Zedi Part 4 – Data Fees, Acquisitions, and OilOctober 8th, 2013 | Posted by in ZED
In the last post I wrote about fracking and how it has created a temporary but massive oversupply of gas in North America. Despite this harsh industry climate, Zedi has survived, and even prospered. Revenue and EBITDA have grown at 30% annual CAGRs through the collapse. This strong performance has been the result of stable data fees,and acquisitions which have expanded the company’s product lines and opened up new markets. I’ll cover each in turn.
The data fee business is attractive not only because it earns very high margins, but also because the ~98% rate of revenue recurrence essentially makes the fee streams cumulative: the data fee stream from a new well doesn’t replace the fee stream from an old one; rather, it is added to it. So even as drilling has plummeted in recent years, Zedi’s data fee revenue base has continued to grow, because as long as any wells are being drilled, at least a few new Zedi devices will be deployed, thereby increasing the number of “nodes” on the Zedi system.
This dynamic is analogous to how the number of gas wells themselves grows. The chart below shows total gas wells in operation in all of Canada (regardless of whose hardware is on them). Note that even though well drilling has fallen almost to zero, the number of wells hasn’t fallen, it has just flattened out. This is because the wells produce for decades, and so, like the Zedi fee streams, new wells are additions to the existing pool, rather than replacements.
Attrition, which as I mentioned is very low, exists for two reasons. First, all wells produce gas at a progressively declining rate, and all wells eventually hit a point at which they no longer produce enough gas to justify paying the Zedi data fee. In an ordinary year this drives roughly 2% attrition in Zedi’s data fee stream.
The second form of attrition is directly related to the price of gas. When gas prices fall steeply, some well owners choose to temporarily turn off (“shut in”) their wells as a speculation on higher future gas prices. In this case Zedi loses the data fee temporarily, but when/if the wells come back online, Zedi earns the fees again.
However, the attrition Zedi has experienced due to these factors has historically been more than offset by retrofit installations of Zedi devices onto existing wells. The number of retrofits fluctuates a lot by year, but is typically a few hundred in number. With Zedi electronic measurement hardware currently installed on roughly 15,000 wells, Zedi only needs about 300 retrofits a year in order to fully offset the typical 2% attrition.
Add in annual price increases of a few percent, and even if Canadian well completions fall to zero (they can’t go any lower), Zedi’s data fee stream should still be flat to growing.
Zedi has made three recent acquisitions of note: Southern Flow, Silverjack, and Field Services.
In 2010 Zedi acquired Southern Flow for about 5x EBITDA. Southern Flow was the leading paper chart provider and processor in the United States. In the U.S., chart use was/is more prominent than in Canada. The business itself is not bad at all, generating stable revenue, and gross margins of about 45%.
The strategic fit between Southern Flow and Zedi was excellent for a number of reasons. First, Southern Flow provided Zedi a quick and cheap entrance into the United States, a large market where Zedi had previously only dabbled. With the purchase of Southern Flow, Zedi now has market-leading positions in well monitoring in both Canada and the United States.
Second, Zedi knew it could quickly increase Southern Flow’s revenue and profitability by selling Southern Flow customers a suite of broader and superior products. This has played out: Southern Flow’s revenue is already up 50% since the acquisition.
The third rationale for purchasing Southern Flow was that over time Zedi could convert a number of the existing Southern Flow paper chart customers to electronic and/or remote monitoring customers. This would, of course, result in additional data fee streams being added to Zedi’s existing base.
This migration is beginning to happen, although it is still in the very early stages. Before Zedi bought Southern Flow, it had no data management customers in the U.S. Today it has 500. (Zedi has about 15,000 data management customers in Candada.) This number will continue to increase over time and is a key point of focus for the company.
Zedi is also aggressively introducing Silverjack, a remotely-controlled oil well pump, into the United States. Silverjack, which I will discuss in more depth momentarily, has the potential to further increase Zedi’s data management customer base.
The conversion of Southern Flow customers to data management products, in combination with growth of Silverjack in the U.S., will help Zedi continue growing its data management business regardless of how Canadian gas drilling fares.
Silverjack is a lightweight hydraulic rod pump product that Zedi acquired in 2011 for about $1 million, net of acquired inventories. (In 2013 Silverjack will probably generate more than $4 million in gross profit). The Silverjack pump is designed for oil wells rather than gas wells. It is suitable for small-to-medium size wells that produce up to 250 barrels of oil per day.
The foremost rationale for buying Silverjack was to expand into oil drilling. Zedi needed to diversify its product line away from strictly gas-focused products for reasons that should be obvious by now.
For Zedi, the beauty of Silverjack was threefold. First, the Silverjack pump, which had no data gathering capabilities at the time of the acquisition, could easily be upgraded to collect and transmit flow data electronically to Zedi, meaning Zedi could collect data fees from Silverjack customers.
Second, the pairing of the pump with Zedi remote monitoring technology would enable well owners to remotely monitor, and more importantly, to remotely modify pump parameters (stroke rate, depth, etc.) in order to optimize well production on an ongoing basis. This enabled well owners to improve production from their wells, and ultimately, to extend the productive lives of the wells. An extended productive life also has the added benefit of further deferring abandonment and reclamation costs.
Finally, Silverjack was attractive to Zedi because Silverjack had essentially no sales in the United States, a region where Zedi was already building a sales presence through the Southern Flow acquisition. The abundance of oil wells in the U.S. made it a great growth opportunity for Silverjack.
Since Zedi purchased Silverjack, orders have increased dramatically. Prior to the acquisition, Silverjack was generating about $1 million of revenue. Zedi management expected to sell $3 million of Silverjack pumps in the first year of ownership, but instead sold $5 million. Now, two years later, Zedi could end up selling as much as $15 million worth of Silverjack pumps in 2013.
The Silverjack pump itself costs about $75,000. To date, essentially every customer who has purchased a Silverjack from Zedi has also purchased a data subscription, and since these data agreements include optimization/modification abilities, they typically generate even more revenue for Zedi than the traditional monitoring-only data agreements for most gas wells.
Of the three acquisitions, Field Services is the oldest and least important. In the first half of 2008, Zedi acquired J&J Oilfield Services and Universal Measurement Systems for a combined $6.5 million. The two companies were joined to form the Zedi Field Operations segment.
This business is comprised of field techs who perform outsourced well operation and maintenance—and sometimes chart and data collection—for well owners. This is a commodity service and the gross margins are in the mid-teens. The merit of this business to Zedi is that the employees essentially serve as an in-the-field sales force for Zedi products. The Field Services employees work directly with Zedi’s customers, the well owners, and are sometimes asked to consult on how to increase or optimize production. These consultations present natural selling opportunities for Zedi products.
In the next couple of posts I’ll finally dig into Zedi’s financials…
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