double digits, due to the improvement in gross margin and the decline in research & development and selling, general, & administrative expenses as a percentage of revenue. We expect EBITDA margins to progress from -2.3% in 2007E, to 9.4% in 2008E, and 11.1% in 2009E (Exhibit 5).

EPS Of $0.27 Expected In 2009

Earnings per share should grow rapidly. With strong growth in EBITDA expected over the forecast horizon, coupled with modest interest income and a tax break over the next few years, earnings should build quickly. Through a Chinese government incentive, ZPP expects to pay no tax in either 2008 or 2009, a tax rate of 13% in 2010, and a normal rate of 25% in 2011. We expect EPS to progress from ($0.01) per share in 2007E, to $0.13 in 2008E, and $0.27 in 2009E.



($M, except per share amounts) 2005 2006 2007E 2008E 2009ERevenue 0.0 0.0 17.1 103.2 178.1

% Growth (YOY) nm nm nm 503.4% 72.7%EBITDA (0.8) (0.7) (0.4) 9.7 19.7

% Growth (YOY) nm nm nm nm 102.8%EBITDA Margin nm nm -2.3% 9.4% 11.1%Earnings Before Spec Items (0.9) (0.8) (0.6) 9.6 19.2

% Growth (YOY) nm nm nm nm 99.3%

EPS Before Spec Items ($0.03) ($0.02) ($0.01) $0.13 $0.27% Growth (YOY) nm nm nm nm 97.2%

Shares Outstanding (M) 29.2 31.9 44.0 72.5 72.7

E-bike Deliveries (K) 0.0 0.0 60.0 284.5 490.0% Growth (YOY) nm nm nm 374.0% 72.2%

Source: Company reports; LBS estimates.

Exhibit 5 - ZPP Financial Outlook (2005-2009E)

Company Well Funded

Expected To Turn FCF Positive By Q1/09

We expect negative free cash flow over the next twelve months before turning sharply higher. With significant investment in working capital and capex required over the next year as e-bike production ramps up, we expect these items to outweigh the impact of positive operating cash flow. However, by Q1/09 we expect this scenario to reverse and ZPP to start generating positive free cash flow, moving steadily higher from there. Of note, the company estimates its Red Sea facility in Wuxi can be easily expanded from 200,000 to 300,000 units with capex of only $250,000. We forecast free cash flow to progress from -$3.9 million in 2007E to -$9.7 million in 2008E, before turning sharply higher to $10.7 million in 2009E (Exhibit 6).

-10

-50

510

15

2006 2007E 2008E 2009E

FCF

($M)

0

12

24

36

48Ne

t Cas

h Po

sitio

n ($

M)

FCF (LHS) Net Cash Position (RHS)


Exhibit 6 - ZPP Financial Outlook (2006-2009E)



ZPP Has Ample Cash Reserves

ZPP is well funded. We estimate by the end of 2007, the company will have cash of $38.4 million and no debt. As noted previously, the company completed two equity issues in 2007:

♦ In July, the company raised $5 million through a private placement at $0.57 per unit, consisting of one ZPP share and a half-warrant carrying an exercise price of $0.89.

♦ In October, ZPP raised an additional $35 million at $3.06 per share, which is to be used for the launch of the Blue Sea line of bikes, plant construction, future product design, potential acquisitions, and a trial of the battery exchange club.

By the time ZPP becomes FCF positive, we estimate the company will have a net cash balance of $30.5 million. This assumes the company does not make any acquisitions over that time. Should ZPP make an acquisition, either to expand its product line and distribution network for e-bikes, or to build on its alternative energy technology base, we would expect a portion of this to be funded by debt. Of note, most acquisitions within China are done on a cash or cash and stock basis; it is difficult to get the appropriate approvals for a straight share swap.

Shares Have Considerable Upside

Buy, $5.25 Target We rate ZPP shares a Buy with a one-year share price target of $5.25. This is based on 20x our 2009E EPS estimate of $0.27 and equates to 18.0x EV/2009E EBITDA. Considering our valuation period captures only the early stage of the company’s development, particularly in light of anticipated earnings growth, we note the shares could be worth $6.75 in two years. Given the lack of comparable companies, we have explored several different groupings in order to arrive at a reasonable valuation multiple.

There are more than 50 Chinese-based companies listed on either the TSX or TSX Venture. This sample, however, can be quickly shortened given that only seven of those companies are expected to generate positive earnings this year. Considering the growth in earnings generally expected at these companies, the shares trade at a relatively high average P/E multiple of 21.0x based on 2008 earnings (Exhibit 7). On a 2009 basis, however, the sample of companies trade at an average P/E of 12.8x, more in line with the TSX Composite average of 13.7x and S&P500 average of 12.7x. Given this convergence of multiples over the long-term, it appears the use of North American-based comparables is reasonable.



(In C$M except per share amounts)

Company Ticker Price Mkt Cap GrowthPx Last CUR_MKTTRAIL_12BEST_EEPBEST_EPS_NXT_YR

GobiMin Inc. GMN-V $2.35 172.6 $0.26 $0.33 $0.38 15.2% 7.1x 6.2xHanwei Energy Services Corp. HE-T $4.95 296.3 n.a. $0.14 $0.51 280.0% 36.7x 9.6xHanfeng Evergreen Inc. HF-T $10.94 669.8 $0.30 $0.32 $0.61 89.4% 34.2x 18.1xMigao Corporation MGO-T $8.25 297.2 $0.32 $0.46 $0.68 49.8% 18.1x 12.1xNeo Material Technologies Inc NEM-T $4.25 419.9 $0.32 $0.30 $0.40 32.4% 14.2x 10.7xSilvercorp Metals Inc. SVM-T $9.42 1,396.7 $0.34 $0.45 $0.43 -3.8% 21.1x 21.9xSino-Forest Corp. TRE-T $17.74 3,231.2 $0.91 $1.03 $1.31 27.4% 17.3x 13.6xAverage (Excl. High & Low) 42.8% 21.0x 12.8x

Zongshen PEM Power Systems Inc. ZPP-V $3.50 212.0 ($0.03) $0.13 $0.30 124.5% 26.5x 11.8x

Company Ticker EV Growth GrowthCURR_ENTP_VAL EBITDA BEST_EST_EBITDA_BEST_EST_EBITDA_NXT_YR_MEAN

GobiMin Inc. GMN-V 134.8 22.6 n.a. n.a. n.a. n.a. n.a. n.a.Hanwei Energy Services Corp. HE-T 257.7 8.0 9.3 15.9% 46.3 396.4% 27.6x 5.6xHanfeng Evergreen Inc. HF-T 632.7 20.2 20.8 3.0% 39.3 89.6% 30.5x 16.1xMigao Corporation MGO-T 284.3 13.9 24.5 76.1% 38.5 57.4% 11.6x 7.4xNeo Material Technologies Inc NEM-T 485.8 58.7 62.0 5.6% 72.4 16.9% 7.8x 6.7xSilvercorp Metals Inc. SVM-T 1,323.4 45.7 83.9 83.7% 104.8 24.9% 15.8x 12.6xSino-Forest Corp. TRE-T 3,337.1 404.9 409.7 1.2% 555.8 35.7% 8.1x 6.0xAverage (Excl. High & Low) 20.4% 44.9% 14.2x 7.7x

Zongshen PEM Power Systems Inc. ZPP-V 209.6 (0.8) 10.3 n.a. 21.8 111.3% 20.3x 9.6x

T - TSX, V - TSX Venture.

Source: LBS estimates; Capital IQ; Bloomberg.

2008E EBITDA

2009E EBITDA

Exhibit 7 - Canadian Listed Chinese Comparables as of January 29, 2008

LTM EPS

2008E EPS

2009E EPS 2008E P/E 2009E P/E

2008 EV/ EBITDA

2009 EV/ EBITDA

LTM EBITDA

Valuation Based On Transportation & Alternative Energy Comps

We have separated the North American comparables into transportation-related manufacturing companies and alternative-energy companies. Although our earnings estimates factor in only the e-bike business at ZPP, we recognize that the company’s ongoing research and development of fuel-cell technology and stated interests in solar power could attract a slightly higher multiple than if the company was involved solely in the e-bike manufacturing business.

Our 20x target P/E multiple falls between the two groups. We note the following:

♦ A sample of transportation-related companies currently trades at a P/E of 13.3x based on 2008 consensus (Exhibit 8). This represents what ZPP might trade at if it were solely an e-bike manufacturer.

♦ A sample of alternative-energy companies currently trades at a P/E of 45.2x based on 2008 consensus. Although this represents the potential upside for ZPP valuation, until the company’s fuel-cell technology moves closer to commercialization, we believe a multiple in line with this sector is overly aggressive.

♦ ZPP could generate YoY EPS growth of 97% in 2009. This growth rate falls between the consensus growth rates for the transportation and alternative-energy comps. We expect the company to generate an ROE of 26.8% in 2009.



(In C$M except per share amounts)

Company Ticker Price Mkt Cap Growth

Harley-Davidson, Inc.* HOG-N $39.68 9,581.2 $3.73 $3.80 $3.98 4.9% 10.5x 10.0xPolaris Industries Inc.* PII-N $43.33 1,516.5 $2.99 $3.38 $3.96 17.4% 12.8x 10.9xWescast Industries Inc. WCA/A-T $8.50 111.7 ($0.08) $0.19 $0.25 30.0% 44.7x 34.4xRBC Bearings Inc.* ROLL-Q $30.03 647.8 $1.71 $1.84 $2.24 21.8% 16.3x 13.4xAftermarket Technology Corp.* ATAC-Q $26.08 576.9 $1.85 $1.82 $2.10 15.1% 14.3x 12.4xTenneco Inc.* TEN-N $26.76 1,246.1 $1.78 $2.22 $2.73 23.2% 12.1x 9.8xLinamar Corp. LNR-T $16.86 1,177.3 $1.71 $1.54 $1.82 18.3% 11.0x 9.3xAverage (Excl. High & Low) 19.2% 13.3x 11.3x

Company Ticker Price Mkt Cap Growth

SunPower Corporation* SPWR-Q $74.60 6,252.3 $0.32 $2.04 $3.26 59.6% 36.5x 22.9xXantrex Technology Inc. XTX-T $7.60 219.9 $0.02 $0.15 $0.53 258.8% 51.4x 14.3xSuntech Power Holdings Co. Ltd.* STP-N $54.00 8,124.9 $0.93 $1.13 $2.03 79.8% 47.8x 26.6xVRB Power Systems Inc. VRB-V $0.18 28.5 ($0.10) ($0.08) $0.02 n.a. n.a. 8.3xCanadian Solar Inc.* CSIQ-Q $18.47 503.7 ($0.44) $0.21 $1.49 614.9% 88.8x 12.4xAverage (Excl. High & Low) 132.7% 45.2x 16.5x

Zongshen PEM Power Systems Inc. ZPP-V $3.50 212.0 ($0.03) $0.13 $0.27 97.2% 26.0x 13.2x

N - NYSE, Q - Nasdaq, T - TSX, V - TSX Venture.*USDSource: LBS estimates; Capital IQ; Bloomberg.

Exhibit 8 - Industrials & Alternative Energy Comparables as of January 29, 2008

LTM EPS

2008E EPS

2009E EPS 2008E P/E 2009E P/E

2009E P/ELTM EPS

2008E EPS

2009E EPS 2008E P/E

Key Risks: Legislation, Chinese GDP, Currency

Legislation Legislation – Although the federal government in China is supportive of e-bikes, municipalities have the power to determine how e-bikes are treated within their jurisdiction. As technological advances have enabled the bike to go at speeds far in excess of the 20km/h limit, some local governments, including Beijing, now require that users have a license. In others, such as Wuhan, an outright ban has been imposed on the vehicle. Should the federal government change the status of e-bikes, it is possible users would be required to obtain a license and/or registration to operate the vehicles, potentially reducing the popularity of the vehicle. In such an event, it is possible the local governments could react more severely.

Chinese Economy Chinese Economy – Given the majority of ZPP sales will likely be generated from within China, the company is vulnerable to the economic cycle there. Although a number of e-bike buyers may consider it a staple, for others, it may still be considered a luxury and could force consumers to seek alternative means of transportation should the Chinese economy weaken. By expanding the amount of revenue derived internationally, ZPP intends to reduce its exposure to the Chinese economy. We estimate more than 20% of revenues could be generated outside of China in several years.



Currency Currency – With ZPP’s revenue and costs generally both denominated in RMB, there is relatively little operating currency risk. Although this could increase as the company expands its international presence, the largest impact on results will likely continue to be the translation of the company’s results from RMB to C$. Exchange rate volatility could impact profitability significantly in C$ terms. We illustrate the movement of the C$ to both the US$ and RMB in Exhibit 9.

Exhibit 9 - C$/US & C$/RMB Performance (2006-Present)

0.600.700.800.901.001.10

Jan Apr Jul Oct Jan Apr Jul Oct Jan

Relat

ive V

alue

C$/US C$/RMB2006 2007

Source: Bloomberg.

Low Barriers To Entry Low Barriers To Entry – The simple modular design has resulted in more than 2,000 e-bike

manufacturers in China, the majority of which produce lower-end bikes. Although ZPP holds a number of patents pertaining to its e-bikes, there is no assurance that the company is adequately protected from misappropriation of that information. The relative complexity of ZPP’s Blue Sea battery booster may make it more difficult to imitate. Furthermore, ZPP has several advantages new entrants do not, including extensive distribution, the Zongshen brand, and buying power through Zongshen, which allows for significant savings on higher quality parts.

Zongshen Commitment

Zongshen Commitment – Considering ZPP solidified its Memorandum of Understanding with Zongshen with the recent signing of the Master Support Agreement, the risk of Zongshen retracting its commitment to ZPP is low. Although unlikely, should some circumstance result in Zongshen being unable to make its resources available, ZPP would be required to take the burden onto itself at potentially a much higher cost.

Material Prices Material Prices – ZPP is exposed to changes in prices and supply of its raw materials, including steel, plastic, and lead. With a limited ability to pass higher material costs through to the consumer, a sharp increase could negatively impact margins. Of note, ZPP does receive preferential treatment from its suppliers given the vast majority of its buying is done through Zongshen.



Financial Statements

(Fiscal Year Ending December 31;$M, except per share amounts) 2006 Q1/07 Q2/07 Q3/07 Q4/07E 2007E 2008E 2009E

Revenues 0.0 1.8 1.7 5.2 8.4 17.1 103.2 178.1

Cost Of Goods Sold 0.0 1.7 1.5 4.8 7.7 15.8 89.2 152.7Research & Development 0.4 0.1 0.1 0.1 0.1 0.4 1.3 1.8Selling, General, & Administrative Expenses 0.2 0.1 0.1 0.2 0.2 0.7 2.1 3.0Other 0.1 0.0 0.2 0.2 0.2 0.6 0.8 0.8EBITDA (0.7) (0.1) (0.3) (0.0) 0.1 (0.4) 9.7 19.7

Depreciation & Amortization 0.1 0.0 0.0 0.0 0.0 0.1 0.7 1.2Foreign Exchange Loss (Gain) 0.0 0.0 0.0 0.2 0.0 0.2 0.0 0.0EBIT (0.7) (0.1) (0.4) (0.3) 0.1 (0.7) 9.0 18.5

Interest Expense (Income) (0.0) (0.0) (0.0) (0.0) (0.1) (0.2) (0.6) (0.7)Special Items (Gain) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0EBT (0.8) (0.1) (0.4) (0.2) 0.2 (0.5) 9.6 19.2

Current Taxes 0.0 0.0 0.0 0.1 0.0 0.1 0.0 0.0Deferred Taxes 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Net Earnings (0.8) (0.1) (0.4) (0.3) 0.2 (0.6) 9.6 19.2

After-Tax (Addback) Of Special Items 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Net Earnings Before Special Items (0.8) (0.1) (0.4) (0.3) 0.2 (0.6) 9.6 19.2

Weighted Average Shares Outstanding - Basic 31.9 39.7 39.8 41.7 54.7 44.0 60.5 60.6Weighted Average Shares Outstanding - Diluted 31.9 39.7 39.8 41.7 54.7 44.0 72.5 72.7

Diluted EPS Before Special Items ($0.02) $0.00 ($0.01) ($0.01) $0.00 ($0.01) $0.13 $0.27Diluted EPS ($0.02) $0.00 ($0.01) ($0.01) $0.00 ($0.01) $0.13 $0.27

Income Statement StatisticsRevenue Growth nm nm nm nm nm nm 503.4% 72.7%EBITDA Growth nm nm nm nm nm nm nm 102.8%EBIT Growth nm nm nm nm nm nm nm 106.2%Net Earnings Before Spec Items Growth -8.5% -4.0% 75.5% 175.7% -156.5% nm nm 99.3%Diluted EPS Before Spec Items Growth -33.3% nm 0.0% 0.0% -134.6% nm nm 97.2%

EBITDA Margin nm -7.4% -19.5% -1.0% 1.3% -2.3% 9.4% 11.1%EBIT Margin nm -8.2% -22.1% -4.8% 0.8% -4.1% 8.7% 10.4%Net Margin Before Spec Items nm -7.7% -21.5% -6.0% 2.2% -3.6% 9.3% 10.8%

Tax Rate 0.0% 0.0% 0.0% -39.7% 0.0% -16.4% 0.0% 0.0%


Exhibit 10 - ZPP Income Statement (2006-2009E)



Financial Statements (continued)


AssetsCash 2.3 2.4 1.8 7.4 38.4 38.4 28.0 38.5Accounts Receivable 0.0 0.0 1.1 2.4 2.3 2.3 10.3 16.1Inventories 0.2 0.1 0.1 0.6 1.7 1.7 14.3 20.2Other 0.1 0.0 0.1 0.4 1.6 1.6 1.9 2.7Future Income Taxes 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Total Current Assets 2.6 2.6 3.1 10.9 44.0 44.0 54.5 77.5

Property, Plant & Equipment 0.3 0.3 0.4 0.3 2.3 2.3 9.1 10.9Other 0.0 0.0 0.0 0.0 0.1 0.1 0.8 1.0Total Non-Current Assets 0.3 0.4 0.4 0.4 2.4 2.4 9.9 11.9

Total Assets 2.9 3.0 3.5 11.3 46.5 46.5 64.3 89.4

Liabilities & Shareholders' EquityShort-Term Borrowings 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Accounts Payable & Accrued Liabilities 0.3 0.4 1.1 3.7 3.0 3.0 10.9 16.2Income Taxes Payable 0.0 0.0 0.1 0.2 0.9 0.9 1.3 1.8Total Current Liabilities 0.3 0.4 1.1 3.9 3.9 3.9 12.2 18.0

Long-Term Debt 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Other Liabilities 0.0 0.0 0.0 0.1 0.1 0.1 0.1 0.1Future Income Taxes 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Total Non-Current Liabilities 0.0 0.0 0.0 0.1 0.1 0.1 0.1 0.1

Total Liabilities 0.3 0.5 1.1 3.9 4.0 4.0 12.2 18.1

Shareholders' EquityCapital Stock 5.6 5.5 5.8 11.1 46.1 46.1 46.1 46.1Retained Earnings (2.9) (3.1) (3.4) (3.7) (3.5) (3.5) 6.1 25.3Accumulated Other Comprehensive Loss 0.0 0.0 (0.0) (0.0) (0.0) (0.0) (0.0) (0.0)Total Shareholders' Equity 2.6 2.5 2.4 7.3 42.5 42.5 52.1 71.3

Total Liabilities & Shareholders' Equity 2.9 3.0 3.5 11.3 46.5 46.5 64.3 89.4

Balance Sheet StatisticsNet Cash 2.3 2.4 1.8 7.4 38.4 38.4 28.0 38.5Net Total Debt/Equity nm nm nm nm nm nm nm nmNet Total Debt/Capital nm nm nm nm nm nm nm nmNet Total Debt/LTM EBITDA nm nm nm nm nm nm nm nmEBIT Coverage nm nm nm nm nm nm nm nm

ROE (Annualized) -32.5% -21.6% -59.0% -25.4% 3.0% -2.8% 20.3% 31.1%Book Value $0.08 $0.06 $0.06 $0.18 $0.78 $0.97 $0.72 $0.98Tangible Book Value $0.08 $0.06 $0.06 $0.17 $0.78 $0.97 $0.72 $0.98


Exhibit 11 - ZPP Balance Sheet (2006-2009E)



Financial Statements (continued)


Operating ActivitiesEarnings (0.8) (0.1) (0.4) (0.3) 0.2 (0.6) 9.6 19.2Non-Cash Items:

Depreciation & Amortization 0.1 0.0 0.0 0.0 0.0 0.1 0.7 1.2Future Income Taxes 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Special Items 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Other 0.0 0.0 0.2 0.2 0.0 0.4 0.0 0.0

Operating Cash Flow (0.6) (0.1) (0.1) (0.2) 0.2 (0.2) 10.4 20.4

Decrease (Increase) In Non-Cash Working Capital (0.0) 0.3 (0.5) 0.8 (2.2) (1.6) (12.6) (6.7)Cash Provided By Operating Activities (0.7) 0.2 (0.6) 0.6 (1.9) (1.8) (2.2) 13.7

Investing ActivitiesAcquisitions 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Short-Term Investments 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Capital Expenditures (0.2) (0.1) (0.0) (0.0) (2.0) (2.1) (7.5) (3.0)Other (0.0) 0.0 0.0 (0.0) (0.1) (0.1) (0.7) (0.2)Cash Provided By (Used In) Investing Activities (0.2) (0.1) (0.0) (0.0) (2.1) (2.2) (8.2) (3.2)

Financing ActivitiesProceeds (Repayment) Of Long-Term Debt 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Dividends Paid 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Common Stock Issuance 1.3 0.0 0.0 5.1 35.0 40.1 0.0 0.0Other 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Cash (Used In) Provided By Financing Activities 1.3 0.0 0.0 5.1 35.0 40.1 0.0 0.0

Net Increase (Decrease) In Cash 0.5 0.1 (0.6) 5.6 31.0 36.0 (10.4) 10.5Cash At Beginning Of Period 1.8 2.3 2.4 1.8 7.4 2.3 38.4 28.0Cash At End Of Period 2.3 2.4 1.8 7.4 38.4 38.4 28.0 38.5

Free Cash FlowOperating Cash Flow (0.6) (0.1) (0.1) (0.2) 0.2 (0.2) 10.4 20.4Change In Working Capital (0.0) 0.3 (0.5) 0.8 (2.2) (1.6) (12.6) (6.7)Capital Expenditures (0.2) (0.1) (0.0) (0.0) (2.0) (2.1) (7.5) (3.0)Free Cash Flow (0.8) 0.1 (0.6) 0.6 (3.9) (3.9) (9.7) 10.7

Dividends 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Free Cash Flow After Dividends (0.8) 0.1 (0.6) 0.6 (3.9) (3.9) (9.7) 10.7

Free Cash Flow Per Share ($0.03) $0.00 ($0.02) $0.01 ($0.07) ($0.09) ($0.13) $0.15Diluted Shares Outstanding 31.9 39.7 39.8 41.7 54.7 44.0 72.5 72.7


Exhibit 12 - ZPP Statement Of Cash Flows (2006-2009E)



Appendix I – E-Bike Outlook

E-Bike Description

Majority Of E-Bikes Are Sold In China

Electric bicycles, or e-bikes, are broadly two-wheeled vehicles powered by an electric motor. E-bikes typically come in one of two designs: bicycle style (BSEB), which give the user the option to power it by either pedals or electric motor, and the scooter style (SSEB) (Exhibit 13). The vast majority of the world’s e-bikes are sold in China.


Exhibit 13 - E-Bike ModelsBicycle Style Scooter Style

Great Appeal Due To Speed, Cost, Flexibility

We highlight the following features of e-bikes:

♦ Speed – Most e-bikes have a maximum speed near 20 km/h, the legal speed limit for e-bikes in China. However, many manufacturers make it easy to modify the e-bikes to reach speeds of more than 50 km/h.

♦ Range – Most e-bikes today have a range of 25-50km on one charge of a lead-acid battery, although this varies by climate and terrain. It typically takes 6-8 hours to fully recharge the battery. E-bikes powered by NiMH and lithium-ion batteries have a much larger range, however they are significantly more expensive and as a result, are generally limited to Western markets.

♦ Cost – Most e-bikes sell for $125-$400 (1,000-3,000RMB) in China. Other costs include battery replacement every 18-24 months at a cost of $32-$40 (250-300RMB) and the nominal cost of electricity spent each time to recharge the battery. Considering urban residents in China spent an average of $80 (607RMB) on transportation in 2006, many would consider e-bikes an affordable means of transportation.

♦ Registration – The law in China currently recognizes an e-bike as a bicycle and as such, does not require the user have a license or registration to drive it. However, we expect that as e-bikes get faster and the popularity of the vehicle continues to grow, the introduction of some form of license or registration is possible.

Largely An Urban Product

E-bikes are most popular in urban areas as the range, power, and road quality often limits its use in rural settings. For those in rural areas that can afford an e-bike, given the limited speed and range, until the battery technology improves we expect motorcycles will continue to be the preferred vehicle.



Cheapest Form Of Motorized Transportation

E-bikes have a number of advantages over other modes of transportation:

♦ Low cost of ownership – E-bikes are cheaper than all other forms of motorized transportation (Exhibit 14), given the low purchase price, maintenance and fuel costs, and lack of licensing or registration requirements. According to industry expert Jonathan Weinert, the cost of ownership for a $325 (2,500RMB) e-bike in China is $125 (950RMB) per year, assuming a five-year life of the vehicle. We note it costs approximately 0.40RMB ($0.05) to recharge an e-bike battery, allowing the user to travel up to 50km.

Exhibit 14- Total Annual Cost of Ownership (RMB)

0

3,0006,000

9,000

12,000

Bicycle E-bike Bus Gas Scooter MotorScooter(LPG)

Compact Car(Gas)

Source: Weinert, PhD, Eng, Alternative Transportation Technologies Expert.

Relatively Fast In Congested Areas

♦ Relative speed in urban areas – Although e-bikes are obviously faster than pedal bikes, they are also often faster than buses in congested areas, as well as cheaper and more comfortable at peak times. According to a study performed in Shanghai, the average operating speed of e-bikes was 14.5km/h, only 0.5km/h slower than cars/taxis (Exhibit 15). The subway was the fastest mode of transportation. However, with a subway or other light rail system in only 10 cities in China, e-bikes could be one of the more efficient forms of transportation in many of China’s other cities. In rural landscapes, however, the speed and range of current e-bikes have limited their popularity.

Mode of Transportation Speed (km/h)Subway 17.0Car/Taxi 15.0E-bike 14.5Fast bus 12.3Bicycle 11.1Slow bus 7.8Walk 4.5

Source: Cherry, PhD, Eng, Alternative Transportation Technologies Expert.

Exhibit 15 - Average Operating Speed (km/h) in Shanghai



Zero Exhaust Emissions

♦ Zero exhaust emissions – Of the 20 worst cities in the world for air pollution, 16 are currently located in China. The Chinese government addressed this in its 11th Five Year Plan (2006-2011). Given their zero exhaust emissions, e-bikes appear to be part of this solution. However, we note that e-bikes do use electricity generated by coal-fired power plants, which are a major source of air pollutants, and when the 18-24 month life of e-bike lead-acid batteries (versus three years for car batteries) is combined with the lack of lead recycling facilities, e-bikes still contribute to pollution.

Same Legal Status As Bicycles

♦ No driver’s license or registration required – Because e-bikes are recognized as bicycles by Chinese law, there are no federal license or registration requirements. As a result, virtually anyone can drive an e-bike. A local government, however, has the authority to enforce more strict rules on e-bikes in its jurisdiction. Beijing, for example, requires e-bike users have a license. In certain other cities, such as Wuhan, e-bikes have been banned outright.

Industry Boom Expected To Continue

Up To 26M E-Bikes Sold In 2007

E-bike sales are expected to grow by a CAGR of 25.3% from 2006-2010 to 48.8 million units by 2010 (Exhibit 16), according to Horizon Research Consultancy Group, a major market research company in China. Estimates for 2007 sales vary significantly between sources, ranging anywhere from 19-26 million units.

Exhibit 16 - Output of E-Bikes in China

0

10

20

30

40

50

2001 2002 2003 2004 2005 2006 2007e 2008e 2009e 2010e

Millio

n

Source: Horizon Research.

Three key drivers behind the growth in e-bikes sales in China are as follows:

♦ Rapid growth in urban and suburban populations.

♦ Rising incomes and, with this, the tendency to spend disproportionately more on transportation.

♦ Legislation aimed at reducing air pollution in major cities.

We expand on each of these drivers below.



Urbanization & Suburbanization

Urban Population To Increase 42% By 2020

The urban population in China is expected to be 742 million by 2020, a 42% increase from 2006 levels. By 2020, almost 53% of the total population is expected to live in cities, up from less than 44% in 2006. As illustrated in Exhibit 17, between 1990 and 2005, the proportion of Chinese citizens living in urban areas grew significantly as the liberalization of the economy resulted in the migration of workers from rural areas to the city in pursuit of higher paying jobs. This trend is expected to continue through 2020.

Exhibit 17 - China's Urban & Rural Population (1990-2020e)

0%20%40%60%80%

100%

1990 1995 2000 2005 2010e 2015e 2020e% of Urban % of Rural

Source: Euromonitor International.

Better Roads, Longer Commute Create Demand

As with Western cities, this rapid urban growth has affected travel in two ways:

♦ Improved infrastructure – Many cities have invested significant money in the road systems, in part to accommodate the rapid growth in car ownership. This surge in car ownership, however, has resulted in significant congestion. With demand for faster, more flexible forms of transportation, combined with the improved infrastructure, including dedicated bicycle lanes in a number of cities, e-bikes are a natural consideration. Shanghai has among the highest levels of e-bike ownership in China, where there were an estimated 1.35 million e-bikes in 2006, in a city of 19 million people.

♦ Longer commutes – With downtown housing prices becoming prohibitively expensive, many people have been forced to move away from the city core and into the suburbs, where traditional bicycles are no longer a practical form of transportation. With public transportation often very time consuming and not always easily accessible, the speed, versatility, and relative low cost of e-bikes has made them an attractive alternative.

Growth in Disposable Income

Disposable Income To Grow At CAGR Of 12.5% Through 2017

Disposable income per capita in China is expected to grow at a CAGR of 12.5% between 2007 and 2017, according to Euromonitor International. This is well ahead of the average growth rate of 6.6% posted over the 1997-2006 period (Exhibit 18).



Exhibit 18 - Chinese Annual Disposable Income (1997-2017e)

05,000

10,00015,00020,00025,00030,00035,000

1997 1999 2001 2003 2005 2007 2009e 2011e 2013e 2015e 2017e

RMB

per C

apita

Source: Euromonitor International.

Transportation & Communication Spending Grows With Wealth

As disposable incomes rise and consumer staples are covered, new spending is typically more discretionary in nature. We illustrate this tendency in Exhibit 19, where spending on transportation and communication grew as a percentage of total expenses as wealth levels increased.

0%2%4%6%8%

10%12%14%

1990 1995 2000 2004 2005

% o

f Inc

ome

Source: National Bureau of Statistics of China.

Exhibit 19 - Chinese Transport and Communications Expenses (1990-2005)

We believe there is still significant upside to the percent of money spent on transportation

and communications. Although the average urban resident in China spent approximately 12.6% on transportation and communications in 2005, even individuals with incomes in the top decile spent less than 20% on that category (Exhibit 20). With an estimated 50%-70% of transportation and communication spending allocated to transportation, this translates into 7% of disposable income for the average urban resident. This is significantly lower than more industrialized countries; in the US, for example, individuals spend an average of 18% of their disposable income on transportation. With approximately half of Chinese urban residents currently commuting to work by bicycle, this represents a potential market of almost 300 million individuals who will likely consider e-bikes as their disposable incomes rise. Longer term, some of this higher disposable income will likely shift from e-bikes to cars.



Category Lowest 10% Average Top 10%Food 47.4% 36.7% 28.0%Clothing 7.8% 10.1% 9.2%Trans. & Comm. 7.3% 12.6% 19.7%

Source: National Bureau of Statistics of China.

Exhibit 20 - 2005 Urban Residents Living Expenses (% of Total)

Legislation Addressing Air Pollution

Federal Government Supportive Of E-Bikes

Legislation at the national level has generally been supportive of e-bikes. In 2004, the Chinese central government ratified the Road Transportation Safety Law, classifying e-bikes as bicycles provided they are not driven beyond 20 km/h. Despite this support, we note it is the local governments that ultimately decide how to enforce the rules. As a result, there are some significant differences between cities.

60 Cities Have Banned Gasoline Motorcycles

It is estimated that over 60 cities in China have banned new ownership of gasoline motorcycles as a means of controlling air pollution. In most cases, this means that those who did not own a motorcycle at the time of the ban are not permitted to buy one. Shanghai was a leader in this initiative, suspending licenses of gasoline-powered motorcycles in the downtown area already in 1996. Since that time, cities including Guangzhou (population of almost 10 million), Shijiazhuang (9 million), and Suzhou (6 million) have followed suit. As a result, demand for e-bikes has surged due to the relatively similar performance to motorcycles in an urban setting, at a lower cost. In most cases, cars are not affordable; in 2006, less than 4 million cars were sold to a population of 1.3 billion people.

Government Focused On Reducing Air Pollution

Environmental protection was an area of focus in China’s 11th Five-Year Plan (2006-2010), in part triggered by air pollution problems in a number of cities. As Exhibit 21 illustrates, some of the most heavily polluted cities in the world are located in China. Some of the key initiatives in the plan include:

♦ Reduction in the sulphur dioxide emissions by 20% from 2005 levels by 2010.

♦ Investments totalling US$170 billion geared toward environmental protection and to reducing energy costs per unit of GDP by 20%.

♦ Increase the proportion of renewable energy from 7% to 12% over the next 15 years.

Encouraging the increased use of e-bikes is consistent with these initiatives.



Exhibit 21 - Particulate Air Pollution in Selected Cities

Source: World Bank.

Certain Cities Have Also Banned E-Bikes

Some cities have elected to ban e-bikes, citing concerns that e-bikes slow traffic, the safety hazards in a car dominated environment, and the lead pollution caused by deficient lead-recycling infrastructure. These cities include Wuhan (10 million), Fuzhou (7 million), and Haikou (less than 1 million). Beijing attempted to ban e-bikes in 2006, however this ban lasted only a few days. Instead, Beijing now requires that users have a license to operate an e-bike. Although we believe the merits of e-bikes outweigh the negatives, as noted in the risk section of this report, even speculation that additional cities could eventually ban e-bikes could curb sales growth.

International Markets

Strong Demand Expected In Africa And Asia

Although we expect modest demand in international markets, we believe China will continue to dominate the e-bike market. Most of the international growth is likely to come from Africa and Asia, particularly India, due to a similar combination of road congestion and growing disposable income. Even still, the Indian Times cited auto industry experts there who estimated sales of only 220,000 units in 2010. It is estimated that about 100,000 e-bikes are sold in each of the United States and Europe per year, the majority of which are very high-end e-bikes.



Competition

Highly Fragmented Market

The Chinese e-bike industry is highly fragmented, with approximately 2,000 manufacturers offering more than 3,000 brands. It is estimated that the largest player has a 2%-3% market share. Only six companies are known to have an annual production capacity of over 200,000 units, in a market that produced over 20 million e-bikes in 2007. Most manufacturers produce between 10,000-50,000 units per year.

The degree of market fragmentation is largely due to the modular nature of the lower-end bikes. With only modest enforcement of intellectual property protection, many parts on lower-end bikes have become standardized. As a result, there are few barriers to entry. There are fewer manufacturers producing higher-end bikes in the market.

Key Factors Include Price, Brand, Battery

Firms compete on the basis of price, battery strength, brand, and distribution. Given the challenge of competing effectively on all fronts, access to more resources gives the larger manufacturers an edge.

We profile below several of ZPP’s competitors:

♦ Giant Manufacturing (9921-TPE) – Based in Taichung Hsien, Taiwan, Giant is the world’s leading bicycle manufacturer. The company has manufacturing facilities in Taiwan, mainland China, and the Netherlands. The company is expected to have revenue of close to US$1 billion in 2007, of which e-bikes could account for approximately 10%.

♦ Chunlan Group (Private) – Based in Taizhou, China, Chunlan is one of China’s largest conglomerates. The company is involved in the electrical appliance, automotive, and alternative energy industries. The company has an annual manufacturing capacity of 300,000 e-bikes and 1 million motorcycles.

♦ Luyuan Electric Vehicle (Private) – Based in Jinhua, China, Luyuan is China’s leading e-bike manufacturers with an annual production capacity exceeding 400,000 units.

♦ Small Antelope Electric Bicycle Co (Private) – Based in Suzhou, China, Small Antelope is one of the largest e-bike manufacturers in China with a production capacity of 350,000 units per year.

♦ Phoenix Co (900916-SHSE) – Based in Shanghai, China, Phoenix is one of China’s oldest bicycles manufacturers. The company had revenue of US$205 million in 2006; the amount generated by e-bikes sales is unknown.



Percentage of companies covered by Laurentian Bank Securities Equity Research within each rating category.

Appendix II – Important Disclosures

Company Ticker Disclosures* Zongshen PEM Power Systems ZPP-V V, U

The analyst(s) certify that (1) the views expressed in this report in connection with securities or issuers they analyze accurately reflect their personal views and (2) no part of their compensation was, is, or will be directly or indirectly, related to the specific recommendations or views expressed by them in this report. The Research Analyst’s compensation is based on various performance and market criteria and is charged as an expense to certain departments of Laurentian Bank Securities (LBS), including investment banking.

* Legend

A The Analyst, in his/her own account or in a related account, owns securities of this issuer.

L LBS collectively beneficially owns in excess of 1% of one or more classes of the issued and outstanding equity securities of this issuer.

O The Director of Equity Research, in his/her own account or in a related account, owns securities of this issuer.

U Within the last 24 months, LBS has undertaken an underwriting liability with respect to equity securities of, or has provided advice for a fee with respect to, this issuer.

V The Analyst has visited material operations of this issuer.

P This issuer paid a portion of the travel-related expenses incurred by the Analyst to visit material operations of this issuer Laurentian Bank Securities Equity Research Ratings Distribution

0%

56%

6%0%

38%

0%

10%

20%

30%

40%

50%

60%

Top Pick Buy Spec Buy Hold Reduce



Recommendation LBS (Laurentian Bank Securities) recommendation terminology is as follows: Terminology

Top Pick Our best investment idea, the greatest potential value appreciation. Buy The stock is expected to generate significant risk-adjusted returns over the next 12 months. Hold The stock is expected to generate modest risk-adjusted returns over the next 12 months. Reduce The stock is expected to generate negative risk-adjusted returns over the next 12 months.

Our ratings may be followed by “(S)” which denotes that the investment is speculative and has a higher degree of risk associated with it.

Additionally, our target prices are based on a 12-month investment horizon.

The information contained in this document is based on what we deem to be reliable sources, but no guarantee or promise, explicit or implicit, is given as to the accuracy and exhaustiveness of these sources. This report shall under no circumstances be considered an offer to buy or sell, or a request to buy and/or sell the stocks mentioned. Laurentian Bank Securities Inc. and its employees may not be held liable for any monetary losses stemming from the implementation of the recommendations contained in this document. Laurentian Bank Securities Inc. and/or its officers, directors, representatives, traders, analysts and members of their families may hold positions in the stocks mentioned in this document and may buy and/or sell these stocks on the market or otherwise. Stocks in foreign currency may be adversely affected by exchange rate fluctuations. Laurentian Bank Securities Inc. is a wholly-owned subsidiary of Laurentian Bank of Canada. The opinions, projections and estimates are those of the Economic and Financial Research department of Laurentian Bank Securities Inc. as at the date appearing on the cover page, and are subject to change without prior notice. Laurentian Bank Securities Inc. may, in exchange for remuneration, act as a financial advisor or tax consultant for, or participate in the financing of companies mentioned in this document. This study may not be reproduced, in whole or in part, without the consent of Laurentian Bank Securities Inc.



Laurentian Bank Securities (LBS) President

Michel Trudeau, MBA

Institutional Equity

Simon Lussier, MBA (514) 350-3060 Senior Vice President [email protected]

Research

David Buma, CFA (514) 350-2957 Head of Equity Research Industrial Products Analyst [email protected]

Alex Grassino, MSc (514) 350-2855 Information Technology Analyst [email protected]

Catherine Bouchard, MSc, MBA (514) 350-2938 Healthcare Analyst [email protected]

Alka Patel (514) 350-2941 Consumer Products Analyst [email protected]

Vincent Perri, CA, CFA (514) 350-2876 Special Situations Analyst [email protected]

Éric Lemieux, MSc (514) 350-2874 Mining Analyst (819) 472-8037 [email protected]

Mathieu Chevrier (514) 350-2949 Research Associate [email protected]

Trading

Maurice Gariepy (514) 350-3055 Head Trader [email protected]

Demitri Prassinos Trader (514) 350-2823 [email protected]

Sales

Suzy Champagne, MSc, CFA (514) 350-2992 [email protected]

Marcia Wisniewski, CFA (416) 865-5982 [email protected]

Patrick D’Amico, MBA (416) 865-5876 [email protected]

Corporate Finance

Patrick Langlois, CFA, MBA (514) 350-3045 [email protected]

Frédéric Beausoleil, CFA (514) 350-2839 [email protected]

Fixed Income Sales Division

Chris B. Ward (514) 350-2904 Vice President Sales [email protected]

Syndication

Pierre Godbout, CIM (514) 350-3050 Vice President [email protected]

Jean-François Carrière (514) 350-2979 Syndication Analyst [email protected]

Retail Division

Riccardo Magini (514) 350-2960 Vice President* [email protected]

Economics & Strategy

Carlos Leitao (514) 350-3000 Chief Economist [email protected]

Sébastien Lavoie (514) 350-2931 Economist [email protected]

Boris Wyka, CFA (514) 350-2975 Strategist [email protected]

Martine Bérubé (514) 350-3006 Coordinator [email protected]

Company Report - VMBL · 1-Yr Target $5.25 Avg Daily Volume (K) 56.9 Dividend $0.00 Control Blocks:...

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