Rising energy prices and high unemployment in the US have brought fracking to the fore of the US energy conversation. On one side, those in favor of fracking cite that the process can access formerly inaccessible oil and gas, and that fracking also creates more US jobs. Those opposed have environmental concerns over the water used in fracking spreading dangerous chemicals. Heckmann Corporation (HEK) is an environmental services company that specializes in water treatment following the fracking process. In light of a recently announced merger with privately held Power Fuels Inc., an unsustainably high short position, and exposure to an ultra-high growth industry, we believe HEK is headed higher in the coming years.
Fracking is the process by which oil- and gas-bearing rocks under land (not seawater) are fractured horizontally using high-pressure water containing certain chemicals. These chemicals are carcinogenic, so companies such as Heckmann are contracted to treat the water after fracking to neutralize the chemicals and then dispose of it. Two other companies, Waste Management (WM) and Veolia Environment S.A. (VE), are competitors to Heckmann in this water treatment specialty.
Heckmann Corp. stands out to us for several reasons. The company was founded by Richard Heckmann, who previously founded United States Filter Corporation in 1990 and successfully sold the company in 1999 to Vivendi S.A. for $8.2 billion. HEK is suffering from an almost 30% short position, but it operates in a very high-growth arena. According to the U.S. Energy Information Administration, natural gas is expected to rise from 23% (in 2009) to 50% of our nation's fossil fuel mix by 2030. This expected increase is based on increased fracking of shale-gas deposits, primarily in North Dakota, Texas, and Pennsylvania.
Heckmann's management team also has recently made a series of excellent moves. The company is young, so management is focused on higher capital expenditures in the short term to build revenue growth. Earlier this year Heckmann acquired privately held Thermo Fluids Inc. for $245 million in cash and stock. "TFI" is an environmental services company like HEK but in a different line of business - TFI converts used motor oil into commercial fuel oil. TFI is the largest player in this service in the Western United States, and the acquisition adds diversification and stability of revenues for HEK.
In an even bigger move, last week Heckmann announced a merger agreement with privately held Power Fuels Inc. in a cash and stock deal valued at $381 million. This merger is different from the TFI acquisition in that it represents a synergistic expansion of its main line of business - water treatment. Power Fuels is the largest environmental services company in the Bakken Shale area of North Dakota and Montana, and with this merger comes a laundry list of new customers: among the names are Statoil (STO), Whiting Petroleum Corp (WLL), and Hess Corporation (HES). Power Fuels has TTM sales of approximately $363.5M and TTM net income of $113M, so this merger will immediately upgrade HEK's cash flows. HEK stock rose over 40% following news of this merger last week.
We interpret last week's deal as a sign of confidence in the future of HEK and the future business of shale-gas fracking water treatment. With this merger, HEK will become a national player in this business, and will certainly not deserve such a high short position nearing 30%. Trading at $4.07 as of last Friday's close, we believe HEK is poised to move even higher.