Description

Tetra Technologies (“TTI”) is one of the more compelling off-the-radar investment opportunities I have seen in a while.  The stock is likely head to $7-10/share provided oil holds in the $65+/bbl range.  This is enough of reason to own the stock.  However, TTI has three powerful ESG options that could generate stratospheric returns if they go into the money.  TTI is the raw material supplier to all three of these options and is set to potentially see a big lift to earnings as two of these concepts are funded for pilot tests of the concept.  Should these pilots prove effective – there is staggering potential.

Core business.  I break the company into three segments which does not correspond to how TTI breaks their segments in public disclosure.

Calcium Chloride:  this is the crown jewel of the company.  The calcium chloride business is a tiny but highly attractive global industry with a duopoly structure.  OxyChem is their competitor.  TTI is active in North America and Europe.  You make calcium chloride by combining limestone and hydrochloric acid.  If any of you have worked on aggregates, you will realize that NIMBY and other restrictions limit your ability to open a quarry wherever you would like.  The end products are bulky – limiting their distribution radius.  This creates local monopolies.  The same is true in the case of calcium chloride – especially when you consider that hydrochloric acid is extremely difficult to safely transport.  As a result, their global duopoly status is further buttressed by real local barriers to entry.  However, this is a tiny industry with hundreds of millions of global demand.  Of note, the calcium chloride once separated from the limestone exits as a slurry which must be dried mechanically or in deserts.  The products go into a variety of diverse applications; food additives, dust management, oil fluids, etc…  Demand dropped due to the pandemic and is in recovery mode.  EBITDA margins are 25% on $100mm of revenues.  I suspect revenues can recover to at least $125mm with at least 40% incremental margins.  This implies $35mm of mid-cycle EBITDA.  I value this segment at 10.0x EBITDA due to high ROIC and FCF driven by global+local oligopoly status.  Lastly, there is a seasonal pick-up in 2Q as Europe buys calcium chloride to place on dirt roads to reduce dust.

Oil field fluids.  TTI supplies oil field fluids that control well pressure in offshore wells.  This segment is fairly attractive with a short-list of global competitors.  The demand is driven by deepwater wells which is experiencing a robust recovery.  Their fluid is a calcium bromide which is extremely dense.  As the drill encounters pressure from the oil and gas reserves, the calcium bromine is poured into the well and is so dense that it contains the pressure.  TTI has extensive bromine supplies via their supply agreement with lanxess on favorable terms.  The other competitors HAL/SLB offer a similar product.  By and large, I view this segment as a commodity product in a consolidated industry.  However, the rally in oil prices is causing a surge in demand for rigs in the Gulf of Mexico and other markets.  Further, calcium bromide is much more favorable on an ESG front and can be poured into the Ocean in all jurisdictions.  Competitive fluids are far more toxic and increasingly banned in many jurisdictions.  This segment is set to improve rapidly in 2h21 and 2022 as these rigs mobilize.  I suspect this segment can get back to $75mm of EBITDA at 6.0x or $450mm.  I will concede that while I have a lot of confidence that the $75mm of EBITDA happens… the 6.0x EBITDA multiple is less certain as deep-water oil wells face a highly uncertain future as we de-carbonize.  That said, HAL/SLB/CHX trade at 10x+ EBITDA and this is one of the more profitable sub-segments.  Further, TTI has a cost structure advantage.  By comparison, TALO is a GOM oil producer which trades at 4.0x EBITDA.  TALO multiple is hindered by the lack of FCF.  Frankly – I think this is better than HAL/SLB/CHX but I would never in a million years pay that for these companies.  So - I will use a highly conservative 6.0x.

TTI also produces a high-end product (Neptune) for extremely high-pressure wells.  TTI is the only supplier of a product for ultra high-pressure wells.  Other suppliers of fluids for lower-pressure off-shore wells re-sell TTI’s product.   Ultra high-pressure wells are fairly rare events.  TTI hasn’t had a customer for several quarters in this segment.  However, current customer inquiries are the “highest they have in ever been.”  Each job is $30mm+ with 60-80% margins.  TTI is usually lucky to get 1-2/year and probably doesn’t have any in 2021.  However, 2022 could yield 2-3 projects based on current conversations.  This is clearly a low multiple sub-segment but 5 wells over the next up-cycle even at 1x FCF could add 120mm to the TEV or ~$1.00/share.  I exclude this $1/share of value from Neptune from the SOTP to be conservative. 

Water products:  TTI supplies a variety of services/products to O&G producers as they frac and manage wells.  To begin, TTI supplies fresh water to the frac site.  TTI processes the oil that flows out, removing the water and sand.  TTI also purifies the waste-water allowing it to be re-used.  TTI’s recycling services are increasingly in demand to help on the ESG front.  TTI relies on a deep bench of chemistry and engineering expertise to compete.  Any fool can deliver a truck full of water.  The fluid processing on the back-end is value-add and fairly complex.  WTTR is the biggest comp in the space.  WTTR appears to be pursuing acquisitions.  TTI seems like a natural/willing seller as it is looking to reduce energy exposure.   EBITDA is correlated with Frac crews operating in the US which are on the rise.  I suspect that mid-cycle EBITDA can get back to $35-45mm/year in 2022 and think that 6-8x is a reasonable range.

In addition, the company has small stakes in CCLP and SIL CN which are worth ~$10mm each.  All told, the stock is easily worth $7/share on mid-cycle SOTP before the benefit of annual and consistent FCF generation.  Mid-cycle might not happen in 2022 but is probably the run-rate by 2H22 if current conditions hold.  One thing is for certain 2022 EBITDA estimates are far too low suspect that they probably end up with 100-125mm of ebitda in 2022 which puts this below 6.0x EBITDA.

Options:  as I wrote in my intro, the company has a lot more to offer and these are definitely free-options in today’s stock price.  Further, there are no consequences to the company if the options expire worthless as they are not extending capital to develop the idea – merely the raw materials.

Carbonfree.  Carbonfree is a potentially revolutionary company with an impressive list of backers; including Apollo.  The company has developed a system that uses calcium chloride to convert smoke stack CO2 into precipitated calcium carbonate (“PCC”).  Carbonfree’s process takes 2 tons of calcium chloride with limited additional operating expenses and it yields 1 ton of PCC and 1 ton of hydrochloric acid.  PCC trades for $100-600/ton depending on the quality versus the operating expense of $100-200/ton of calcium chloride.  Carbonfree believes that its PCC product will garner a price at the higher end of the spectrum; creating a highly attractive IRR before any carbon credit economics and eliminating C02 emissions from the smoke-stack.  Cement and steel facilities are obvious potential targets.  Carbonfree has a pilot working on old technology which works but has poor yields.  Carbonfree is raising capital to fund a new project which they believe will yield the above-stated returns.  TTI has a MOU with carbonfree to be the supplier of the calcium chloride.  Should Carbonfree succeed in raising the capital and move forward with the ONE pilot, this one plant would require a massive amount of calcium chloride annually – roughly $140mm worth.  TTI will only move forward if they obtain a long-term take-pay contract from the cement, steel, chemical or O&G company who is the counter-party to Carbonfree.  If this works, the potential is staggering.  The PCC market is $40bn in size and goes into sealants, adhesives, plastics, rubber, inks, paper and other applications.  Carbonfree / TTI can grow massively before this saturates the market.  Further, TTI believes it has developed a novel calcium chloride manufacturing process that will use the produced hydrochloric acid in a closed loop and allow for localized calcium chloride manufacturing.  This could be an essential development to allow for this technology to expand beyond locations where calcium chloride has been produced historically.  If each plant that Carbonfree adds is $25mm/year of EBITDA on a 20+ year take/pay contract with an investment grade counter-party and limited capex needs, there is tremendous potential here.  Further, the great thing here is that the potential is so staggering that somebody has to be willing to fund the next pilot which have would be worth $25mm * 10x to TTI or $2/share before any consideration for the increased value of the option that this grows into a $250-500mm of EBITDA segment based on Carbonfree adding 10-20 plants.  The second leg to the option is certainly speculative and frankly sounds too good to be true.  However, my suspicion is that the pilot gets the greenlight in 2021.  By my math, the new pilot is worth $2/share to TTI versus $3.94 as I type.  This is before the fact that winning this contract would immediately catalyze a material global price increase as this contract would put them deeply into sold-out conditions for calcium chloride. If the price increase added another 10-20mm of EBITDA, this would add another 1-2/share in this 10x business.  I have done work to evaluate the technology.  It clearly works but I can’t speak to the economics and whether the new technology will work at the economics they state.  This is an option and I continue to do more work to assess feasibility but it could also turn into a bust too.  However, if it is a bust, it is probably after a huge surge in calcium chloride demand with a long-term contract to supply the pilot.

Standard Lithium:  TTI owns 45,000 acres in Arkansas that are highly prospective for Lithium and Bromine mining.  They signed a deal with Standard Lithium that provides them with a modicum of shares and $1mm/year of cash in return for the rights to mine TTI’s Lithium.  Beyond the short-term share issuance, TTI will receive 2.5% royalty on all lithium mined and all the bromine which is extruded for free.  The reserves contain far more bromine than lithium on volumetric basis.  TTI estimates there are $18bn of reserves.  890k tons of lithium at $8k/ton = $7.1bn * .025 = $178mm / 20 years = $9mm/year.  The bromine is far more valuable to TTI.  3.9mm tons * $3,500 / ton = $13.7bn of value but Standard Lithium only supplies them the slurry once they have removed the lithium.  TTI must extract the bromine from the solution.  That said, this slurry is free and a sharp discount to historical supply.  It is far more bromine than they currently need.  However, mgmt. suspects that this supply will be needed for the zinc bromine market as it takes off (see next.)  If the zinc bromine market doesn’t develop, they will convert into a market supplier with what should be bottom quartile position on the cost curve.  Management believes the option is worth $3-4/share.  Standard Lithium is completing a feasibility study.  It would require $100mm of capex to build the mine – a fairly modest hurdle in today’s world.  TTI has controlled the reserves for ages and has done extensive reservoir work.  They believe it is a highly prospective project with extremely high Lithium content.  Standard Lithium IS NOT AAA.  SIL has a novel extraction process, the deal with TTI and not much else.  If they fail to get the project off the ground, TTI could execute this on its own or partner with Lanxess or Albermarle who have facilities on the reservoir just to the east.  Also note:  I am using trough pricing for lithium and bromine.  I suspect that Standard Lithium’s feasibility project concludes favorably this year based on my remarks above. 

Mass energy storage:  TTI is also positioned to supply highly pure zinc bromine to mass battery storage providers.  There are several start-ups focused on using zinc bromine as batteries to store/deploy massive energy banks generated by renewable energy at times that don’t necessarily match peak grid needs.  The technology appears to have multiple advantages over conventional battery technology for this.  Redflow (RFX AU) appears to be the leader in this nascent industry.  TTI claims that many can provide zinc bromine but TTI’s chemistry and technical background in the sector allows them to produce the highest purity product.  So far, this segment has generated zero revenues but the company believes they could potentially obtain an order which could be needle moving in 2021 as start-ups trial the product.  Should this technology take-off, it could materially tighten the bromine market.  While an order is potentially around the corner, it is currently unclear to me if this technology moves to mass adoption and the potential cashflow stream for TTI.  I suspect that they start to receive orders that could materially improve earnings and this could happen in 21/22 but this could taper off if the technology doesn’t prevail.

Why cheap?

The stock is cheap because it has changed dramatically.  TTI used to own over 50% of CCLP and consolidated all of CCLP.  This made TTI look rich/overleveraged and increased complexity.  They just  exited the majority of CCLP to eliminate this.  I further suspect that they will exit the remainder of CCLP and the water segment into the next upcycle; reducing energy exposure and complexity.  Nobody really covers this on the sell-side.  Evercore is tantalized by the potential but is skin deep.  Stifel does a solid job though.  That said, I suspect the complete change in the company and its fairly complex make-up has materially limited efficiency.  I think 2022 EBITDA is more like $125mm.  7x 125 = 6.5/share prior to 21 FCF.

Qualification:  Most of the ideas I have posted have been slam-dunk upside opportunities.  I do think the base case upside is meaningful further upside in the core business with high likelihood that some of the ESG optionality is triggered short-term.  That said, I would note that Carbonfree sounds too good to be true.  The mass storage technology is nascent at best.  The Arkansas Lithium/Bromine reserves seem very real and in the money – but they are potentially partnered with the wrong team.  These options are worth 2-3/share today in my opinion but could expire worthless. 

Catalysts:

Stock is loaded with potential catalysts this year.

1)      Beat 2021/2022 estimates

2)      Standard Lithium feasibility

3)      Carbonfree funding – supply agreement

4)      Zinc bromine supply agreement

Catalyst

Stock is loaded with potential catalysts this year.

1)      Beat 2021/2022 estimates

2)      Standard Lithium feasibility

3)      Carbonfree funding – supply agreement

4)      Zinc bromine supply agreement