The Energy Report: Dominick & Dominick is looking at small high-tech companies serving energy exploration and related enterprises. Why?
James McIlree: We are looking for micro-cap firms that apply advanced technology to developing traditional sources of energy—natural gas, coal and oil. We focus on companies intent upon making fossil fuels more efficient, cleaner and cheaper to produce.
"A fiber-optic geophone is much more sensitive than the traditional geophone. . .this is advantageous in the exploration market, where greater accuracy helps determine the size of reservoirs [and] the most efficient placement of wells."
TER: What companies meet those standards?
JM: We're in print right now on a holding company called Acorn Energy Inc. (ACFN:NASDAQ). Acorn owns several subsidiaries that meet these standards. One of its holdings is U.S. Seismic Systems Inc. U.S. Seismic has developed a fiber-optic sensor with applications in oil and gas exploration, as well as in reservoir management. Its fiber-optic sensors have much greater sensitivity than traditional geophones do, and that capability can be important to the hydraulic fracturing market.
TER: How do fiber optics improve geophone technology?
JM: A traditional geophone converts seismic energy into an electrical signal, which is measured and used to create maps, or representations of geologic formations. The seismic event can be created with explosives or vibrating plates. Seismic events are also created when a well is hydraulically fractured. The seismic event creates sound waves that travel through the earth and are "heard" by the geophone. The sound wave is modified as it travels through formations.
When an energy company is looking for oil and gas, it does a seismic survey. It then interprets the data to determine whether or not there is oil and gas in the area of interest. The traditional geophone converts seismic energy to electrical signals. The advantage of a fiber-optic geophone is that it is much more sensitive than the traditional geophone; the fiber-optic geophone is capable of "hearing" more.
This is advantageous in the exploration market, where greater accuracy helps determine the size of reservoirs. And it is advantageous in the hydraulic fracturing market as well, by assisting the gas company in siting its wells in the most efficient locale.
TER: Can you be more specific about how this technology works?
JM: The fiber-optic geophone is a spring with fiber wrapped around it. Sound waves generated by a seismic event cause the spring to change shape. And when the spring changes shape, the fiber that's wrapped around it expands or contracts. The engineers shoot a "reference" light through the fiber. The light's return signature is different than the reference signature. The differences are compared and used to create a database of how the sound wave changed as it traveled through a formation. The fiber-optic geophone U.S. Seismic has developed has been shown to be much more sensitive—that is, it can hear better than a traditional geophone.
An interrogator, or the electronics of the system, is housed in a trailer some distance away. The interrogator is the electronic device that compares the reference signal and return signal and creates the database that is used by the exploration company or the oil and gas company. This is a critical aspect of the system that U.S. Seismic recently licensed from Northrop Grumman.
TER: How new is this fiber-optic technology?
JM: The technology has been pursued for many years, but Acorn has overcome some of its limitations.
TER: Is this fiber-optic geophone a proprietary product?
JM: Yes, it is proprietary; there are patents and some trade secrets surrounding it. There are two basic seismic products sold by Acorn's U.S. Seismic. The fiber-optic geophone is placed either on the ground or down a hole, and the interrogator interprets the signal changes.
TER: Acorn is engaged in a number of different types of technological ventures geared toward energy exploration. Can you talk about its scope of operations?
"U.S. Seismic's fiber-optic geophones can show that the seismic events are limited to certain areas, and generate a high degree of confidence that the fracking is not contaminating any of the water supply in that area."
JM: Acorn addresses the entire food chain of energy production—from exploration through distribution. It has a unit called GridSense, which serves the electrical utility. GridSense has developed a line of transformer monitors that help electric utilities predict where transformers are likely to fail and, based on that information, do preventative maintenance. In the United States, the transformer fleet is relatively old and, consequently, transformers are a significant point of failure. GridSense has developed a low-cost way to monitor transformers and replace them before they fail.
TER: Does Acorn have competitors in the grid-monitoring space?
TER: Let's talk about the environmental concerns around fracking. How do these types of high-tech products address those issues?
JM: There are four major environmental concerns about fracking. The first is water supply, and to what extent fracking fluids and gas can infiltrate the water supply. The second is disposal of the fracking fluids once fracking has taken place. The third concern is earthquakes, which can occur if fracking creates a large enough seismic event. The fourth concern is greenhouse gas emissions, to which natural gas contributes. U.S. Seismic's technology targets the first and perhaps biggest cause of concern, that is, will fracking contaminate the water supply? U.S. Seismic's fiber-optic geophones can show that the seismic events are limited to certain areas, and generate a high degree of confidence that the fracking is not contaminating any of the water supply in that area. Regulators are trying to understand exactly what environmental risks are involved in fracking. U.S. Seismic's ultra-sensitive instruments can alleviate these fears.
TER: And conversely, the sensors could determine that such-and-such an area should be off limits.
JM: Yes, exactly.
"The energy industry is an international industry. But a lot of high technology is originally developed in North America, proven in North America and then sold to the rest of the world."
TER: This sounds like a growing field. Does this type of technology apply to solar, wind or geothermal energy?
JM: There are opportunities there, but we are currently focused on the traditional sources of energy, not the alternative sources.
TER: Pipeline corrosion is a problem in the aging energy grids. Who is looking at that issue?
JM: Acorn has two products applicable to that problem. One is produced by U.S. Seismic. It's a fiber-optic sensor that could be used to monitor pipelines. And Acorn recently acquired a company called OmniMetrix LLC, which also has a product used for pipeline monitoring.
TER: Let's talk about what you look for in management. What is the situation with Acorn?
JM: Acorn is a holding company. Its CEO is John Moore. John has a very good track record of identifying companies with emerging technologies in the energy industry. He invests in companies with proven management teams, such as U.S. Seismic, GridSense and OmniMetrix. Acorn offers these companies relative autonomy and financial resouces. As companies grow and mature, John Moore typically sells them. Over its history, Acorn has executed a couple of successful sales, including a company called Comverge and another called CoaLogix Inc., which does pollution-control technology for the coal-fired electric industry.
TER: What is it about the recent trajectory of Acorn's stock price that attracts you?
JM: The stock started the year close to $4-5/share and ran to about $13/share. It rose based upon expectations for good news coming out of its U.S. Seismic business. There has been increased focus on that business as oil prices have moved up. But Acorn had a rough May, like the rest of the market, and so the current $8/share level looks fairly attractive. We have a target of $14/share, and that's based upon our belief that, over time, the divisions that Acorn owns will mature and become increasingly attractive to potential buyers.
TER: Is Acorn's price tied to the ups and downs of the energy sector in general?
JM: Yes. But what we like about the Acorn stock movement is that it's not just driven by the price of oil or gas. The company's products enable energy companies to reduce their costs and to improve output. There is a viable market there, even with fluctuating resource prices. The viability is tied to the necessity of the oil and gas companies to lower costs and improve the quality of production.
TER: Does Acorn have its eyes on international business, or is it purely domestic, to the United States?
"The strategic philosophy behind Acorn's investments is that traditional energy industries are going to be with us for a very long time. Acorn is looking for companies that can help those traditional sources of energy operate more efficiently."
JM: Initially, the Acorn products will be proven in the North American markets, and then migrate to international markets. The energy industry is an international industry. But a lot of high technology is originally developed in North America, proven in North America and then sold to the rest of the world. I envision that the same type of progression will occur with Acorn's products.
TER: Do you view Acorn itself as a company that has acquisition potential down the road, or a company that will grow and maintain itself on its own steam?
JM: The reality of the small-cap market is that the successful ones have a higher likelihood of being acquired. But it would be difficult for one company to buy the whole portfolio of companies that Acorn owns. Energy service companies like Baker Hughes Inc. (BHI:NYSE), Halliburton Co. (HAL:NYSE) or FTS International (FTSI) are potential candidates to buy U.S. Seismic. Different sets of companies would be interested in GridSense and OmniMetrix.
TER: Well, Acorn is a holding company at this point, right? So companies can come and go and it can maintain its structure if it wants to.
JM: Right. And that is what has happened. Acorn sold Comverge, took the proceeds and found other companies that it thought were interesting. It sold CoaLogix, took the proceeds, and purchased companies that it thought were interesting. I think that's the more likely scenario: that somebody comes along and offers an attractive price for an Acorn property. Moore says "Sold," takes the proceeds and finds something else to develop.
TER: Do you have an approximate dollar figure that you could attach to what Acorn earned from those sales and were able to put back into their companies?
JM: Acorn's Comverge subsidiary went public in 2007 at a $250 million (M) valuation and Acorn sold its entire position later in the year for $50M. In 2011, Acorn sold CoaLogix at a $101M valuation and banked close to $60M, after taxes, for its share.
TER: Let's go back to the theme of Acorn making energy cleaner, cheaper, safer, and more reliable. Can you sum up how Acorn is approaching those goals?
JM: The strategic philosophy behind Acorn's investments is that the traditional energy industries are going to be with us for a very long period of time. Acorn is looking for companies that can help those traditional sources of energy operate more efficiently. John Moore wants firms that have already had the initial round of investments—he is not a venture capitalist. He looks at companies that are either on the verge of product development, or that have a product but need help bringing it to market. Acorn is not going to be the first investor. It will be the second or the third investor. Many companies go through a lifecycle of the venture capital where it's founders have a great idea, but they run out of cash or expertise, and that's when Acorn can assist these companies.
TER: Is Acorn returning a dividend at this time?
JM: Yes, it returns a small dividend, at an annual rate of $0.14 per share.
TER: Thank you for your time.
JM: Thank you for having me.
James McIlree has 25 years of experience in the investment business as a sell-side research analyst and buy-side analyst and portfolio manager. He focuses on emerging growth companies in the technology, telecomm, energy and defense electronics markets. Prior to joining Dominick & Dominick in October of 2011, Mr. McIlree was a managing director and research analyst at Merriman Capital covering firms at the intersection of satellite communications and defense electronics. Prior to Merriman Capital, McIlree was with Collins Stewart and its predecessor firm, C. E. Unterberg, Towbin, where he covered the defense electronics/communications sector and was director of research. McIlree holds a Bachelor of Arts in economics from the University of Chicago and a Master of Business Administration from the University of Colorado. He is a CFA charter holder.
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1) Peter Byrne of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Acorn Energy Inc. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) James McIlree: I have not, nor has my family, been compensated by any companies mentioned in this interview. Neither I, nor my family, own shares in any company mentioned in this interview. I was not paid by Streetwise Reports for participating in this story.
4) The following disclosures are applicable to Acorn Energy Inc.: The research analyst responsible for preparing reports on Acorn Energy Inc. has received compensation based upon various factors including the firm's total revenues, a portion of which is generated by investment banking activities.
Dominick & Dominick LLC expects to receive or intends to seek compensation for investment banking activities from Acorn Energy Inc. in the next three months.
Dominick & Dominick LLC has received compensation for investment banking services from Acorn Energy, Inc. in the last 12 months.