I initially wrote about Heckmann Corporation (HEK) back in February of this year. I was initially attracted to the company because of Richard Heckmann’s previous success in building U.S. Filter Corporation into a multi-billion dollar operation before selling out to Vivendi and his follow-on success at K2 Corp. Richard Heckmann, the CEO of Heckmann, gave a presentation this week at the Wedbush Securities: 2011 Clean Technology & Industrial Growth Conference (the investor presentation is available here) so I thought it would be a good idea to update my thoughts on the business.
The company originally raised several hundred million dollars on Richard Heckmann’s name and reputation as a company builder. An initial foray into bottled water in China was a disaster but is now in the process of being written off and disposed of by management. The real story at Heckmann is the water service business that it provides to the oil and gas industry. Most investors are very familiar with the shale gas and shale oil revolution that is transforming the North American oil and gas industry. What many investors may not realize is the amount of water that is necessary to frac one of these wells and the amount of waste water that is produced after the well is drilled. In a nutshell, after the well is drilled it requires fracing which cracks or breaks up the rock so that the oil and gas from the formation will flow more easily to the wellbore. This fracing is facilitated by massive amounts of water which can average around six million gallons per well. After the fracing takes place most of the water that was injected into the well flows back out along with produced water. Produced water is very salty water that is produced by the well along with the oil and gas. The produced water makes up 80% of the water that comes up from the well over the course of its life, which in many cases can be as long as 30 years. This saltwater must be disposed of in a very strict manner.
This is the business that Heckmann is now in and it is going gangbusters. This industry is fairly new so there are many small mom and pop operators. These smaller operators simply do not have the resources to provide the level of service or expertise that Heckmann can with its business. Quite frankly, the larger oil and gas operators such as Shell (NYSE:RDS.A), Chesapeake (NYSE:CHK), XTO, etc., would rather deal with a turnkey operator that has the resources to do the job in a manner that is safe and environmentally compliant. This is especially true with all the scrutiny being placed on these operators due to fears around hydraulic fracing. Heckmann has all facets of the business covered including water delivery, storage, waste gathering and disposal. It has the size and resources to be the preferred water vendor to these large oil and gas companies.
The management of Heckmann has been very aggressive in growing the business and now operates in the four main shale areas including the Haynesville, Barnett, Marcellous and Eagleford shales. The company has a tremendous competitive advantage in the Haynesville shale as they operate the only wastewater disposal pipeline and water supply pipeline. The company also controls most of the nearby saltwater disposal wells. Heckmann is able to deliver the freshwater required for the fracing of the wells and then is in a position to dispose of the produced water from the well as it cleans up over the course of its life. In my initial write-up of the company I did not realize the significance of this revenue stream. Over the course of the wells' life it will continue to produce water that has to be disposed of properly. This creates an annuity stream of revenue for Heckmann long after the well is placed into service.
I originally bought into the company based solely on Richard Heckmann’s reputation as a company builder and in the ensuing months the vision for the company has become clear: Focus on water treatment for the oil and gas industry. Here are my reasons for owning Heckmann:
- The management of the company which includes many hands from U.S. Filter has done this before. They know how to build a water company.
- They have found a niche business that is very fragmented. The competition are small operators that do not have the resources to play at the same level as Heckmann.
- This is a “Levi Strauss” business; they are providing an indispensable service to the emerging shale oil and gas industry. This is a way to play the shale gas boom without the commodity price risk of oil and gas.
- This is a “razor blade” business in that even after the majority of the service is provided on the front end - drilling of the well - there is a continuing revenue stream with saltwater that has to be properly disposed of, which is produced along with the oil and gas.
- The oil and gas companies are in the position that they need this service and are looking for an experienced, well-run and well capitalized partner to manage this issue for them.
- Plenty of running room for this business. The shale gas/oil revolution is just getting started and tens of thousands of wells will has to be drilled over the next few years. Somebody has to supply and get rid of the all the water.
The risks in my mind are operational execution risk which is mitigated by the experienced management team and a slowdown in drilling due to low oil and gas prices. This may be a short term risk but longer term this will be mitigated by the fact that drilling will continue over the long haul as these large oil and gas companies make drilling decisions over a 3-5 year period and do not base them on short term movements in oil and gas prices. One other note is that Steve Cohen of SAC capital has purchased over six million shares in Heckmann Corp.
Disclosure: I am long HEK.