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Takeover candidate Zenon Environmental resilient
after warning of lower earnings

Romina Maurino
Canadian Press


October 13, 2005

TORONTO (CP) - Investors' "aggressive bet" on Zenon Environmental Inc. as a possible takeover target has kept its stock resilient despite another warning of poor quarterly results, analysts say.

On Wednesday, the water treatment company warned that third-quarter earnings will fall short of forecasts because of production delays. Zenon said it expects to report an operating loss of between $4 million and $6 million on Nov. 8 for the quarter ended Sept. 30.

Analysts had been forecasting net earnings of 13 cents a share, on average, according to Thomson Financial.

Zenon shares (TSX:ZEN) were down $2.65, nearly 11 per cent, to $22 on the Toronto stock market shortly after the announcement but narrowed to a drop of $1.45, or almost six per cent, to $23.20 soon after.

"I am one of those analysts who are surprised by the strength, or relative strength, of the stock - not only today but leading up to today," said Sara Elford, an analyst with Canaccord Capital.

"When you get companies that miss expectations for that period of time, investors, typically, will punish them. That hasn't happened here. So really, the only conclusion that I can come that is that investors believe that Zenon is a takeover candidate."

She said investors may also be motivated by a high rate of consolidation among water companies. The only other big Canadian player, Trojan Technologies Inc., was acquired over a year ago in $247-million move by U.S-based Danaher Corp.

"The market in general thinks that it's a strategic asset that has value," said Doug Cooper, an analyst with Paradigm Capital Inc. which has a "sell" on the stock and a target price of $16.50.

"From my perspective, I find it hard to believe that a company would pay that kind of price for that kind of financial performance."

But Zenon has faced more than production delays in the past - other expenditures such as legal fees related to Zenon's patent infringement suit against U.S. Filter, have led to disappointing results in the last five quarters.

Zenon had previously announced manufacturing delays in shifting to a new version of the ZeeWeed 1000 membrane module for water purification.

Andrew Benedek, chairman and CEO, said Wednesday that even though the company had dealt with the initial problems causing the delays so that production capacity was met, the quality of the product did not meet Zenon's new quality standards.

"I am happy to report that we are now producing an exceptional-quality product, which we have already shipped to one location in Germany and we are ready to ship two more orders: one to Saudi Arabia this week and the other later to Australia," he said in a statement.

"We are continuing to ramp up production and expect to achieve our targeted production level by the end of 2005."

Although Zenon expects to regain most of the production losses, the setback will also hurt the company's 2005 year-end results. Manufacturing capacity will be increased in 2006 to satisfy orders for 2005 and 2006.

Despite this delay in production, Zenon is forecasting a profitable fourth quarter.

Elford said only time will tell whether the takeover bet is a practical one.

"While stranger things have happened, I just cannot come to a valuation level that I think any one of the consolidators would step up to the plate and pay a higher level than where we are today," she said.

"It's speculation at best. Fundamentally, I can't come up with the current valuation."

Zenon also announced it has been selected to supply a ZeeWeed 1000 membrane system for a 100-million-gallon-a-day drinking water treatment plant to be built in Twin Oaks Valley in San Diego, Calif.


The Canadian Press 2005