by Debra Fiakas CFA
Energy Recovery (ERII: Nasdaq) has announced a breakthrough license of its hydraulic fracturing pump to oil and gas patch service provider Schlumberger (SLB: NYSE). Called the Vorteq by Energy Recovery, the pump features the company’s core pressure exchange technology, representing an entirely new approach to driving the chemical-laced water producers send deep into the earth to extract oil and gas.
Energy Recovery develops and markets components and equipment for fluid flow and pressure cycles found industrial processes. Its patented pressure exchange devices are designed to take advantage of energy created in fluid flows and pressure cycles. The company has developed applications for reverse osmosis desalination, industrial turbines and pumps, and high pressure fluid flows such as oil and gas pipelines.
Energy Recovery’s most recent product innovation is an alternative hydraulic fracturing pump for use in extracting gas from shale deposits. The Vorteq value proposition is compelling as it replaces the bank of high-priced pumps that must be deployed around the well site to keep fracking operations underway without interruption. Field tests with another gas patch field services company have helped prove the versatility of the pumps in various conditions.
Apparently impressed and keen to capture the potentially disruptive forces of the Vorteq pump, Schlumberger has agreed to pay an upfront fee of $125 million to gain exclusive world rights to the technology. Once fully commercialized sometime in 2016, Schlumberger will pay royalties based on the number of Vorteq pumps in use. Previously, the Company had planned to lease the Vorteq pump to oil and gas producers, retaining all risk in the asset functionality and useful life. While not yet tested, the leasing arrangement appeared to be a low-margin business model.
The license arrangement solves a vexing problem for Energy Recovery, which has long been known more for its product engineering capabilities than its ability to market and sell. The Vorteq was the third product Energy Recovery had aimed at the oil and gas market. Sales have been few given the extended down cycle of the oil and gas sector.
After sharpening his teeth on this deal, newly appointed CEO, Joel Gay, may have the confidence to move more aggressively in other markets. Energy Recovery engineers have suggested there are additional applications for other industries with significant flows of high pressure or corrosive fluids. Energy Recovery can use Schlumberger as a reference relationship taking advantage of that company’s reputation for discerning due diligence.
In the first day of trading following the news of a landmark license deal for the Company, shares of Energy Recovery soared. Volume on the day was several multiples of recent trading volumes and the stock had started the day by gapping dramatically higher on the open. We believe the conference call that management had scheduled in the hour prior to the market open helped stoke the fires of enthusiasm for the development.
Shares of Energy Recovery had been stagnant for months despite a widely publicized launch of the Vorteq hydraulic fracturing pump in December 2014, and its plans to field test and eventually lease the equipment in the U.S. oil and gas patches. The reluctance of investors to accord value to the Company’s unproven leasing business model for the Vorteq could be understood. Now that the Company had proven its ability to craft a profitable business arrangement for the Vorteq , in our view the value of the other oil and gas applications of Energy Recovery’s pressure pumping technology should be recalibrated.
Energy Recovery seems to have staged its own revival. It is a company well worth revisiting on the Schlumberger breakthrough.
Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.