Solaris Oilfield Infrastructure (SOI) is a 60% EBITDA margin oil services company operating primarily in the Permian and Eagleford trading at 3.6x our estimate of next year’s EBITDA and growing EBITDA at triple digit rates. We believe SOI has over 100% upside over 18 months as the Street begins to see the cheap multiple, believe the FCF story and differentiate the company from traditional pressure pumpers and sand miners.

Summary of Thesis: SOI’s siloed pneumatic sand storage systems save E&P companies time and money on frack jobs in addition to providing transparent tracking software to track sand from mine to wellhead. The company manufactures and leases the systems and the number of systems leased out is expected to more than double during 2018 which will more than double their run-rate revenues and EBITDA. If the EV/EBITDA multiple gets cut in half from TTM of 16x to 8x by end of 2019, the stock would be worth $34 (>100% upside).

The Business: SOI’s flagship product is a unique 6-pack silo storage system for frac proppant. Given that a picture really can tell a thousand words for someone not familiar with this space, I’ve used a lot of pictures from the company’s presentation to more easily convey the point. The best way to quickly understand how the system works is to watch the video on the company’s home page: http://www.solarisoilfield.com/

One of the primary advantages of this system is that it is mobile and can be setup or taken down in under an hour. In addition, due to the vertical nature of the silos, the storage takes up significantly less space on the pad than traditional boxed “sand king” systems.

The silos can be filled either with pneumatic trucks (automatically blowing sand into the silo) or with traditional belly dump trucks using a gravity-based loading system.

The majority of the company’s customers are using pneumatic trucks to fill the silos. One of the biggest issues, historically, with pneumatic filling is the dust created in the process. SOI uses a dust collection system in each silo and on the conveyor belts where it attempts to keep everything enclosed and largely reduces dust compared to other traditional systems.

Lastly, the company adds value to its customers by providing its PropView inventory management system where, for example, a management team back in Houston can view how much proppant it has in each silo at each well in the Permian. Additionally, well operators can use the Solaris app on their phone or tablet to stay on top of their proppant levels in their silos.

The other software the company provides is a recent acquisition called RailTronix. This is software that allows a customer to track their inventory all the way from the sand mine to the wellsite. Once again, this is critical information for management teams to manage inventory levels and understand where their bottlenecks are in the supply chain.

Valuation:

Due to the significant ramp in number of systems in operation over the course of 2018 (see Key Metrics at the bottom of the write-up), we expect EBITDA to ramp over 160% in 2018 and over 60% in 2019 (even being conservative and estimating minimal additional systems being added in 2019).

As a result, when we look at 2019 estimates, the company is trading at less than 4x EBITDA.

Below we discuss why we believe the stock is priced so cheaply currently and why that should change going forward. However, we wanted to provide a sensitivity analysis of what the stock price would be using current assumptions for 2019 numbers.

We don’t believe 7-8x is an unreasonable multiple for a 60% EBITDA margin business that will either shutdown growth and drive material FCF ($100M+/yr) in 2019 and beyond, or will find other avenues for adding value to their customers (mgmt has recently discussed water storage, for example, or more transload facilities like their Kingfisher facility) and continue to drive EBITDA growth.

Additionally, it’s worth noting that current pricing is in an environment where the E&Ps have been pretty stingy on pricing for servicers due to lower oil prices. The company recently pushed through a price increase of ~8% and utilization of their systems is the highest its ever been. If a frack crew can frack 2.5-3 wells per month, the cost per well of this system is $35-40K and it saves the crew time as discussed above. When you think about the total cost of a frack job of $5-7M per well, the $40K that SOI’s systems costs are a minimal expense relative to the whole job and shouldn’t be an issue to push through price increases in a $70-100/bbl oil environment (where we believe we are headed). The small cost and TAM are also the main reasons the big boys are unlikely to compete in this space.

Why This Opportunity Exists:

The opportunity exists because:

1. This is a small cap, underfollowed stock in a hated cyclical industry with no pure play comps. The company IPO’d in 2017, is a $780M market cap and only trades 47.5K shares in ADV (translation: no one cares). Due to its nature as sand storage, it is usually covered on the sell-side by the same guys who cover the sand miners (SLCA, SND, etc.) which are typically 20-30% EBITDA margin businesses vs. SOI at ~60% EBITDA margins. Or it is lumped in with smaller pressure pumpers like PUMP and SPN which are 10-20% EBITDA margin businesses. Given that there is no clear comp for this business and EBITDA is ramping so fast, no one knows what a fair multiple is to put on the business. We aren’t exactly sure either, but we know that 3.6x is wrong.
   
   

2. Aggressive investment in manufacturing silos shielding steady state FCF generation, causing the stock to screen poorly. As you can see in the Key Metrics below, the company is more than doubling its fleet of proppant storage systems over the course of 2018 which is likely going to cost ~$150M. This significant investment eats all the FCF and requires the company to take on a little bit of debt to fund the expansion, which we view as a smart use of capital given the pent-up demand for their product and the IRRs the company receives on them.
   
   Of the ~425 frack crews active in the US, SOI currently works with 98 of them (23% market share) and expects to exit 2018 with approximately 35% market share. The 6-silo systems cost approximately $1.8M to build and are leased out for ~$107K per month, leading to gross profit of $95K/mo, meaning payback periods are just over 18 months. The company expects the systems to last at least 5-7 years.
   
   

3. Recent acquisition of QuickThree by Smart Sand (SND) creating fears SOI is doomed. QuickThree has similar looking silos but can only hook up one truck at a time per silo (compared to 4 with SOI) and they don’t hold as much proppant as SOI’s. We’ve discussed with SND mgmt and they intend to start manufacturing these silos in June/July (they will need to issue a bunch of debt to fund it), begin rolling them out to their current customers in late Q3/Q4 and then start using them in their marketing in 2019. We think this is unlikely to materially impact SOI as our estimation is that the QuickThree product is inferior and SOI will largely have met its goals by the time SND is ramped up.

4. Street concerned about what’s next. The company is a victim of its own success because in a year’s time it will likely have come close to saturation in the market. On the one hand, if they want to spend a little bit of R&D to ensure they maintain the best systems in the space and cash flow the business while keeping utilization high, we are fine with that. However, we believe it’s more likely (since we all know management teams are not well incentivized to simply stop growing) that the company will look to expand the product/service offerings it has to its current customer base. Management has thus far done a decent job of capital allocation, but this does remain a risk. However, we would note that once all of these systems are in place, the company will have built a reputation and a number of relationships it can then leverage to cross sell additional products and services it acquires/builds. As such, we believe the ultimate reality is going to be higher EBITDA numbers than we had projected and lower FCF numbers as the company continues to find ways to profitably invest its capital.

Risks:

1. Someone invents a better mousetrap. Can discuss more in comments if you’d like.

2. Capital allocation – discussed above but happy to discuss more in comments

Appendix: