Poseidon Concepts Offers A Sea Of Opportunity

Dec. 7.11 | About: Poseidon Concepts (POOSF)

Background

It seems like we have entered an era of spin-offs. This is a complete reversal of the previously very popular merger mania that created so many conglomerates in the previous century, and I am all for it. I don’t like conglomerates. It’s almost impossible to value them correctly and to predict their future since so many divisions may experience completely different directions in terms of growth and profitability. My best investments are always simple vertical businesses. If you need to diversify your portfolio, you can always do it on your own according to your risk/reward ratio.

I recently came across another spin-off. This time it is a spin-off by an energy company. The newly created entity, Poseidon Concepts Corp. (OTCPK:POOSF) was created on November 1, 2011. Poseidon grew out of Open Range Energy Corp. (ONRRF.PK) which is an actively growing Canadian company involved in the exploration and production of oil and natural gas . It looks to me like Poseidon outgrew its parent, and the board made a wise decision to let both companies develop independently. I agree with the board’s math here: 1+1 > 2 in this case.

As many of you are probably aware, there is a revolution going on in North America, and it is not the Occupy Wall Street or the Tea Party kind. This revolution is taking place in the energy business and it is called hydraulic fracturing. I will not go into details about hydraulic fracturing since there are thousands of articles already dedicated to it. A good description of the hydraulic fracturing process can be found in this Wikipedia article. There are obviously huge benefits for USA and Canada to have an economical source of energy. However, there are many environmental issues around hydraulic fracturing. For more detailed explanation of the environmental issues I would recommend countless articles in the New York Times. One good example can be found here.

Poseidon Concepts builds and rents huge water tanks (pdf) that can be used for both completing the fracturing process and storing the flowback fluid. Storing the flowback fluid is very important to customers of the company due to concerns about contaminated water that is being retrieved from the wells after fracturing is complete. Poseidon Concepts products help exploration companies save money by avoiding transportation and preparation of multiple metal tanks for fracturing. Poseidon tanks are modular, can be easily transported and have very large capacities. According to the company, a tank can be transported by only two trucks. This is important since multiple heavy trucks have a tendency to destroy roads and, naturally, upset the local population. It seems like the Poseidon tanks are popular with E&P companies. Poseidon started in Canada, where its tanks have an additional advantage: they can be heated during winter to prevent water from freezing. Lately the company has reported the exceptional growth in its US business.

The company has also indicated that it is signing long term contracts. This should serve as a stabilizer for the utilization rate which currently stands at an impressive 90%. As of the end of last quarter, the company rented 210 tanks versus 60 in the beginning of the same year. The growth is very strong and the market is wide open, since Poseidon doesn’t have a competitor yet.

I like high growth companies. However, when I read that Poseidon is paying dividends, I was even more intrigued. The company promises to pay $.09 dividend on a monthly basis. This amounts to about 9.5% with a share price of $11.30 at the time of this writing. Overall, what we have here is a small cap, high growth, and high dividend paying company. I think it is a pretty unusual situation.

The story looks good so far. Let’s see if this company is a good stock.

Valuation

Since the stock is paying a dividend I have decided to use a three stage Dividend Discount Model (DDM). My base case scenario assumptions are as follows:

  • Duration and growth in the first period: 3 years and 30% growth
  • Duration of transition period: 5 years
  • Growth in stable period: 3%
  • Intrinsic value (base case): $27.49

As you can see, the assumptions I made are relatively conservative. Currently the company has a growth rate of higher than 30%. I also assume that my conservative growth rate of 30% will last only 3 years. This will be followed by five years of a transition period, when the rate of growth will decrease to 3%.

If we change my first period to be 5 years instead of 3, the present value jumps to $37.09. However, even the base scenario shows that the company is undervalued by almost 300%!

Conclusion

Poseidon Concepts Corp. is quite unique because it was just created out of the Open Range Energy Corp. and Wall Street is not aware of it yet. The historical data for the company is not available yet. So, many financial databases are missing the data on the company, and whoever is trying to search based on ratios such as PE, PEG, ROE or Dividend yield, will not be able to see this company. However, this should change in a matter of months since the company will start reporting independent financial results soon. As soon as the company starts reporting its results, the stock symbol should appear on filter screens for either high growth or for high dividend.

There are potential risks, of course. The major risk is the arrival of a strong competitor. However, I think even with two or three players the field is very large. The other major risk is regulatory since hydraulic fracturing is a very controversial issue right now. However, the solution provided by the company helps E&P firms to be more environmentally correct.

As you can probably feel, I am quite convinced that Poseidon Concepts and its stock will have strong growth in the future. As always, I strongly recommend that you do your own due diligence before acting on this writing.

Disclosure: I am long Poseidon Concepts Corp.