metoo105 (30.91)

Energy Recovery (ERII)

November 17, 2010 – Comments (0) | RELATED TICKERS: ERII

This small cap has recently hit my radar. The company makes a device to facilitate the purification of water through reverse osmosis in desalination plants. Specifically, it corrects a design flaw in earlier desalination designs that permitted the high pressure water, made at great energetic expense, to go to waste. The company's technology is protected by 8 US patents, 15 international patents and various unmentioned trade secrets.

The device and its tech sound very intriguing. Right now the valuation seems like it might be on the cheap side. Currently the company trades at 1.5 times book with an enterprise value of $125 million, $50 million in revenues, and $3 million in EBITDA. Last quarter was rough and accounted for most of the precipitous drop with revenues cut in half quite near an all time low of $3 per share at $3.50 per share as of November 18, 2010.

13 analysts are predicting that the company will lose $0.08 a share this year and break-even earnings next year. This company is obviously looking to leverage what will likely be an explosion in desalination plants in the coming years. One assumes that construction on these plants has hit a snag with troubled credit markets and poorer governments cutting back in all areas, including many necessary projects. Hence, my feeling is that the recent performance isn't so upsetting and the key questions are about the technology and water desalination.

The company claims that by preserving the energy spent in making high pressure water for the desalination, the energy expended is less than pumping water over large distances. That claims is very interesting. My first question is under what conditions that claim might be true. (i.e. what energy expense is assumed, what distance, etc.)

My next question is what should we expect in the way of patent infringement from the construction companies. It seems quite likely that the desalination construction companies could quite easily read the patent, simply copy it, and then sit waiting ofr a lawsuit to arrive, hoping that the privacy in the plant would make such a suit unlikely. That is, policing the patents seems expensive and next to impossible given the privacy and international issues involved.

What risks does the company have in trying to develop technology relating to its ceramic parts from scratch. Right now the company is supplied these parts. I gather that the materials science behind ceramic parts manufacturing is considerable. The company does not have much in the way of an R&D budget at a few million per year. Also the company looks like it might be a one hit wonder that gets later trumped by better technology. 

Other risks are that reverse osmosis desalination is not the best or most efficient means of purifying water or that the company is itself found to be infringing another's patent or patents. 

These are just some preliminary thoughts after a quick look. I'll have to read the rest of the Ks to get a better sense of what's what.