Cosco Research Note 20.10.2006

RESEARCH REPORT

COSCO ESP Ltd

October 2006

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VSA Resources is committed to providing objective research. This report has been commissionedby COSCO ESP Ltd and is therefore unlikely to be perceived as objective. Your attention is further drawn to the disclaimer at the end of this research report.

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Investment Summary: A bright prospect beckonsCOSCO ESP Ltd is an Irish based holding company that for the last 20 years hasprovided high quality Electric Submersible Pump (ESP) equipment, including surfaceand control systems it manufactures and downhole components it distributes. Itstraditional markets are North Africa, the Middle East, and the Russian Federation.

Advantage over competitorsCOSCO has a distinct advantage over some of its competitors because it can supplyits own control products. Consequently, its products give better protection to thesystem equipment, while capturing more operational data. COSCO also has anationality advantage in certain countries where customers prefer to have a supplierfrom a perceived neutral country.

Future prospectsCOSCO hopes to become a manufacturer and distributor par excellence of ESPequipment and systems, and establish regional test/repair/service centres at a timewhen the market for ESP systems and ancillary services is expected to growsignificantly to meet the world’s increased demand for oil. It is likely that COSCO willestablish a motor and pump manufacturing facility in China to supply new productsand replacement components more efficiently to customers. Joint ventures with aSaudi Arabian and another Middle Eastern partner are expected soon.

FinancialsWe estimate that COSCO could increase its revenue stream from US$1.9m in 2005to just under US$4m this year if its current expansion plans are successful. This islikely to mean that net earnings would rise significantly from a loss of US$63,000 toa profit of US$186,000 in 2006 increasing to US$3.6m in 2008.

Pre-IPO fundingThe Company is seeking US$6.5m to establish a motor and pump manufacturingfacility in China, expand its submersible pump and repair business, increase itsmarket presence, especially in Africa and the Middle East, and expand its workingcapital base in order to finance existing and larger contracts.

Valuation – significant upsideIn arriving at a value for COSCO we have used a number of tools, such asprospective 2007 earnings and cash flow multiples. On this basis, we value COSCOat between $16.9m and $31.5m, giving an average of $24.2m.

Pre-IPO Funding

COSCO ESP LtdPrice n/a

Market Cap €m n/a

SHARE DETAILS

CODE n/a

LISTING n/a

SECTOR n/a

SHARES IN ISSUE 38,064,426

PRICE

52 weeks

High Low

n/a n/a

BALANCE SHEET

Debt/Equity (%) 0

NAV (US$m) 24.2

(Net borrowings)/Cash (US$m) 0.8

BUSINESS

GEOGRAPHY (based on revenues))

CANADA LIBYA MIDDLE EAST OTHER

0% 34.5% 54.3% 11.2%

ANALYST

Brian McBeth 020 7628 3989

[email protected]

SALES

Neil Pidgeon 020 7628 3989

[email protected]

COSCO is a holding company thatmanufactures and distributes highquality Electric SubmersiblePumps, together with surfacecontrol systems and components.The Company is based inEdmonton (Canada), and has anoperating unit in Malta serving itsLibyan clients.

Year end Revenue PBT EPS DPS PE Yield 31 Mar (US$000s) (US$000s) (US$) (US$) (x) (%)

FRS3 FRS3

2006a 1899 -228 (0.006) 0 0 0

2007e 3900 254 0.007 0 0 0

2008e 13600 2471 0.065 0 0 0

2009e 20280 4132 0.109 0 0 0

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4 COSCO ESP LTD PRE-IPO FUNDING OCTOBER 2006 VSA RESOURCES INVESTMENT RESEARCH

Investment summary: A new kid on the block

Strategy is to build on Company’s unique experience COSCO ESP Ltd (COSCO) is an Irish based holdingcompany that for the last 20 years has manufacturedand distributed high quality Electric SubmersiblePumps (ESPs), together with surface control systemsand components. COSCO manufactures ESPpenetrators, switchgear, downhole sensors, ESPcontrollers and dataloggers, and auxiliary products.COSCO formerly distributed Temtex pumps andmotors in Libya, and was a reseller in other markets.Currently such components are obtained from otherthird party sources. Its traditional markets are in NorthAfrica, the Middle East, and the Russian Federation.

COSCO also manufactures the Vortex ESP controllerunder an exclusive license for the Libyan market. Thiscontroller was developed by COSCO’s President MarkDorin and others, and sold to Centrilift in 1991. From1998 to 2000, COSCO was the majority owner ofControl Telecom Inc., and worldwide distributor forthe CTI ESP controller until it sold its interest in thecompany to Wood Group ESP. COSCO has thereforebeen involved in the development and marketing oftwo of the main three control systems used in theindustry. COSCO is currently developing a newadvanced controller/datalogger.

COSCO’s combined product line is possibly equal orbetter both in range and quality than that of some itsmajor American and British competitors.

The Company's advanced technology control andmonitoring equipment allows improved managementof oil production from new and existing oil reservoirsand increased protection of ESP equipment.

Valuation: conservative value withsignificant upsideIn arriving at a value for COSCO we have used anumber of tools such as prospective 2007 earningsand cash flow multiples. It is clear that owing to itssize and business, COSCO is much smaller than itsnearest competitors such as Schlumberger and BakerHughes. In order to reflect this disparity in size wehave discounted the above multiples by 25%.COSCO can then be valued at between US$16.9m andUS$31.5m, giving an average of US$24.2m

Sensitivities: Challenges of operating in emerging marketsThe Company faces four main challenges:

1. To establish COSCO as a first class servicecompany in the area of ESPs by using its owntechnology, which is competitively priced,technologically more advanced, and with fieldproven equipment and systems that generategreater field operational data for optimisingproduction and maintaining oilfield productionwhile minimising production costs.

2. To establish a motor and pump manufacturingfacility in China.

3. To become a manufacturer and distributor parexcellence of ESP equipment and systems, withregional test/repair/service centres in Libya,Saudi Arabia, and the Middle East.

4. To maintain or increase its market share in itsmain markets, and to expand in other areas ofthe world such as the Russian Federation andSouth America.

Financials: positive cash flow in 2007The buoyancy of the oil market is expected tobenefit COSCO considerably this year and for theforeseeable future. It should be noted that COSCO’sbusiness is not reliant on high oil prices. In 2005,COSCO reported a net loss of US$63,000 for theyear ending 31 March 2006. We expect turnover thisyear to reach US$3.9m because of increased activityin the Company’s main markets. Turnover isexpected to continue to rise in subsequent yearsreaching US$20m in 2008, driven by itsestablishment of a motor and pump manufacturingfacility in China and by its joint venture in SaudiArabia. Gross margins are expected to increaseowing to lower costs realized from Chinamanufacturing and a squeeze on the Company’ssuppliers. If our projections are correct, then wewould expect the Company to generate a largeamount of cash over the next 24 months, which willserve it well in its capital expenditure programmeand possibly in paying a maiden dividend. We expectnet earnings to rise significantly from a loss ofUS$63,000 in 2005 to a profit of US$4.1m in 2008.

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HistoryCOSCO manufactures and/or distributes high qualityElectric Submersible Pump (ESP) systems, together withsurface control systems and components. In 1996, COSCOadded downhole pumps and motors to its product line,and since then has been a complete ESP supplier. Over thelast 20 years, the company has supplied a quality productline that has increased the productivity of oil wells whilereducing costs. The Company is registered in Ireland, withits headquarters in Edmonton (Canada), and an operatingfacility in Malta serving its Libyan clients. Its main marketsare Libya, the Middle East and the Russian Federation.

COSCO has a distinct advantage over some of itscompetitors because it can supply its own control products.Consequently, its products give better protection to thesystem equipment while capturing more operational data.COSCO’s combined product line is possibly equal or better inrange and quality than its competitors, and the Company hasa nationality advantage in certain countries where customersprefer to have a supplier from a perceived neutral country.

BackgroundWhen there is insufficient natural pressure to bring thecrude oil to the surface, artificial lift is used to increasehydrocarbon production. Such a method of assisting oilproduction is increasingly used in mature oilfields that havedeclining productivity, and in newer oil fields whereimprovements in oilfield management practice becomemore widely deployed and more rapidly adopted. (SeeAppendix A for a fuller explanation). COSCO suppliesElectric Submersible Pumps (ESPs), the fastest growingsection of the artificial lift market for hydrocarbons.

Electric Submersible Pumps (ESPs)The world ESP market has steadily grown and is over $1.3 billion per annum, with continued growth expected.ESP sales are half the artificial lift market, that is, sales ofESPs exceed all other types of artificial lift combined.

ESPs require very little space and can be installed in highlydeviated wells, making them ideal for offshore operations.ESPs are also used where there is insufficient reservoirpressure to lift the oil. ESPs are best installed where thereis large production and insufficient reservoir pressure to liftthe crude oil. The intensity of ESPs in the industry is seen inthe following table.

Increasing Intensity of ESP Use

Year Industry World Oil Intensity RatioRevenues (US$m)* Production (m b/d)

1990 $330 66.7 5.0

2001 $985 77.0 12.8

2005 $1300 81.4 16.0

*COSCO estimates. Split 50-50 between equipment/ supplies &

testing/repair/service.

Source: COSCO

It is estimated that there are between 80,000 and 100,000oil well ESP systems installed worldwide, with the RussianFederation and the FSU accounting for 50% of the totalinstalled units. Russia relies heavily on ESPs but the systemsare generally smaller and less sophisticated, with theRussian market accounting for only 20% by value of thetotal ESP world market.

VSA RESOURCES INVESTMENT RESEARCH COSCO ESP LTD PRE-IPO FUNDING OCTOBER 2006 5

A new kid on the block

World distribution of ESPs

Region Russia/FSU USA/Canada Indonesia UKCS Africa Middle East Rest of SE Rest of World

ESP Units Installed 50000 15000 4000 1000 2200 2100 5000 5000

Oil Prod 2001 mb/d 8.8 11.1 1.1 7.3 9.5 23.9 5.4 9.1

Potential Resources 386.5 405.7 30 72.1 285.2 1248.5 100 402

ESP Growth Prospects Positive Static Static Static Strong Strong Strong Strong

ESP Market Size (US$m) $300 $310 $220 $50 $150 $220 $30 $60

COSCO Priority (high=5) 4 1 3 0 5 4 1 3

Source: COSCO

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6

With any ESP completion, operators are interested inextending the life of the pump. There are major benefits indoing this because it reduces the down time of the pump,thus increasing production over time as well as reducingthe cost of replacing worn or damaged pumps.

It is estimated that ESPs can lift between 200 to 100,000barrels of liquids at a maximum depth of 12,000 feet, andare routinely found in reservoirs under water flood as wellas in offshore wells. ESPs have a working life of a fewweeks to 10 years. The average worldwide run life isbetween 8 – 15 months.

In its most basic form, the ESP completion is a pumppowered by a coupled electric motor suspendeddownhole on a tubing string. The pump receives powerfrom a cable secured to the exterior of the tubing, andpower is supplied by three-phase transformers. A switchboard provides instrumentation for control andmotor protection. A junction box acts as a vent to preventgas migrating up the power cable and reaching theelectrical switchboard. The electric motor at the bottom ofthe tubing string is isolated from well fluids by means ofspecial seal section (protector), which also equalizes thepressure in the motor with the well bore pressure, and amotor driven pump above it, which is normally amultistage centrifugal pump. If free gas is present, a gasseparator is also used. Downhole instrumentation may beused to monitor the performance of the well and protectthe motor from damage by overheating. A variable speeddrive may be used instead of a switchboard, allowing themotor speed (rpm) to be varied, thereby providing a widervolume range to be produced as opposed to operatingthe unit at a fixed speed.

The discharge rate of the pump is a function of thedifferential pressure across the pump system, which isdetermined by the speed at which the pump motor rotates,the pump impeller design, and the viscosity of the fluid.The lift that the pump provides is determined by thenumber of stages employed.

The wellhead needs special provisions to bring the ESPpower cable into the wellbore and provide sealing. Aservice rig is used to pull and run the downhole equipment.

An ESP system has to be engineered before it can beinstalled, with the sub-surface equipment meeting theparticular specifications of a well: One of many possiblepump types is chosen to provide the volume required, thenumber of pump stages is determined to provide therequired lift, and the motor size is dependent on the pumptype and number of stages. Cable conductor size isdependent on the motor size and operating parameters.Quality well data is required to properly size an ESP unitand is often unavailable.

Numerous factors affect the run life of an ESP such as: (1) proper design; (2) power supply quality; (3) downholeconditions (temperature, presence of gas, sand or corrosivefluids); (4) using effective controls that properly protect theinstallation; (5) operational practices; and (6) operating theunit within the optimal flow rate range. Pulling the ESP fromthe well is often more costly than the ESP equipment itself.

Oil well ESP equipment is highly specialised and isprincipally obtained from the primary ESP suppliers ortheir regional distributors. Those having a test/repairfacility/ service in reasonably close proximity to the oilfield where the ESP is used may have an advantage overother suppliers. The components of an ESP system areserviced, repaired, modified, replaced and upgradedmany times over the production life of a well. The cost ofa complete ESP system can vary from less than $100,000 US dollars to over $500,000 US dollars per well(ESP components only).

Downhole SensorsDownhole sensors are sometimes used to monitor and loginformation used for reservoir management and ESPmonitoring and control. Sensors may be attached tocommon brands of ESP motors if an upper tandem or centretandem motor is employed. Data is transmitted to thesurface via a digital signal that travels along the main ESPpower cable, and a surface choke is used to isolate themotor voltage before the signal is interpreted by the surfaceinterface panel. Various types of downhole sensors exist interms of complexity, reliability and price, and whether or not,and how, data is electronically stored in memory.

ESPs & COSCOCOSCO supplies ESPs that increase fluid, and hencehydrocarbon, production when there is insufficientnatural pressure to bring crude oil to the surface or whenthere is a need to increase production. It alsomanufactures and distributes ESP surface control systemsand accessories, including motor controls, switchgear,Variable Speed Drives, wellhead equipment andconnector (electric feed-through) systems, transformers,downhole sensors and monitoring equipment, and motorlead flat extension cables.

COSCO manufactures the Vortex ESP controller under anexclusive license for the Libyan market. Developed byCOSCO’s President Mark Dorin and others, it was sold toCentrilift in 1991. More oil well ESPs are controlled byVortex equipment than any other ESP control device.COSCO was previously the majority shareholder of ControlTelecom Inc., and worldwide distributor for the CTI ESPcontroller. It sold its interest in the company to Wood

COSCO ESP LTD PRE-IPO FUNDING OCTOBER 2006 VSA RESOURCES INVESTMENT RESEARCH

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Group ESP. As a result, COSCO has been largelyresponsible for much of the control innovation in the ESPindustry and has a successful track record of introducingnew products to the industry. COSCO is currentlydeveloping a new ESP control system that should becomethe leading control device when it goes live.

COSCO’s advanced monitoring equipment allowscustomers to maximize production, extend theequipment’s life, and reduce down time and operationalcosts while optimising well performance and datagathering. COSCO’s subsidiary, COSCO PumpCompany Limited is a full service ESP supplier with aprimary focus on Middle East markets, headquartered inSliema, Malta.

COSCO’s product line and services provided are givenbelow.

International MarketThere are 11 primary suppliers of ESP systems that control 95% of the world market, of which five, viz, Schlumberger(Reda), Baker-Hughes (Centrilift), Wood Group (Wood GroupESP), Weatherford and COSCO, are active internationally.The other six primary suppliers (Russian (3), Chinese (2) andSaudi (1)) mainly confine their activities to their domesticmarkets. COSCO can compete in product, technology andprice against its large competitors but it clearly needs toincrease its capacity to compete for after-market service, andestablish a stronger profile in the market.


Motor Controllers

Variable Speed DriveSwitchboard

Penetrator ESP Wellhead with Penetrator ESP Transformer

DischargeHead

Pump

Gas Separator

Protector

Cable

Motor

Down HoleSensor

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Future Growth In order to achieve its targets, COSCO intends to establisha motor and pump manufacturing facility in China at a costof around $5m. The addition of pump and motormanufacturing will mean that COSCO will have aninternally-sourced product line similar to that of any otherESP competitor.

COSCO has acquired the Intellectual Property required tomanufacture “Reda Type” ESP pumps, motors, protectors,gas separators, and associated equipment to bemanufactured in the Tianjin/Baodi district of Tianjin City,some 70 kilometres away from Beijing, with a population of10 million people.

In order to attract foreign investment, the localgovernment will grant tax breaks to companies with acapital of $1m or over. As a result, when COSCOestablishes the motor and pump facility, it will enjoy a twoyear income tax holiday and after that will only pay 50% ofnormal corporation tax over the next six years.

There are other possible benefits to manufacturing inChina for COSCO. The majority owned Chinesegovernment oil companies such as CNPC and Sinopec areaggressively acquiring oil fields worldwide that utilize ESPs.It is anticipated that the Chinese government will givepreference to Chinese ESP manufacturers such as COSCObecause none of the domestic suppliers have internationalservice capabilities.

In addition, COSCO is negotiating to purchase atest/repair facility in Libya. It is also in discussions with twopossible partners in Saudi Arabia and Iran to set-up twojoint ventures to provide service/test/repair facilities. Thejoint venture partners would provide factory space andpurchase a minimum of between $3.5m – 6m in shop repairequipment and inventory. Each joint venture will distributeCOSCO equipment, perform repairs and provide servicewithin a territory.

The ability of having service/test/repair facilities means thatCOSCO will benefit from the increased business ofservicing and repairing its own equipment as well asservicing the equipment of other manufacturers. It is alsoclear that by expanding its service and distributionchannels that COSCO will gain market share andmanufacturing scale, allowing the Company to expand intonew markets.

Management and Operational CentresThe Company’s main operational and manufacturingcentre is at Edmonton, Canada. It also has a sales andengineering office in Malta servicing the North Africanmarket, with local agents active in Saudi, Oman/UAE,Sudan/Egypt and Iran.

Directors & Senior ManagementThe Directors and Senior Management of the Company aregiven below:

Mark Dorin PresidentCo-founder of COSCO and president since 1998. He hasa 30 year background in oilfield production and ESPs, with20 years in the ESP industry, starting two successful ESPindustry companies.

Andrew Male Director, VP Corporate FinanceCorporate Finance background, mainly in raising capitaland corporate governance.

Andrew Walker Director, Chief CounselSecurities Lawer. Legal Director on many boards of listedcompanies.

Geoffrey Warr Manager, COSCO Pump Company MaltaHas a degree in engineering, and an MBA. Over 15 yearsexperience in the ESP industry, primarily in Libya.


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Sensitivities: four main challengesThe Company faces four main challenges:

1. To establish COSCO as a first class service company inthe area of ESPs. The Company expects to achieve thisby using its own technology, which is competitivelypriced, technologically more advanced, and with fieldproven equipment and systems designed to generategreater field operational data for optimising andmaintaining oilfield production while minimisingproduction costs.

2. To establish a motor and pump manufacturing facilityin China.

3. To become a manufacturer and distributor parexcellence of ESP equipment and systems, withregional test/repair/service centres in Libya, SaudiArabia, and Iran.

4. To maintain or increase its market share in its mainmarkets in North Africa and the Middle East, and toexpand in other areas of the world such as the RussianFederation and South America.

FinancialsAt the moment, COSCO manufactures at its Edmontonbase around 10%-15% of the total value of an ESP system,with the rest purchased from third parties. The largestcomponent by value in an ESP system is the pumpassembly, power cable, and transformers, representingapproximately 60 % of the total cost of supplying the ESPsystem. When COSCO acquires its motor and pumpmanufacturing facilities in China, it will be able to capture alarger share of the value added by these two components

in the ESP system. It is estimated that gross margins for avariable speed ESP is around 40 %, whereas for a fixedspeed system it is higher at between 50%-55%.

The buoyancy of the oil market is expected to benefitCOSCO considerably this year and for the foreseeablefuture. In 2005, COSCO reported net loss of US$63,000 butwe expect turnover this year to reach US$3.9m because ofincreased activity in the Company’s main markets. Turnoveris expected to continue to rise reaching US$13.6m in 2007and US$20.2m in 2008, driven by its new motor and pumpmanufacturing facility in China and by its joint venture inSaudi Arabia. (See table below)

The rapid increase in turnover is based on the followingassumptions:• Establishment of motor and pump manufacturing

facilities in China.

• In Libya, COSCO will own 100 % of its repairs-test-servicing facility.

• For the rest of North Africa, the large increase inrevenue will be mainly from Egypt.

• Joint ventures established in Saudi Arabia, and Iran.

• COSCO establishes a foothold in Indonesia, Venezuelaand Ecuador.

Gross margins are expected to increase owing to a rise inturnover as well as a squeeze on the Company’s suppliers.If our projections are correct, then we would expect theCompany to generate a large amount of cash over the next24 months, which will serve it well in its capital expenditureprogramme and in paying a maiden dividend. Our forecasttogether with the balance sheet and cash flow projectionsare given below.


Estimated Revenue Projections ( US$m)

New Equipment Service Revenues

Surface Downhole Other Testing Repair FieldEquipment ESP Equip supplies Service Service Service TOTAL

2006e 1.5 1.5 0.5 0.1 0.2 0.1 3.9

2007e 4.5 5.2 2.0 0.5 0.8 0.6 13.6

2008e 8.2 8.3 2.9 0.8 1.1 1.0 20.3

Source: VSA Resources

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Profit & Loss, Balance Sheet & Cash Flow ProjectionsYear-end March 31

US$000s US$000s US$000s US$000s2006a 2007e 2008e 2009e

Revenue 1,899.00 3,900.00 13,600.00 20,280.00

Cost of sales (963.00) (2,028.00) (7,072.00) (10,550.00)

Gross profit 936.00 1,872.00 6,528.00 9,730.00

EBITDA (210.00) 1,772.00 5,728.00 8,730.00

Depreciation (17.00) (50.00) (400.00) (500.00)

Operating profit (before GW and except.) (193) 1,822 6,128 9,230

Goodwill amortisation 0 0 0 0

% of intangile assets 0% 0% 0% 0%

Exceptionals 0.00 0 0 0

Administrative expenses (1,129.00) (1,500.00) (3,000.00) (4,000.00)

Operating profit/(loss) (243.00) 322.00 3,128.00 5,230.00

Net interest (32) (18) (35) (45)

Other 15.00 0.00 0.00 0.00

Exceptionals 165.00 0.00 0.00 0.00

Profit before tax (norm) (228.00) 322.00 3,128.00 5,230.00

Profit before tax (FRS 3) (63.00) 254.00 2,693.00 4,685.00

Tax 0.00 (67.60) (656.80) (1,098.30)

Profit after tax (norm) (228.00) 254.40 2,471.20 4,131.70

Profit after tax (FRS3) (63.00) 186.40 2,036.20 3,586.70

Minority interest 0 0 0 0

Net income (norm) (228.00) 254.40 2,471.20 4,131.70

Net income (FRS 3) (63.00) 186.40 2,036.20 3,586.70

Average number of shares outstanding (m) 38.0 38.0 38.0 38.0

Share options and others outstanding (m) 38.0 38.0 38.0 38.0

EPS - normalised (US$) (0.006) 0.007 0.065 0.109

EPS - normalised and fully diluted (US$) (0.006) 0.007 0.065 0.109

EPS - FRS 3 (US$) (0.002) 0.005 0.054 0.094

Dividend (US$) 0.0 0.0 0.0 0.0


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Balance SheetYear-end March 31

Fixed assets 356.00 1,250.00 6,200.00 8,700.00

Intangible assets 300.00 800.00 1,200.00 1,200.00

Tangible assets 56.00 450.00 5,000.00 7,500.00

Investment in associates & JV's 0.00 0.00 0.00 0.00

Current assets 814.00 1,989.00 6,936.00 10,342.80

Stocks 196.00 585.00 2,040.00 3,042.00

Debtors 306.00 819.00 2,856.00 4,258.80

Cash 312.00 585.00 2,040.00 3,042.00

Other 0.00 0.00 0.00 0.00

Current liabilities (1,091.00) (1,950.00) (6,120.00) (9,126.00)

Creditors (868.00) (1,560.00) (4,760.00) (7,098.00)

Tax and social security 0.00 0.00 0.00 0.00

Short term borrowings (223.00) (390.00) (1,360.00) (2,028.00)

Long term liabilities 0.00 0.00 0.00 0.00

Long term borrowings 0.00 0.00 0.00 0.00

Other long term liabilities 0.00 0.00 0.00 0.00

Net assets 79.00 1,289.00 7,016.00 9,916.80

Minority interest 0.00 0.00 0.00 0.00

Shareholders equity 79.00 1,289.00 7,016.00 9,916.80

Year-end no of shares m 38.04 38.04 38.04 38.04

Opening shareholders equity 94.50 79.00 1,289.00 7,016.00

Net debt/(cash) (89.00) (195.00) (680.00) (1,014.00)

Net current assets (277.00) 39.00 816.00 1,216.80

Cash Flow

Operating Cash Flow (299.00) 1,772.00 5,728.00 8,730.00

Net Interest (32.00) (18.00) (35.00) (45.00)

Tax 0.00 (67.60) (656.80) (1,098.30)

Capex (11.00) (500.00) (750.00) (750.00)

(Acquisitions)/disposals 0.00 (2,000.00) (2,500.00) 0.00

Equity financing 583.00 6,500.00 2,500.00 2,500.00

Dividends 0.00 0.00 0.00 0.00

Other (166.00) 250.00 250.00 250.00

Net Cash Flow 75.00 5,936.40 4,536.20 9,586.70

Opening net debt/(cash) (174.00) (249.00) (6,185.40) (10,721.60)

HP finance leases initiated 0.00 0.00 0.00 0.00

Other 0.00 0.00 0.00 0.00

Closing net debt/(cash) (249.00) (6,185.40) (10,721.60) (20,308.30)

VSA RESOURCES INVESTMENT RESEARCH COSCO ESP PLC PRE-IPO FUNDING OCTOBER 2006 11

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Pre-IPO Funding and Use of New FundsIn order to capitalise on the strong ESP market, COSCOwants to acquire a motor and pump manufacturing facilityin China and expand its submersible pump and repairbusiness as well as increasing its geographical reach,especially in the Middle East. Up to now, COSCO hasfunded its expansion from internal cash flow and short-term loans from existing investors. Most contracts in theESP industry are large, placing a company without financialmuscle at a disadvantage. Consequently, if a companydoes not have sufficient financial resources at its disposal itis unable to win such contracts. COSCO finds itself in sucha position and can only bid on smaller contracts that it canfinance. COSCO has therefore decided to seek Pre-IPOfunds of US$6.5m that will allow it to grow in this particularmarket segment.

The increase in funds will allow COSCO to bid and winlarger projects and establish its own downholemanufacturing facility. Many companies with performancebased contracts (See Appendix A) will only deal with adownhole manufacturer. The manufacturing facility meansthat COSCO, apart from increasing its profit margins ondownhole equipment, will be able to bid on ESPs projectsworldwide instead of only in Libya. Finally, COSCO willincrease its operating margin significantly with its ownrepair/test/service facilities. The use of the funds will bedistributed as follows:

Use of Funds (US$)

US$

Research & Development $250,000

Staffing & Training $800,000

Working Capital for Jobs Funding/Work in Progress $1,000,000

Manufacturing Facility and Intellectual Property $3,450,000

Trial Units $550,000

Costs and Expenses $450,000

TOTAL $6,500,000

Source: COSCO

Dividend PolicyCOSCO does not expect to pay a dividend in the nearfuture. We expect that such a policy will be reviewed in2008 when the Company will be in a stronger position topay a dividend if the situation warrants it.

Major ShareholdersThe major shareholders are given below:

COSCO: Major Shareholders

Name %

Mark Dorin 25.8

Andrew Male 8.6

Andrew Walker 1.6

Cooperative Shareholders 26.7

ValuationIn arriving at a value for COSCO we have used a number oftools that are appropriate for the sector in which itoperates. We have used prospective 2007 earnings andcash flow multiples of the oil service companies that makeup the Philadelphia Oil Service Sector index 11.1x and 9.4xrespectively.

It is clear that owing to its size and business, COSCO ismuch smaller than the companies in the Philadelphia OilService Sector index. In order to reflect this disparity in size,in our valuation we have discounted the above multiples by25 %. COSCO can then be valued at between US$16.9mand US$31.5m as we can see in the table given below.

COSCO Valuation

Multiple US$m

Prospective 2007 P/E 8.3x 16.9

Prospective 2007 Cash-Flow 7.0x 31.5

Average of the above two 24.2

Source: VSA Resources

Comparative ValuationThere are no listed companies that are directly comparablewith COSCO’s area of expertise. As can be seen in thetable below, the ESP divisions of the 10 largest suppliersare extremely small compared with the companies’ totalturnover. Robbins & Myers, Inc., a leading manufacturer ofProgressive Cavity Pumps (PCPs) as well as simple wellheadequipment for low pressure applications, is perhaps theclosest company to compare COSCO. It has a marketcapitalisation of US$417.5m , with a 2007 PER of 20.5x anda PCF multiple of 13.6.


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Primary ESP systems suppliers

Company ESP Sales 2005 Parent Parent’s Revenue ESPs sales as a Area of OperationUS$m 2005 US$bn % of total sales

Centrilift 350 Baker-Hughes 5.8 6.0 NA, Indonesia, UKCS, Latam, Middle East, Africa

Reda 300 Schlumberger 10.1 2.9 NA, Indonesia, UKCS, Latam, Middle East, Africa

Wood Group 180 John Wood 2.0 9.0 NA, Indonesia, UKCS, Latam, Middle East, Africa

COSCO Pump 1.9 COSCO n/a 100 Libya, ME, Russian Federation

Novomet 110 100 Russian Federation

Alnas 60 Yukos 11.4 0.5 Russian Federation

ShengLi 60 SinoPec 41.0 0.1 China

DaQing 50 China Nat Pet Co 29.5 2.1 China

Al Khorayef 30 Al Khorayef Group 2.0** - Saudi Arabia

Borets 20 Eastlink Lanker* - - Russian Federation

Weatherford 20 Weatherford 2.3 0.9 NA, Indonesia, UKCS, Latam, Middle East, Africa

Source: COSCO

* Major shareholder ** Estimate


IntroductionIt is estimated that more than 90% of oil wells need someform of artificial lift. The rate at which an oil well producesoil and gas depends on the permeability (the rate of flow ofa liquid or gas through a porous material) and porosity (thespace between the rocks) of the producing horizon and thenatural pressure available that drives the hydrocarbonstowards the borehole. The casing of the borehole seals thewell from any fresh water intervals through which it passesto prevent crude oil contaminating the water. A small-

diameter tubing string carries the oil and gas from thereservoir to the surface and is centered in the wellbore. Thereservoirs are usually at a higher pressure than the wellborebecause of underground forces, with either a water or gasdrive forcing the hydrocarbons to the surface. A water drivereservoir is linked to an active water aquifer that providesthe drive mechanism, whereas a gas drive reservoir gets itsenergy from gas expanding from either a gas cap or fromgas breaking out of solution. Depending on the conditionsof the reservoir, the underground pressure at the start of a

APPENDIX A – Notes on Artificial Lift

Water Drive Reservoir Gas Drive Reservoir

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well’s productive life will often push the hydrocarbons tothe surface for many years. However, when the pressuredifferential is insufficient for the oil to flow naturally, thensome method of lifting the liquids artificially, such as ESPs,needs to be installed to bring the oil to the surface.

Artificial LiftMost wells have a predictable production rate known as adecline curve, reaching peak production relatively soon afterfirst coming on-stream followed by a long, slow decline. It isthe condition of the reservoir that determines the shape andthe length of this decline curve, with some wells producingfor more than 50 years while others stop producing ineconomic quantities after a few years. A variety of techniquesare can be used to curtail a well’s decline curve. A workovercan be performed, which involves cleaning out the wellboreto help oil or gas move more easily to the surface. Thereservoir rock may be fractured or treated with acid aroundthe bottom of the wellbore in order to increase the channelsthrough which the oil and gas moves to the producing well.Water can be injected into the reservoir to maintain pressure.Such a method pushes the oil out of the pores in the rocktowards the producing well and maintains reservoir pressure.In more advanced cases, enhanced oil recovery (EOR)techniques are used, such as injecting into the reservoirsteam, nitrogen, carbon dioxide or a surfactant to removemore oil from the pore spaces and increase production.

Most oil wells produce a combination of oil, gas, and waterthat is separated at the surface. Initially, most of the liquidsfrom the reservoir may be oil and gas with small amounts ofwater but with time water increases significantly. Increasedwater production inevitably leads to the need for artificial liftbecause the pressure formed by the column of oil/watermixture in the wellbore may exceed the reservoir pressure.

Any system that adds energy to the fluid column in awellbore is defined as artificial lift. A number of differentoperating principles are applied to generate artificial lift,including rod pumping, gas lift and electrical submersiblepumps. The five different types of artificial lift technologies,are detailed below.

1. Electric submersible pumps

2. Beam/Sucker rod pumps

3. Progressive Cavity pumps

4. Subsurface Hydraulic pumps

5. Gas lift

The use of a particular technology depends on thecharacteristics of the reservoir, the individual oil wellparameters, and capital expenditure. In the 1990s, thelargest market for artificial lift was for Beam/Sucker Rods(nodding donkeys) as can be seen from the table givenbelow. Since then, ESPs have grown significantly, andcurrently account for over 50 % of the total market forartificial lift.

Annual Sales US$m

Pump Type 1990 % 2001 %

Electric Submersible 330 28 985 52

Beam/Sucker Rod 496 43 546 29

Progressing Cavity 16 1 220 11

Subsurface Hydraulic 140 12 45 2

Gas Lift 180 16 110 6

Total 1162 100 1906 100

Source: Baker Hughes

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Comparisons between Artificial Lift Types

Artificial Lift Type General Comment Comment

Beam Pumping/ A positive displacement pump is inserted Simple to operate and tends to beSucker Rod Pumps or set in the tubing near the bottom of the cheaper to use than other methods,(Rod Lift) well. The pump plunger is connected to but are less efficient and have lower

the surface by a long rod string and pumping capacity.operated by a beam unit at surface.

Progressive Cavity This consists of a surface drive, drive Low capital investment, more reliable Pumps (PCP) string and downhole progressive cavity and better at dealing with solids such

pump. In some instances, an electric as sand and scale deposits. Liftsubmersible motor is used (with a gear capacity limited and can not handlereducer) instead of rods and surface much gas. Good for heavy oil production.drive.

Subsurface Hydraulic This consists of a surface power fluid Has high initial capital costs and complexPumps system, a prime mover, a surface pump to operate. Good for multiple wells on

that pumps the power fluid, and a one surface pad location because onedownhole jet or reciprocating /piston surface power fluid package can providepump. Power fluid is mixed with produced power fluid to several wells. Any fluid and separated at surface with the malfunction of surface equipment power fluid re-used. means that all wells will not produce.

Electric Submersible ESP System has an electric motor and High volume and depth (lift) capacity;Pumps centrifugal pump unit suspended high efficiency over 1,000 bopd; low

on a tubing production string and maintenance; minimal surface equipmentconnected back to the surface control requirements; high resistance tomechanism and transformer via an corrosive downhole environments;electric power cable. Generally used adaptable to gas, sand causes problems.where high volume fluid production Used in both deviated and vertical wells.is required.

Gas lift Compressed gas is injected through Essentially, the liquids are lightenedgas lift mandrels and valves into the by the gas which allows theproduction string, lowering the hydrostatic reservoir pressure to force thepressure in the production string to fluids to surface. A source ofreestablish the required pressure gas, and compression equipmentdifferential between the reservoir and is required for gas lift. Highwellbore, thus causing the formation capital costs.fluids to flow to the surface.

The advantages and disadvantages of the various systems of artificial lift pumps are given below.

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The use of ESPs in the Middle East, where there waspreviously little artificial lift used owing to wells flowingnaturally for decades, is largely responsible for the surge inESP installations in recent years. ESPs are usually the onlypractical means of artificial lift in the Middle East due to theability of most wells to produce volumes that other forms ofartificial lift cannot provide economically. ESP use will onlybecome greater, and the pace of implementation shouldonly accelerate. Consequently, ESPs should continue tocapture more than half of the value of artificial liftinstallations worldwide.

ESPs SystemAn ESP system is composed of a motor/centrifugal pumpcombination that is submerged in the fluid to be pumped.Submersible pumps are used in sewage pumping, generalindustrial pumping, slurry pumping, and in oil wells.However, designs for deep submersion applications differsignificantly from those used in shallow submersion waterwell applications, as briefly outlined below:

• High voltage motors are used to reduce cable sizeand cost

• The deeper the submersion, the higher thetemperature, which has an adverse effect on motor life

• Deep wells such as oil wells are smaller in diameter,therefore slimmer pump and motor designs are required.

Well fluids are prevented from entering the motor andcausing a short circuit by a system of mechanical seals.Water well submersible pumps are hermetically sealed;while oil well submersible pumps employ a special sealchamber (commonly called a protector) that equalizes thepressure in the motor with the wellbore pressure to reducethe chances of well fluids entering the motor.

Typical Surface Beam Pumping unit (Nodding Donkey) used for Rod Lift

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Pump Section Stages andbearings shown

Pump Stage(Impeller &Diffuser)

The ESP system consists of a number of components thatturn a staged series of centrifugal pumps to increase thepressure of the well fluid as it passes through the pumpand push it to the surface. The energy required to drivethe pump is provided by a special motor that works athigh temperatures of up to 232°C and high pressures, todepths of up to 4.5 km and in casing sizes from 4.5 inchesto 13.38 inches.

The electric motor is submerged together with the rest of thepump assembly at a pre-calculated depth in the well. ESPmotors differ from conventional electric motors in that theinternal airspace is filled with a high dielectric strengthmineral oil, that provides a non-compressible medium insidethe motor. In the case of hermetically sealed motors, thisprevents the structure from imploding under the intense borepressures, and transfers heat to the motor housing, which iscooled by the flow of fluids past the motor. For this reason,the motor is always installed below the pump.

The pumps have limited ability to deal with solids such assand because of their high rotational speed and compactnessof size. If free gas is present, a gas separator is also employedsince the presence of gas in the pump will reduce the amountof liquids pumped and could cause gas locking.

he ESP, by lowering the pressure in the wellbore,significantly raises the amount of fluid producedcompared to a well’s natural drive. New varieties of ESPsinclude a water/oil separator that allows the water to bere-injected into the reservoir without the need to lift it tothe surface.

A downhole sensor can be coupled to the bottom of themotor to provide an operator with additional informationon the performance of the well.

Drawbacks to ESPsESPs are complicated mechanisms that have limitedoperational life. The pump can be damaged by solids ordebris so protective shrouds are placed over the fluidintakes to prevent this from happening. Sand abrasion isthe biggest problem with ESPs because all the bearingareas in the pump and intake are exposed to well-borefluids. Clearly, when abrasive materials enter theproduction fluids, the bearing surfaces rapidly wear outand a premature system failure occurs. Exotic bearingmaterials and extra bearings are often used in wells thatproduce sand.

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As with all types of artificial lift, the reduced pressure in thewellbore due to the operation of the pump can cause gascontained in solution in the casing annulus to break out, sothe casing annular space must be vented to the flowline atsurface in order to maintain a fluid level above the pumpintake. The possibility of producing large volumes of free gasthrough the pump can cause wear damage as well aspotential motor overheating, although this is minimized bymodern controls. Gas separators and other means are usedwhere free gas is present, and are effective in reducingproblems caused by gas in most cases.

Once a downhole component of an ESP system fails thereis little that can be done but to pull the entire ESP systemand replace it with new, repaired or tested components.

For lower volume applications (less than approximately1,000 barrels per day) the high cost of ESPs compared toother forms of artificial lift is a drawback. Similarly, if the liftrequirement is less than approximately 5,000 feet, PCPpumps may be more economical. However, for highvolume, high lift applications, ESPs are usually the artificialmethod of choice. This is the main reason ESPs are usuallyonly used to produce volumes that other forms of artificiallift are not capable of providing, or similarly to lift fluidsfrom deep depths where this cannot be accomplished byother forms of artificial lift.

Contract Market for ESPsIn general terms, there are three main types of commoncontracts for delivering ESPs: (a) Performance BasedContracts; (b) Fixed Term Contracts or Alliances, and (c),Standard Contracts & Purchase Orders.

(A) PERFORMANCE BASED CONTRACTS

In the Middle East and other geographical areas, many oilcompanies with a large number of wells often specify fixedprice, fixed duration, performance-based contracts withone ESP supplier for a period lasting between two to fiveyears or longer. Although contract terms vary widely, anumber of features are common such as:

• Equipment is often leased (or services provided) by thesupplier at a fixed daily rate per well

• A target run time is set for each well, determined by theconditions of the well and/or history

• There are penalties for short equipment run times andbonuses for long equipment run times

• The ESP supplier replaces or repairs faulty equipment atits own cost unless it is determined that the fault was notcaused by the supplier

• The ESP supplier operates the wells on a daily basis

Under this form of contract, the contractor not onlysupplies and services the ESP equipment but also needs tounderstand and be able to perform oilfield operationsbecause part of the services provided entail daily welloperations the contractor. In addition, in the case of leasingthe contractor has to finance the cost of the equipment outof its daily fixed rate, and needs to demonstrate that it hasthe financial solvency to complete the contract. Aperformance bond or bank guarantee, which is usually 10%of the estimated contract value, is almost always required.A bid bond is also required at the time of a bid submission,which is forfeited if the bidder does not accept the contractor fails to provide a performance bond in the event of asuccessful bid.

(B) FIXED TERM CONTRACT OR ALLIANCES

This type of contract is also used by customers having asignificant number of ESPs to operate and maintain. Analliance is formed with an ESP product and service providerto supply and test/repair ESPs and provide installation andremoval services for a fixed term (3-5 or 5-7 years forexample) at set prices. However, performance-basedcontract terms are not included.

(C) STANDARD CONTRACTS AND PURCHASEORDERS

Customers with fewer wells such as in Iran, Egypt, Syria,Iraq, and UAE, or in countries where ESPs have a longerhistory such as Libya and Indonesia, normally purchaseESP equipment directly from the manufacturer. Somecustomers also prefer to buy various components fromdifferent vendors. Repair work for these types ofcustomers is normally charged at a book rate for thespecific equipment component. The repair price isapproximately fifty percent of the list purchase price. Thetype of purchase contract a particular customer prefersvaries according to numerous factors including: (1)experience of customer using ESPs; (2) geographiclocation of customer; (3) the degree of isolation of theoilfield; (4) proximity to established oilfield/ESP servicecenters, and (5) geopolitical factors.

The economic factors that dictate what artificial liftequipment a customer will choose, and the type ofcontract to be signed, varies widely as can be seen by theexample given below where two wells have similarartificial lift costs but the amount of oil produced issignificantly different:

Well Liquids Water Cut bopd Revenue/dayprod b/d % ($75/bbl)

Well A 5000 5 4750 $356,250

Well B 5000 95 250 $18,750

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S.W.O.T Analysis

➔ Good and experienced managementteam with extensive knowledge inLibya and the Middle East, and activeexperience in Russia and Asia.

➔ More ESPs are needed to increaseproduction from existing wells.

➔ Possibility of becoming a motor andpump manufacturer.

➔ Its core market in Libya and the MiddleEast buoyant in its demand for artificiallift.

➔ Strong oil service market.

Strengths

➔ Management unknown to the UKinvestment community.

➔ Weak legal system and extensivebureaucracy in some of the countrieswhere it operates.

➔ Main competitors form part of verylarge oil services companies withsubstantial financial muscle.

➔ Heavy reliance on joint ventures forgrowth.

Weaknesses

Opportunities

➔ High oil prices expected to remain forsome time leading to higher oilcompany expenditure, benefiting oilservices companies.

➔ ESP usage is expected to climbsignificantly during the following yearsin the Middle East, particularly in SaudiArabia, Iraq, and Iran.

➔ Many oil companies prefer dealing withan ESP supplier not associated with theBig Three.

➔ Competitors having problems meetingdemand for ESPs

Threats

➔ High oil prices lead to a decline inworld economic growth and hence afall in oil consumption, thus loweringthe need to increase productionsubstantially.

➔ Some of the large regional suppliers ofESPs expand into COSCO’s traditionalmarkets.

➔ Political issues in the Middle East.

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Growth EBITDA Net cash

Growth metrics % Profitability metrics % Balance sheet metrics

EPS CAGR 05-09e -278.5 ROCE2008e 106.6 Gearing 2008e 109.0

EPS CAGR 07-09e 18.7 Avg ROCE 05-09e 51.6 Interest cover 2008e 205.1

EBITDA CAGR 05-09e -310.7 ROE 2008e 41.7 Stock turn 2008e 54.8

EBITDA CAGR 07-09e 15.1 Gross margin 2008e 48.0 Debtor days 2008e 76.7

Sales CAGR 05-09e 60.6 Operating margin 2008e 45.5 Creditor days 2008e 127.8

Sales CAGR 07-09e 14.2 Gross mgm/Op margin 1.1

Principal shareholders % Management team

Mark Dorin 25.8 Mark Dorin President

Andrew Male 8.6 Andrew Male Director

Andrew Walker 1.6 Andrew Walker Director

Cooperative Shareholders 26.7

Forthcoming announcements/catalysts Date Company details

AGM - 9760 60th Avenue, Edmonton, Alberta, Canada T6E OC5

Trading update - Phone +1 780 430 0840

Interim results - Fax +1 780 430 0367

Full results - www.COSCOesp.com

This research report has been prepared by VSAResources Limited, for which it has been paid a fee, ascorporate finance advisors and arrangers to COSCO ESPLtd and is solely for and directed at persons who haveprofessional experience in matters relating toinvestments and who are Investment Professionals, asspecified in Article 19(5) of the Financial Services andMarkets Act 2000 (Financial Promotion) Order 2001. Thisresearch report is exempt from the general restriction onthe communication of invitations or inducements toenter into investment activity and has therefore not beenapproved by an authorised person, as would otherwisebe required by Section 21 of the Financial Services andMarkets Act 2000 (the "Act"). Persons who do not fallwithin the above category should return this researchreport to VSA Resources Limited, 43 London Wall,London, EC2M 5TF, immediately. This research report isnot intended to be distributed or passed on, directly orindirectly, to any other class of persons. It is beingsupplied to you solely for your information and may notbe reproduced, forwarded to any other person orpublished, in whole or in part, for any purpose, withoutout prior written consent.

Neither the information nor any opinion expressedconstitutes an offer, or an invitation to make an offer, tobuy or sell any securities or any options, futures or otherderivatives related to such securities.

The information and opinions contained in this researchreport have been compiled or arrived at by VSAResources Limited (the "Company") from sources

believed to be reliable and in good faith but norepresentation or warranty, express or implied, is made as to their accuracy, completeness or correctness. Allopinions and estimates contained in the research reportconstitute the Company's judgements as of the date ofthe report and are subject to change without notice. Theinformation contained in the report is published for theassistance of those persons defined above but it is not tobe relied upon as authoritative or taken in substitutionfor the exercise of the judgement of any reader.

The Company accepts no liability whatsoever for anydirect or consequential loss arising from any use of theinformation contained herein. The company does notmake any representation to any reader of the researchreport as to the suitability of any investment made inconnection with this report and readers must satisfythemselves of the suitability in light of their ownunderstanding, appraisal of risk and reward, objectives,experience and financial and operational resources.

The value of any companies or securities referred to inthis research report may rise as well as fall and sumsrecovered may be less than those originally invested. Anyreferences to past performance of any companies orinvestments referred to in this research report are notindicative of their future performance.

The Company and/or its directors and/or employees mayhave long or short positions in the securities mentionedherein, or in options, futures and other derivativeinstruments based on these securities or commodities.

Not all of the products recommended or discussed in thisresearch report may be regulated by the FinancialServices and Markets Act 2000 and the rules made for theprotection of investors by that Act will not apply to them.

If you are in any doubt about the investment to which thisreport relates, you should consult a person authorisedand regulated by the Financial Services Authority whospecialises in advising on securities of the kind described.

The Company does and seeks to do business with thecompanies covered in its research reports. Thus,investors should be aware that the Company may have aconflict of interest that may affect the objectivity of thisreport. The analyst who prepared this report has not andwill not receive any compensation for providing a specificrecommendation or view in this report.

Investors should consider this report as only a singlefactor in making their investment decision.

The information in this report is not intended to bepublished or made available to any person in the UnitedSates of America (USA) or Canada or any jurisdictionwhere to do so would result in contravention of anyapplicable laws or regulations. Accordingly, if it isprohibited to make such information available in yourjurisdiction or to you (by reason of your nationality,residence or otherwise) it is not directed at you.

VSA Resources Ltd. is Authorised and Regulated by theFinancial Services Authority

IMPORTANT NOTICE

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NOTES

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For further information please contact

COSCO ESP Ltd9760 60th AvenueEdmontonAlbertaCanada T6E 0C5

Tel +1 780 430 0840Fax +1 780 430 0367www.COSCOesp.com

VSA Resources43 London WallLondon EC2M 5TF

Telephone +44 (0)20 7628 3989Fax: +44 (0)20 7920 [email protected]

© VSA Resources Ltd

VSA Resources Ltd. is Authorised and Regulated by the Financial Services Authority andis a member of the London Stock Exchange

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Cosco Research Note 20.10.2006

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Transcript of Cosco Research Note 20.10.2006