ZEN Graphene: A Potential Hyper-Growth IP Play With Many Paradigm-Changing Applications, Including COVID

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Investment Thesis

ZEN Graphene Solutions Ltd. (OTCPK:ZENYF) (ZEN.V) has a major catalyst ahead of it with the decision of Health Canada as to the safety and efficacy of its game-changing biocidal, anti-viral and anti-microbial AgGO mask coating. I think the risks are in favor of approval, which would be a major de-risking event, causing a rapid and significant (roughly 100%+) re-rating of the stock. For those less inclined to purchase before approval, the intermediate and longer term upside would remain significant, even from higher levels. The business model is extraordinary (discussed below), so if the company executes anywhere near plan, this will be a hyper-growth company that will be a "must own."

Major Catalyst Any Day/Week Now

ZEN is located in Guelph, Ontario, Canada. The stock and company are at a pivotal moment: awaiting approval (or not) by Health Canada (HC) of surgical masks manufactured by TreborRx (a private Canadian company) that are coated with ZEN’s AgGO solution, called, "ZENGuard". HC’s decision should come any time now (hours to weeks). In my opinion, if the masks are approved the story will be significantly de-risked and quickly re-rate to be valued more like a company that is about to have explosive growth than one that has a big opportunity but still has a regulatory hurdle.

Therefore, HC approval is a big milestone. My research leads me to believe HC’s decision (in one direction or the other or a request for more information, which could re-start the clock on a decision and push timing out a few weeks) is imminent, but regulators often take more time than previously expected on innovative products, so it’s worth the wait for an approval that, if received, also should create a significant barrier to entry for potential competition.

An IP Play on an Innovative Nano-Material, Not a Mining Company

ZEN was a mining company. It is now an IP nano materials play (“graphene-enhanced” technology). Indeed, the company recently announced it is asking shareholders to approve a change to their industry status with the stock market and that it will seek to move to a bigger exchange, hopefully in the US. The company has a graphite deposit which is at the development stage, which costs very little to maintain for now and which won’t be mined for many years, if ever. I expect de minimis expenses for the deposit for the foreseeable future.

Graphene Is

• 200x stronger than steel
• Extremely high surface area to mass ratio
• Stretches to 120% of its original size
• 10x the thermal conductivity of copper
• Impermeable to hydrogen
• 1,000x the current capacity of copper

Three Initial Target Markets

Prevention, Detection and Treatment

1. Personal Protective Equipment ("PPE," e.g., masks, gowns, caps, booties, nitrile gloves (hospitals and restaurants, etc.) and Air Filtration (e.g., HVAC filters),

2. Detection/Sensors (e.g., game-changing rapid, inexpensive and high accuracy COVID testing, with other tests behind that, such as STDs (a huge and rapidly growing problem), certain types of cancer and other diseases/viruses) and

3. Therapeutics - both topical and ingested, but that's longer term in nature due to the early phase of development, along with regulatory hurdles. It could could be tremendous, but let’s leave that for another time.

In addition, there are many other potential applications, such as fuel additives to improve efficiency, paints to reduce ice on plane wings, and countless other applications. For now, let’s stick to the near term opportunity that I think will be the company-maker.

Personal Protective Equipment (PPE)

ZEN’s first market will be the application of its formula to surgical and other masks. The effect of their formula is innovative and game-changing: it is to be applied on an additional layer of mask, which essentially grabs the particle (the formula is hydrophilic) when it hits the mask (either coming at the wearer or from the wearer) and then renders it harmless. That means it should no longer be able hurt you, even when you remove the mask and then touch your face with your hands.

Graphene is 20x stronger than steel and at the nano level, basically, "sharp," so it destroys viral, bacterial, microbial and generally, pathogenic particles, according to the company’s lab studies and tests done at and with major universities and labs in both the US and Canada. The next PPE application will be for nitrile gloves. Given the tremendous threat posed by MERSA, alone, it seems logical that the company’s customers ultimately also will apply ZEN’s formula to surgical caps, gowns and booties.

Air Filtration: Air Conditioning Filters

This is an enormous market, with various industry reports reporting it in the many billions of dollars. That’s when things are “normal” (i.e., pre-COVID). But with COVID, imagine if everyone wants to upgrade their A/C filters to be capable of destroying COVID... at the same time? If the mask market is a company-maker, the A/C filtration market is a barn burner. There are millions of office buildings in the US and Canada. There are over 6,000 hospitals. There are over 21,000 nursing homes and elder care facilities. There are airports, airplanes, trains, subways, restaurants, theaters, malls - all are high traffic, often densely packed and require the best quality filters on the market. And all are desperate for solutions to create a safe environment to bring back business.

Here’s why it’s such a big deal

The industry standard for A/C filters according to my research is called “MERV”. As I understand it, a typical office building operates with a MERV 8 (or 2 MERV 8’s) for every air handler. Given they are handling much larger spaces than a typical apartment or home, they also are much larger. I’ve used 3m x 3m as a standard, which conveniently, is about 100 mask equivalents by my estimates. However, the CDC has increased the suggested rating due to COVID to MERV 13. MERV 13 is a more tightly woven filter that, according to the company, requires 15-20% more air pressure and energy to push air through the filter. This increases both energy bills and the stress on and maintenance required for the air handlers. MERV 13s also cost 1-2x as much as MERV 8s. Thus, a far simpler solution would be to coat a MERV 8 with the company’s product, thus obviating the need for the MERV 13. While tiny dry particulate matter that a MERV 13 would capture would not be captured by a MERV 8, the point is to stop COVID and other pathogens, which it appears from the company’s research would be accomplished. This would dramatically reduce the cost to the customer, while leaving plenty of room for margin for everyone in the supply chain, including, of course, the lynchpin: ZEN.

Detection and Sensors

The company’s product (separate from the AgGO solution) provides next generation rapid, saliva-based antigen detection. In about 8 minutes and at very low cost per test, according to the company, the product uses a patent-pending DNA aptamer that recognizes the SARS-CoV-2 spike protein simply through a saliva test. This is game-changing technology, IMHO.

Imagine going to an indoor concert today with 1000s of other people packed in in close proximity and no masks? Or maybe getting on a cruise ship?

I didn't think so.

But what if for something like a $10 ticket surcharge, you could arrive at a pre-assigned time (let's say an extra 10-30 min early, depending on the size of the venue and number of entrances), get tested, have a highly accurate answer in 8 min, and then go in to the concert, free of concerns that the 100s of people anywhere near you and the 1000s in the auditorium have COVID?

Personally, I can't wait to get back to events like that, but realistically, it's a pretty high-risk proposition without such technology and testing in real time. Thus, ZEN's solution appears to be easy to use, inexpensive and rapid.

Can you imagine that in other environments? I think there are countless applications. Everyone from cruise lines to airlines to universities to office buildings to concert halls and more should be clamoring for it

Please see the company’s presentation for more details: ZEN Graphene Solutions. The solution appears to be scalable, accurate, comfortable (goodbye nasal swabs - making PCR tests look awful) and has the added benefit that aptamers can be adapted to be used for many diseases, well beyond COVID, and including some types of cancer. It's a tremendous market opportunity for the company that cracks this nut and also a very high margin business.

Therapeutics

Down the road, the company is looking to enter the therapeutics market, including both topical and ingested applications. Management believes this market opportunity may be even larger than the aforementioned markets. As these take time to enter and will not drive revenue in the near-term, but also won’t cost much to pursue in the short term, I’ll address them at a later time.

The Model

The company has initiated a pilot line and is or will soon be producing roughly 1 million masks per day (1M mpd). The company is also building out a 25M mpd facility nearby their offices that is scheduled to begin ramping production in Nov.

If I understand correctly, the same coating can be applied to many different use cases, so the company thinks about sales in “masks equivalent” (“me”). For instance, if a typical industrial air filter is 3m x 3m (my slightly educated guess), that would require roughly 100me.

Margins

I’m assuming GM north of 80%, given that graphite (the underlying commodity) is pretty cheap and plentiful, especially because we’re talking about a nano-material, so very small quantities are required relative to output and revenue.

Expenses

I expect the company to be running at about $300K per month in opex, which already allows for running the new facility since most of it is automated machinery. I believe their most recent opex was $200K/month, but given what the Chairman recently said on a public investor call, I think they’re hiring at least a few heads. For the sake of conservatism, I assume that given the massive ramp in revenue and profitability, they may end up spending more than that, so I doubled their current opex number to $400K/month.

Capex

I assume capex will be around $5M-ish, a good bit of which already has been spent. Regardless, the number is so low as to be inconsequential if the company is generating the kind of cash flow I think it will (see below), given their current cash position of something around $4M plus a bit more than that amount in warrants, many of which are in the money and some of which have acceleration clauses and some of which expire soon (so we’re at roughly $8M-ish+, all in, vs a very low burn rate).

Obviously, since they’re only beginning to ramp and generate revenue, there is a wide range of profit possibilities. Based on what the co has said, here's how I'm modeling it:

Assuming the company makes something like 4c/mask, based on what I think would be a conservative assumption, which is using the lower end of the midpoint of the revenue per mask the company mentions in its presentation, which you can review, as noted, above (and I highly recommend you take the time to do this because this is a high level introductory note to get the stock on your radar, but there is much more information in the presentation). Let’s say that at some point in 1H:2022 they’re selling out the 25M mpde (masks per day equivalent). That’s:

25M masks/day equivalent x .04 = $1M/day in revenue (all numbers in Canadian Dollars)

x 80%+ GM = $800K/day GP (using low end of what management has said)

x 30 days/mo = $24M/mo GP

-$400K/mo opex (being conservative, I doubled the company's most recent #, both for small additional headcount and to build cushion) = $23.6M EBITDA PER MONTH

x 12 months = $283.2M EBITDA / year

-27% tax rate = $206.7M in Net Income (the company has a $30M NOL that will reduce this on first earnings)

/99M shares (fully diluted) = C$2.09 annualized run rate EPS (approx. $1.66 in USD)

Please note: this does not even include the detection and sensors business on the revenue line, but does include it's operating costs (a study might cost several $100k, which is not modeled).

Valuation

Too good to be true? Maybe. But I’ve yet to find the hole in it and I’ve been working on this company for months. C$2 seems like a reasonable scenario for the company once they’re selling out the first commercial production facility, with plenty of ways there could be meaningful upside to those numbers (more on that in future articles; first let’s see if they get HC approval).

In my opinion, this would be worth a minimum multiple of 20x and frankly, as they ramp production, start to prove out the applications and model, as the market cap becomes more investible for larger funds and as management proves they can continue to execute, I think the stock could attract a much higher multiple of 30-50x. So my initial price target is C$40, but if they earn more like $3 (based on my assumptions being too conservative) and attract at least a 30 multiple, the stock could be C$90. Please note: I'm referring to the stock price in Canada, which is C$3.15 as I write this. The US price of ZENYF is $2.50, reflecting the FX conversion at this time (approx. .794 USD:CAD). 20x USD$1.66 yields a price target of $33.20 for ZENYF, again, greater than 10x the current stock price.

If they get HC approval, I would expect the stock to reflect this quickly. That de-risking event should at least double the stock price immediately, and I don't think the stock will stop there, given that it opens the door to revenue and earnings potential for a company that should go into hypergrowth (to be clear: I think 20x for a hypergrowth company is ridiculously cheap, and likely not the right number, so I will re-assess my price target at that time).

Balance Sheet

With $4M in cash and more than that in in-the-money warrants, some of which have accelerator clauses and expire soon, the Company doesn’t need capital, in my opinion. Assuming they get HC approval, are generating meaningful rev and cash flow and want to improve the company’s public profile, I definitely can see this Street-savvy management team raising capital opportunistically. I’m ok with that: a company that doesn’t need to raise money won’t be forced to do so at unattractive prices, like so many small cap companies. A company growing rapidly with their business accelerating and a long runway will have investors clamoring to get in at scale, so deal terms should be very attractive for all parties involved. Since they don’t need money, they can be opportunistic about whether and at what price they might consider a deal. I suspect if they continue to hit milestones, any such deal would only be done at multiples of the current price. (Yes, I know that sounds like every other small cap dream, but if you dig into this one, you’ll see it’s quite rational.)

I would anticipate that the company will seek uplisting on the US markets later this year.

Misc

Lock-up expiration behind us:

There was a deal in the spring. The lock up expiration is now well behind us (early Aug).

Insider Buying

The CEO recently bought 50,000 shares (over $100,000) in the open market. He's already the largest shareholder, owning about 4% of the company. I see this as a vote of confidence in ZEN's prospects of winning HC approval.

Short term Risks

HC Approval. In the short term, it’s all that matters, IMHO.

This company has many opportunities not discussed here, so the long term view is quite bright, in my opinion. In other words, the face mask and PPE market opportunity is just a launch pad for the even larger opportunities that will come later. Thus, if HC approval does not come through (more questions that delay things beyond, let’s say a month or 2, or worse, an outright rejection – neither of which I expect, but you never know with regulators until you know, which is why I repeat: getting approval is a MAJOR de-risking event for the company), then I expect the stock to have a rough time of it. On the other hand, if they get approval...

This company is in what I think Stan Druckenmiller has described as “Inning 1.” If for some reason, HC does not grant approval and bless it as anti-viral and biocidal, but leaves the door open, then the stock steps back and it will be Stan’s Inning 0, as long as HC ultimately grants approval.

What To Do

As I see it, there are 3 approaches to investing in ZEN:

1. Lowest risk/reward: wait for HC approval. If and when they get it, even if you pay 2x the current valuation, it's still over 6x to my initial price target

2. Intermediate risk/reward: buy some now, wait for the HC decision and, if it's approval, then buy more. You get a blended return of around 13x and 6x to my initial price target

3. Highest risk/reward: buy now. You bear the risk of HC, but if this company executes, the returns on a much larger position due to the lower price than one you might get paying 2x after a positive HC decision are, obviously, significantly amplified if it turns into a much, much bigger stock (i.e., 30-50x a $3+ EPS number).

From a strategic standpoint, I'm taking approach #2, leaning towards #3. I own a significant position now, into the HC event and, if it’s positive, that moves the company into Inning 2 and I’ll do what Stan would do upon such a meaningful de-risking event that opens the door to revenue, significant profitability and expansion into many other markets: “be a pig.”

And then watch it very, very carefully.