MII - L - Flotek Industries _FTK_

Flotek Industries (FTK) Memo
Name:(Chase(Pion(
Phone(#:((310)(353K6857(
College/School:(College(of(A&S(
Year:(2(
Company(Description(
Flotek'Industries'[FTK]'is'a'diversified'global'supplier'of'drilling'and'production'related'products'and'services.'Its'core'focus'
is'oilfield'specialty'chemicals'and'logistics,'down@hole'drilling'tools'and'down@hole'production'tools'used'in'the'energy'and'
mining'industries.'Flotek'operates'in'three'segments:'Chemicals'and'Logistics,'Drilling'Products'and'Artificial'Lift.'
Investment(Thesis(
Flotek'Industries'is'a'long'due'to'its'unique'position'within'the'hydrocarbon'recovery'industry.'Hydraulic'fracturing'is'a'
recovery'technique'that'is'on'the'rise'and'Flotek'is'positioned'as'the'environmentally'conscious'provider'for'this'type'of'
drilling.'This'industry'is'increasingly'coming'under'fire'for'using'hazardous'techniques'for'hyrdraulic'fracturing'(fracking)'
and'companies'are'being'forced'to'adhere'to'new'regulations.'Flotek'is'positioned'to'garner'increased'revenues'from'
drilling'companies'that'are'switching'over'to'more'environmentally'friendly'methods'of'operation.''
Thesis(/(Key(Points(
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The(hydrocarbon(drilling(industry(is(changing(quickly('
1. Shale' development' has' changed' the' way' drilling' companies' operate' by' creating' demand' for' horizontal' wellbore'
drilling' and' multi@stage' stimulation' of' horizontal' wells,' both' of' which' are' elements' of' fracking.' Horizontal' drilling' is'
much' more' complex' than' traditional' vertical' drilling' and' necessitates' an' increase' use' in' chemicals,' drilling'
technologies,'and'airlift'strategies.'
2. There'are'numerous'benefits'of'drilling'horizontal'wells.'The'most'important'of'which'is'the'increased'exposure'to'the'
reservoir.' Most' reservoirs' have' much' more' volume' spread' horizontally' than' vertically.' Therefore,' a' vertical' well' is'
perpendicular'to'the'direction'of'greatest'volume.'By'entering'a'reservoir'horizontally,'much'more'oil'or'natural'gas'
can'be'extracted'per'well.'
3. In' the' U.S.,' fracking' for' shale' gas' is' on' the' rise.' The' Energy' Information' Adminstration' expects' U.S.' natural' gas'
production'will'increase'44%'between'2011'and'2040,'saying'almost'all'this'growth'will'be'due'to'shale'gas'that'must'
be'fracked.'
4. Flotek' provides' the' chemicals' and' drilling' tools/technology' for' horizontal' wells' and' fracking' methods.' So,' with' the'
continuing'increase'of'these'practices,'Flotek'will'grow.'
5. Flotek'takes'part'in'the'entire'life'cycle'of'a'well'being'drilled.'From'technical'drilling,'to'directional'surveys,'to'drilling'
chemicals' that' enhance' drill@bit' penetration' and' bring' fluid' to' the' drill,' to' pump' services' that' recover' the'
hydrocarbons.' Therefore,' once' a' company' contracts' Flotek' for' part' of' its' well,' it' is' likely' that' it' will' engage' all' of'
Flotek’s'services'for'the'well.'
Scrutiny(of(the(environmental(consequences(of(fracking('
1. Flotek'Industries'is'a'leader'in'environmentally'friendly'chemicals'for'drilling'processes.'Many'of'these'chemicals'are'
citrus'based'and'with'the'acquisition'of'Florida'Chemical,'the'company'will'have'constant'access'to'the'ingredients'it'
needs'for'its'chemicals.'
2. The'publicity'of'the'environmental'repercussions'of'fracking'is'a'huge'plus'for'Flotek.'This'is'due'to'the'fact'that'Flotek'
is' focused' on' environmentally' friendly' methods' of' fracking.' As' regulations' increase' on' fracking,' more' drilling'
companies'will'switch'from'their'current'providers'of'drilling'materials'over'to'Flotek.'In'fact,'California'has'just'signed'
into'law'its'first'regulations'and'New'York'is'weighing'its'options.'Colorado'has'been'a'very'fracking@friendly'state'and'
Flotek'does'a'lot'of'its'business'there.'This'shows'that'once'regulations'are'put'in'place'and'fracking'has'been'allowed,'
companies'will'use'Flotek'for'its'green'services.'
3. The' most' recent' trend' in' state' fracking' regulations' is' the' full' disclosure' of' all' chemicals' used' in' the' process.' This'
means' companies' will' need' to' start' using' more' environmentally' friendly' chemicals' because' the' information' will'
become'public.'Companies'will'switch'over'to'Flotek'chemicals'from'more'hazardous'materials'currently'used'in'many'
drilling'operations.'
a. Wyoming,'Michigan,'and'Texas'currently'have'public'chemical'disclosure'on'fracking.'
b. Arkansas,' California,' Illinois,' Indiana,' Maryland,' Massachusetts,' New' York' and' Pennsylvania' have' pending'
legislation'for'the'disclosure'of'fracking'chemical'practices.'
Opportunity(for(international(growth'
1. Flotek' operates' 85%' of' its' business' in' North' America' due' to' the' heavy' concentration' of' hydraulic' fracturing'
equipment'in'North'America.'As'soon'as'other'countries'catch'up'with'oil'and'gas'technology,'Flotek'will'have'many'
new'markets'and'customers'around'the'world.'The'United'States'and'Canada'are'some'of'the'few'countries'that'use'
hydraulic'fracturing'to'obtain'hydrocarbons.'Once'the'rest'of'the'world'realizes'the'production'potential'of'fracking,'
Flotek'will'have'huge'growth'opportunities'throughout'the'world.'
Flotek Industries (FTK) Memo
Misperception(
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Significant' decreases' in' the' number' of' oilrigs' in' North' America' has' shaken' investor' belief' in' the' growth' potential' of' Flotek.'
However,'something'not'taken'into'account'is'the'increased'number'of'wells'drilled'per'quarter'per'rig.'Although'overall'U.S.'rig'
'activity'decreased'7.1%'and'9.8%'for'the'three'and'nine'months'ended'September'30,'2013'compared'to'2012,'respectively,'the'
number'of'wells'drilled'per'rig'per'quarter'increased'from'5.9%'and'6.0%'for'the'three'months'and'nine'months'ending'September'
30,' 2013,' respectively.' While' the' increased' number' of' wells' does' not' completely' offset' the' drilling' reduction,' it' is' significant'
enough'to'severely'reduce'the'effect'of'the'decrease'on'the'company.'
The'fact'that'fracking'is'being'challenged'by'environmental'groups'is'good,'not'bad,'for'Flotek.'It'will'cause'the'drilling'companies'
to'shift'their'business'to'Flotek'because'it'is'a'greener'alternative.'While'the'market'may'see'uproar'over'fracking'as'a'negative'sign'
because'it'may'lessen'the'number'of'fracking'wells'drilled,'it'is'positive'in'that'it'will'create'changes'in'the'industry'regulations'that'
will'benefit'Flotek.'In'fact,'“the'regulations'will'not'hinder'the'fracking'practice.'We'ran'some'numbers'and'the'new'regulations'will'
only'cause'about'a'0.5%'increase'in'the'cost'of'well'drilling”'–'Hal'Washburn'(CEO'of'Breitburn'Energy).'So'the'new'regulations'will'
not'deter'companies'from'fracking,'it'will'simply'force'them'to'use'greener'methods.'
The'acquisition'of'Florida'Chemical'Company'has'caused'substantial'revenue'growth'(25.6%'quarterly'YoY'and'14.4%'YoY)'but'the'
costs'resulting'from'incorporating'Florida'Chemical'Company'has'minimized'the'effect'that'the'acquisition'has'had'on'net'income.'
However,'as'soon'as'the'company'is'successfully'incorporated'into'Flotek'those'costs'will'subside'and'margins'will'rise'significantly.'
I'think'this'is'another'potential'market'misperception'because'the'market'has'not'picked'up'on'the'nature'of'these'costs.'
1. In'fact,'the'acquisition'of'Florida'Chemical'Company'will'significantly'decrease'R&D'costs'in'the'long'run'because'Flotek'
will'able'to'synthesize'new'citrus'based'drilling'chemicals'in@house'through'Florida'Chemical.'
VAR(
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I'spoke'to'Hal'Washburn,'CEO'of'BreitBurn'Energy'(BBEP),'about'fracking'and'oil/gas'production.'This'is'what'he'said…'
o “Fracking'is'real'and'its'going'to'continue”'
o “There'has'been'a'lot'of'research'done'and'there'is'virtually'no'scientific'evidence'of'any'environmental'issues'with'
fracking.'There'is'only'evidence'that'people'have'disposed'of'used'frack'fluids'improperly.'For'example,'people'have'
taken'it'to'disposal'sites'that'weren’t'set'up'to'handle'it,'and'trucks'have'run'off'the'road'and'spilled'fluid.'But'as'far'
as'the'actual'act'of'fracking,'there’s'just'no'evidence'that'any'environmental'damage'has'occurred'from'that.”'
o The' regulations' of' what' we' do' downhole' are' already' very' strict,' and' will' probably' get' stricter,' but' the' disposal' is'
where'there'have'been'issues'and'that’s'not'even'an'oil'and'gas'related'thing,'that’s'just'disposal'of'waste'fluids'like'
any'sewer'plant.”'
o '“We'will'have'to'comply'with'the'new'regulations,'and'as'an'industry'we'will'be'disclosing'all'the'chemicals'that'are'
used.' There' is' no' doubt' in' my' mind' about' that.' So' if' a' company' has' more' green' products' that' are' as' effective' or'
almost'as'effective,'it'is'probably'a'good'thesis'that'they’re'going'to'benefit'from'that.”'
How(It(Plays(Out(
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States'will'increasingly'allow'fracking'but'put'stringent'regulations'in'place,'creating'demand'for'Flotek’s'products.'
As'fracking'expands'internationally,'Flotek'will'be'able'to'penetrate'new'markets'across'the'globe.'
Risks(/(What(Signs(Would(Indicate(We(Are(Wrong?(
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If'states'decide'to'ban'hydraulic'fracturing'entirely.'
“The'only'thing'that'could'really'put'a'dent'in'fracking'is'if'states'and'municipalities'completely'ban'it.”@'Hal'Washburn'
If'Flotek’s'chemicals'do'not'pass'the'potential'environmental'regulations'placed'on'fracking.'
“If'we'see'oil'prices'below'$70'a'barrel'for'six'months'to'a'year,'then'unconventional'drilling'[fracking]'will'come'to'a'halt”@'Hal'
Washburn'
o Oil'prices'are'currently'at'$94.19'per'barrel'and'are'expected'to'rise,'not'fall.'
Signposts(/(FollowKUp(
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Fracking'regulations'are'by'far'the'most'important'events'
to'watch.'
News'about'the'current'environmental'studies'about'the'
environmental'effects'of'fracking.'
Important(Company(Financial(Data(
Gross'Margin'increased'by'10.8%'for'the'quarter'(YoY)'and'7.4%'
year'to'date.'The'gross'margin'percentage'declined'in'both'time'
metrics'due'to'portfolio'mix'attributable'to'the'Florida'Chemical'
Company'acquisition.'Thus,'we'can'expect'that'once'the'company'
is'successfully'integrated,'gross'margin'will'rise'with'falling'costs.'
Many'more'of'the'increased'expenses'have'occurred'as'a'result'of'
the'acquisition'and'are'unrelated'to'the'operations'of'Flotek.'This'
has'affected'net'income'among'other'measures.'Therefore,'I'
believe'the'market'is'severely'underestimating'the'growth'that'
Flotek'is'currently'undergoing.'
The'financial'story'of'Flotek'at'the'moment'is'that'revenues'are'
growing'fast'but'costs'are'outpacing'those'revenues.'This'is'
because'of'the'acquisition'and'once'those'temporary'costs'
subside'we'will'see'more'fundamental'growth.'
Flotek Industries (FTK) Memo
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(Exhibit(1:(Horizontal(Wellbore(Drilling((A)(vs.(Traditional(Vertical(Drilling((B)(
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Exhibit(2:(Shows(the(difference(between(the(U.S.(rig(activity(decrease(and(the(increase(in(number(of(wells(per(rig.(The(reduction(
in(actual(wells(drilled(is(the(difference(between(the(red(and(blue(columns.(While(the(market(is(nervous(about(the(reduction(in(
activity,(the(situation(is(not(as(severe(as(stated(when(looked(at(actual(total(wells(drilled.(
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Flotek Industries (FTK) Memo
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Exhibit(3:(Areas(of(shale(plays(and(potential(shale(plays(in(the(continental(United(States.(
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Exhibit(4:(In(orange(you(can(see(the(areas(of(active(or(proposed(fracking.(In(blue(are(the(areas(of(potential(fracking.(As(you(can(
see,(many(reservoirs(are(present(to(foster(the(growth(of(fracking(in(the(United(States.(
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