After eight months of extensive research on Abtech Holdings Inc. (ABHD.OB), we now believe that the ultimate end-game for the company will be a takeover. With its patented, disruptive technologies, SmartSponge and SmartSpongePlus, poised to take share in three multi-billion dollar verticals, Abtech's potential is enormous. Considering its 5-year partnership with the company, Waste Management (WM) would seem to be the most logical suitor to buy Abtech. Up until now, however, we did not think that WM would be in a rush to do so. Fortune 500 companies are not prone to acquiring a company just entering commercialization. WM is certainly no different. Since an acquisition now would be hard to justify to its shareholders, Waste Management would rather acquire Abtech down the road after its revenues and earnings have begun to scale.
We question whether such a tact will eventually come back to haunt them. Recent developments within the fracking space seem to have raised the odds that one or two suitors from this sector could swoop in and beat WM to the altar. In particular, both Heckmann (HEK) and Cameron (CAM) appear to be two logical candidates to do just this. Should this occur, we see five reasons why Waste Management would quickly counter with a higher bid, potentially setting the table for a bidding war to develop for Abtech next year. Let's examine the various pieces of the puzzle to explain why we feel this way.
Accelerated adoption of a new and groundbreaking technology typically requires a catalyst to spur demand. Such a catalyst recently arrived for Abtech in its fracking initiative when the company received the best technology innovation award at the 3rd annual shale and oil gas conference in Houston, Texas.
Within fracking, industry participants have been treading very cautiously, searching for the best and most cost-effective solutions to treat produced water. With environmentalists rightfully questioning the effects that fracking is having on the environment and with the EPA becoming highly visible in this area as well, the oil and gas industry seems backed into a corner: to continue to frack they will need to adopt treatment solutions which will protect the environment from both water and air pollution.
To those who do not feel that regulation is coming to fracking, think again. For the second time in the past week, a government study linked contaminated groundwater to fracking. Rob Wile did an excellent job summing up the results of this most recent study by the EPA in this article found on Bloomberg.com. According to Mr. Wile, the EPA's study concluded that drilling activity by Cabot Oil and Gas (COG) had caused methane to seep into the water near-by. These study results corroborate recent findings published by the USGS (U.S. Geological Survey), which found groundwater near a Wyoming town containing chemicals associated with fracking. The USGS report is important, as it would be the first time a government report directly linked fracking with groundwater contamination.
Because Abtech's SmartSponge technology is capable of cleaning 99.99% of the flow back water in the fracking process, Abtech's technology has the potential to bridge the divide of what has become a very contentious fracking debate. Currently there seems to be no middle ground on the subject. Instead, views on fracking seem to fall into two camps: you are either for it due to the economic benefits that will accrue or against it due to environmental concerns. Abtech's technology could be the solution which will spearhead a much needed compromise to make fracking work in an environmentally secure manner.
In a recent Op-Ed piece in the Washington Times, NYC Major Michael Bloomberg espouses such a move to the middle:
Fracking for natural gas can be as good for our environment as it is for our economy and our wallets, but only if done responsibly. With so much at stake for the environment, jobs and energy security, it is critical that we make reasoned decisions about how to manage the use of hydraulic fracturing technology.
Considering this backdrop, it is easy to understand why Abtech's SmartSponge was chosen for the most innovative technology award.
For those unfamiliar with the technology, SmartSponge offers the following economic and environmental benefits to oil and gas companies:
- The SmartSponge has tremendous porosity, allowing it to treat high volumes of water very cheaply on-site. SmartSponge can cost less than $.10 a barrel to remove the hydrocarbons, as opposed to $5-$7 a barrel to treat the water off-site.
- Smartsponge will make such downstream systems as reverse osmosis and reverse membranes more efficient. When these downstream systems clean the water, a small amount of oil stays in the water, coating the surface with de-activated carbon in the membranes, which makes it more costly for these systems to operate. SmartSponge would rectify this problem.
- By removing the last of the good hydrocarbons out of the water before they go through the reverse osmosis systems, the good oil becomes permanently bonded to the sponge. With every pound of the sponge holding three pounds of oil, the used sponges can then become solid sources of fuel.
- While current technologies such as skimmers and reverse osmosis help clean the water, it is still too polluted to be re-used. Incorporating the Smart-Sponge on-site changes that.
- Treating flow back water successfully on-site with Smartsponge would dramatically reduce the current carbon footprint on surrounding communities.
- A recent N.Y. Times article referenced how oil and gas companies are competing against farmers and out-bidding them for water in Colorado. With the record drought seen across the nation this past summer, oil and gas companies will need to become more strategic about not only accessing water for fracking but also doing so in such a way that will encourage re-use.
Looked at from both an economic and an environmental perspective, Abtech's technology seems to be positioned in the right place and at the right time. We see accelerated adoption taking shape within fracking if and when regulation gets enacted in 2013. This makes Abtech ripe to be scooped up by a large oil service provider.
We feel that Cameron International could be one candidate that may be interested in Abtech. Already the de facto leader in onsite water treatment and as an $8 billion company, Cameron is doing just fine without Abtech. Nonetheless, a look at the company's Petreco Hydromation system shows that it removes 90-99% of insoluble hydrocarbons. What if they incorporated SmartSponge into this solution, thereby increasing the levels of treated hydrocarbons up to 99.99%? This could eventually translate into hundreds of millions of dollars in increased market share. We tend to therefore view Abtech as potentially worth $150-$200M to CAM in a take-out.
This brings us to Heckmann Corp. With ambitions to become the one-stop shop for all things water-remediation related, Heckmann has been making a series of acquisitions to increase its market share. Up until now, Heckmann has been carting the water away and treating it off-site. This business model does not make sense to us.
Perhaps this is why the company has already begun to look at acquisitions to build out an on-site remediation business. Here is what the company had to say about this initiative:
By the end of this year, we will begin rolling out environmental services to our water customers. Our team's significant abilities and experience in the water business with respect to treatment recycle and reuse will be tailored for the environmental services customers. .
With Mr. Heckmann stepping aside into the Chairman's role, he is focusing on additional acquisitions that would solidify the company's ability to offer a one-stop water remediation shop for all things fracking.
Think about that for a second. Heckmann already has all of the bases covered for those oil and gas companies who want nothing to do with water. Simply cart it away and get it off of their sites. What happens to Heckmann if regulators put restrictions on how much water can be dispersed down wells or transported from certain fracking sites?
Thought of this way, an acquisition of Abtech by Heckmann could ultimately serve as the company's perfect hedge, allowing them to offer both off-site and on-site remediation solutions to their clients, while simultaneously hedging them against sudden regulatory movement after the elections have passed.
We tend to view Heckmann as the more likely suitor for Abtech from the fracking space. Needless to say, this would not sit well with Waste Management. Over the past decade, WM's stock has done absolutely nothing. Its revenues and earnings have also been stagnant for years. Without its 4.2% dividend yield, the stock would probably be much lower. To be blunt, Waste Management needs to tap into new multi-billion dollar verticals to spur growth. Abtech could very easily be a very important piece of this puzzle for WM.
To that end, we see five important reasons why Waste Management will do whatever is necessary to make sure Abtech becomes their property. These include:
1. First, the company has already committed time, capital, and its balance sheet to its burgeoning stormwater initiative with Abtech. Although they moved slowly at first, over the past few months, Waste Management has begun to aggressively roll-out Abtech's stormwater solutions around the country. Proposal growth has begun to accelerate. We expect it to shortly mushroom.
How big could the stormwater opportunity become for WM and Abtech? Think about it this way: If Abtech were able to penetrate just 5% of Waste Management's current 33,000 municipality and city clients, Abtech could build a 3 year backlog, which at $1M per client, would equate to $1.5 billion of multi-year backlog by the end of 2015.
For those wondering when the movement will begin for Abtech within the municipality space, a major catalyst arrives this Thursday,October 4th. As seen here, L.A. County will be finalizing the waste discharge requirements for municipal separate storm sewer system (MS4) discharges at this meeting. This is a huge catalyst. With the rest of the nation typically following California's lead on environmental issues and with California usually deferring to protocols set in L.A. County, finalizing the requirements that municipalities will need to adhere to in L.A. should result in immediate movement for various contracts in the queue for Abtech.
2. Acquiring Abtech would also be a very seamless and logistical acquisition for WM. With its employees already tasked with weekly rounds for its various environmental services, they could very easily add in the servicing of SmartSponge for these municipalities and cities.
3. Although they have been keeping their fracking initiatives quiet, WM has been forging a presence in the Marcellus shale space. With plans to expand to other sites such as the Utica, Bakken and Eagleford, having SmartSponge under its umbrella would only increase the odds of making major headway within the important fracking space.
4. With 1,400 facilities around the country, one has to wonder how many of them are in need of stormwater remediation. Let's say half. That means that acquiring Abtech for $250Million would essentially pay for all of the company's own sites that may need stormwater remediation.
5. The fifth and final reason to bring Abtech in-house is this: it would eventually augment its already significant cash-flow generation abilities. With high-margin recurring revenues poised to ramp in late 2014-2015, Abtech could become an additional cog in WM's cash-flow generation, eventually be generating hundreds of millions of cash-flow a year.
Taken together, the evidence suggests that Waste Management may eventually be forced to buy Abtech much sooner than it wants to do. If we are right and a bidding war does that place, WM will win. With Abtech providing them with the perfect conduit to much desired growth into new multi-billion dollar verticals, Waste Management will out-bid any other suitors. An ultimate price tag of $250M-$300M would certainly be justified. This equates to $2.75-$3.30 a share, based on 90 million shares fully diluted.
As with any stock, there is always the risk that events do not materialize in accordance with our models and investment thesis. If regulation were pushed back within the fracking industry, our thesis for a bidding war may not play out as we have have envisioned in this article. Should the economy weaken, Waste Management may not be as forthcoming with its balance sheet, a potential risk that investors should consider before buying into Abtech's shares.
Investors should always keep in mind that investing in bulletin board and/or micro-cap stocks carries a high-degree of risk, unique to these types of equities. Bulletin board/micro-cap stocks are often thinly traded and lack the liquidity of stocks traded on a major exchange. Because bulletin-board stocks are not subject to the listing requirements of a major exchange, public information can often times be limited, obfuscating share-holders from performing due diligence. As such, investors should understand their own risk tolerance before considering a bulletin board/micro-cap investment.
Disclosure: I am long ABHD.OB.