Real Money's Long Shot column is dedicated to trading ideas that are highly risky, but which present an opportunity for significant payoff if they work. Such ideas are sometimes characterized as "lottery tickets" and are for only the most risk-tolerant investors, as the potential for loss is high.
One of the most important investable themes in the U.S. today is the shale energy revolution, which is fundamentally changing the energy economy. The challenge is finding ways to play it, since so far the most profound impact has been on natural gas prices, which have collapsed on the increase in supply.
The best angle is now derivative plays, such as oilfield services names like Halliburton (HAL) or technologies like natural gas engines that use the low gas price as an "enabling technology." Engine vendors like Westport Innovations (WPT) fall into the latter category.
This week I stumbled upon another derivative play that is both a great growth opportunity and a hidden value play. Ecosphere Solutions (ESPH) is a south Florida-based company that makes portable wastewater treatment systems for cleaning the water used in hydraulic fracking. These patent-protected, million-dollar systems use several ozone-related approaches to turn the "black" water coming out of the well into clean water that can be discharged or recycled back into the frack tank. The systems are held within a customized semi trailer and can be easily transported to the well sites.
The company built its business model intelligently, which investors will appreciate over time. Rather than simply selling the hardware to water servicers, Ecosphere Solutions sells a license that includes the hardware sale and a recurring payment for gallons processed. In addition, to jump-start the market the company created its own water servicing subsidiary, which obviously collects recurring revenue as it services wells. Ecosphere Energy Services is 52% owned by the parent company, and generates roughly one-third of the company's revenue. Overall, Ecosphere Solutions generated $20 million of revenue in 2011, with $2 million of operating cash flow in the latest quarter, and is set to grow meaningfully in 2012.
The story gets more interesting. Because the Energy Services subsidiary is not 100% owned, there is the potential to spin it off or sell it to unlock hidden value. The sub is transitioning to licensing the technology to other third-party water processors, the first of such deals is with a company named Hydronix. Over time the Energy Services should be getting most of its revenue as high-margin royalties. Numbers are a bit hard to ferret out, but I think the Energy Services subsidiary alone could be worth more than the current market cap of $65.4 million.
The second interesting element is the fact that the technology is not limited to processing fracking wastewater. In fact, it is applicable to almost any water purification need, such as municipal wastewater, etc. The company is actively exploring deals with strong partners in these other categories.
ESPH is trading at $0.45, so it's subject to the usual caveats about trading low-dollar stocks. The bid-ask spread can be wide; set your levels and wait to get filled.
I visited the company this week and came away impressed with the management team, the technology, the business model and the growth opportunities. I am always looking for derivative shale/fracking plays that are undiscovered and undervalued, with tremendous growth opportunities, and Ecosphere Technologies fits that bill.