This Small-Cap Just Got A Big Endorsement From Schlumberger

• Energy Recovery, Inc. ERII shares are up 35 percent year-to-date, and are trading closer to the high-end of their 52-week range of $2.07 - $8.16.
• Credit Suisse’s Patrick Jobin upgraded the rating on the company from Neutral to Outperform, while raising the price target from $3 to $10.
• The company has inked a deal with Schlumberger, which includes upfront payments and royalty revenues, and validates of technology’s prospects, Jobin mentioned.

Energy Recovery has announced a 15-year deal with Schlumberger Technology Corporation to commercialize the former’s VorTeq hydraulic pumping system for use in onshore hydraulic fracturing.

This exclusive agreement encompasses an upfront payment of $75 million, along with two payments of $25 million each, likely in 2016. The latter payments are subject to Energy Recovery meeting two milestones.

Moreover, the agreement includes annual recurring royalties, commencing likely in 2017. Energy Recovery believes that the deal could result in stable, recurring revenues from this one market of $80-$200 million per annum.

Analyst Patrick Jobin said that the agreement is “transformative” for Energy Recovery, citing the reasons as:

1. Providing validation of the prospects of the technology and boosting the probability of successful commercialization
2. Boosting the balance sheet, such that the company would have the flexibility for further R&D investments
3. Allowing the company to “capture the value of their simple, yet disruptive, energy recovery technology in a capital-light manner”

Jobin commented that the valuation for Energy Recovery has been adjusted to include $375 million in value from the Schlumberger deal, based on licensing fees, and reaching $50 million per annum in royalties by approximately 2019.

“Admittedly, there is still commercialization risk (two more milestones for integration in 2016) but at this point we feel increasingly confident ERII will be able to successfully penetrate a large $700m TAM,” the analyst wrote.

The EPS estimates for 2015, 2016 and 2017 have been raised from ($0.24) to $1.01, from ($0.05) to $0.67 and from ($0.03) to $0.02, reflecting the upfront payments and recurring revenues.