Thursday, February 21, 2013

Computer Modelling Group ( Toronto - CMG ) -- Schlumberger Falls Behind

Computer Modelling Group ( $22.00) reported Q3 (Dec.) results that were somewhat below our expectation.  The company is the leading provider of simulation software used by energy companies to understand their underground reserves, and manage them for maximum profit.  Computer Modelling's specialty is heavy oil and hard to recover reservoirs.  Competition is provided by Schlumberger and Halliburton, the largest all around oilfield service providers.  Those companies dominated the software market during the "black oil" days, when new discoveries were just giant pools of petroleum that were relatively easy to exploit.  Computer Modelling started up in the 1990s and created advanced mathematics to work on more challenging fields.  Today, those are the only reserves left to find.

Earnings rose a modest 6% in the last quarter to $.17 a share.  Revenues also were up 6% to $16.8 million.  Excluding the company's deal with the Venezuelan national oil company, though, recurring revenue climbed 34%.  Computer Modelling trusts the government of Venezuela to pay its bills.  But its auditors don't.  So the official books don't recognize any accounts receivable.  Revenues equal cash collected.  The bad comparison isn't the result of delayed payments, at least in the December period.  What happened is that Venezuela fell behind last year during the run up to to the elections.  Then they made up for it in the year ago quarter.  So this year's comparison was muted.

Referrals from Halliburton continue to rise.  That company still has a terrific collection of customers with black oil reserves.  They continue to be served by Halliburton's in-house software.  When it comes to new drilling, though, Halliburton can't even give it away.  Computer Modelling's technology is superior.  The rate of return on the technology is far beyond whatever it might be worth to get Halliburton's product for free.  So Halliburton has started to license Computer Modelling's products, figuring it will keep its customers happy and make up the difference by selling all its other products and services.

Schlumberger still has not joined forces with the company.  It hasn't come out with a competitive product, either, from a technology standpoint.  And its top software engineer and product manager recently left the company, casting doubt on the likelihood a big breakthrough is coming soon. 

The offshore project could finish by the end of the year.  That effort continues to be funded 33%-33%-33% along with Shell and Petrobas.  Computer Modelling retains 100% of commercial sales potential to other companies.  The company's partners will get first use of the software.  The structure of the technology allows ample plug-in opportunities.  Shell and Petrobas are developing quite a few of those proprietary programs, which probably won't be made available to their competitors.  Over time, though, word gets around, and those competitors may write their own.

Computer Modelling remains a phenomenal company.  Gross margins are sufficient to pay for aggressive marketing, high levels of product development, and plentiful dividends.  The executives running the company are approaching retirement age.  So a buyout is possible.  But Computer Modelling has a clear cut runway to 2020, perhaps farther.  If it remains independent above average growth could persist as the new product kicks in, existing customers expand, Halliburton referrals keep rising, and Schlumberger throws in the towel and licenses the software, too. 

( Click on table to enlarge )