In the recent patent infringement case between Ion Geophysical Corp. (IO) and WesternGeco, a subsidiary of Schlumberger (SLB), a federal jury found that Ion Geophysical had provided services that copied the ones provided by WesternGeco, thereby infringing on Schlumberger's patents on four counts and netting WesternGeco $105.9 million in damages. It was an important victory for Schlumberger as the organization prides itself on investing around $1 billion in R&D each year.
The service in question was provided through Ion's DigiFin, which captures underwater images to determine the likelihood of any oil and gas exploration opportunities. However, the product itself, i.e. DigiFin, will remain available for sale. Following the verdict, Ion's shares dropped by almost 16%.
DigiFin was not Ion's major product and accounted for only 3% of its revenues. Ion, whose $1 billion market cap just over 1% of that of Schlumberger, will try and fight the verdict. The jury decided that Ion had deliberately infringed on Schlumberger's patents, which means that the energy giant can appeal for a further increase in damages. With the humble amount of cash Ion has, roughly around $83 million, it will be difficult to fight against Schlumberger and for a product that ultimately is not core to their current business, but will force them to reassess their longer-term strategies.
Statoil (STO) recently awarded the electric wireline logging contract along the Norwegian Continental Shelf for all the production and exploration to be performed in the region to Schlumberger. The two companies have signed a four year deal worth $342 million, which will start from February 2013, with a possibility of an extension in the future. Earlier this year, Statoil had signed another agreement with a Schlumberger's business unit worth $155 million, for design and construction of subsea gas compression plants.
Since the beginning of this year, Schlumberger has outperformed its main competitors Baker-Hughes (BHI) and Halliburton (HAL). Schlumberger is up 7.1% year to date compared to Baker-Hughes's and Halliburton's drop of 3.9% and 0.8% respectively. Both of them have been dealing with the collapse in North American natural gas prices and the volatility of the price of guar gum. The U.S. Brent Oil Fund (BNO) bottomed back in mid-June and has risen more than 20% since then, approaching the February high. As we move towards winter, seasonality will take over and prices for natural gas and heating oil will rise. United States Diesel-Heating Oil Fund (UHN) is tracking normally after bottoming at $28.33 on June 21st to the current price of $34.69.
In its second quarter results for the current year, Schlumberger posted a 22.1% increase in Q2 profits year over year and a 9.4% increase sequentially. The increase was attributed to the improvements in exploration, deep water activities and efficiency in business operations. After the sale of their two business units, i.e. Wilson distribution and their stake in CE Franklin, they have excised marginally performing divisions; streamlining their organization and raising cash for future deployment.
The company is continuing with its acquisition strategy. The acquisition of Norway based SPT Group is complete and it has bought the remaining 60.1% stake in the Russian based Radius-Servis, a market leader in hydraulic down-hole motors in Russia. Schlumberger, like other firms in the oil and gas industry, is also keen to dive into the Chinese market. In July, it purchased 20.1% stake in Anton Oilfield Services, which enjoys a unique position in the Chinese oil and gas industry as it is not only a leading Chinese oil and gas firm, but unlike most of its peers, is privately owned.
Schlumberger is truly global and that is where its competitive advantage comes from. North America remains its primary market but despite the decrease in revenues in this region, the business was still able to post an increase in overall profits. With all other regions increasing to offset the North American decline, Schlumberger's management is aware of this and therefore they continue to expand everywhere. Furthermore, there are significant opportunities in the quickly developing shale gas market coming up in China, Australia and Saudi Arabia. All three major oil servicers have their irons in those fires where margins could be explosive due to low production costs and locally high demand and a willingness to build the proper supporting infrastructure, unlike the U.S. whose balkanized pipeline system is holding back its domestic use.
Current oil and gas prices are the new normal and even in the face of a global recession demand and supply will remain, at a minimum, in relative balance. Schlumberger is expensive here at a multiple of 17.8, paying only 1.50%. I like selling short-dated out of the money puts here to take advantage of seasonality in oil and gas prices while watching to see if these latest deals are accretive. It's a relatively low risk, steady return strategy that, when properly managed, should pay the electric bill.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.