Is Particle Drilling's Technology Worth a Drill Bit?

Particle Drilling Technologies Inc (PDRT-$2.80), based in Houston, Texas, is a development-stage oilfield service company in the process of commercializing its patented advanced drilling technology known as Particle Impact Drilling (PID).

Unlike earlier particle recovery systems, PID technology does not require high surface pressures—up to 11,000 psi—in order to give the small particle the velocity to abrade the formation ahead of the drill bit. The PID System, which incorporates hydraulic energy, utilizes larger particles at normal rig pressures to fracture the formation ahead of the drill bit.

The PID system proprietary technology employs a specially designed “fit for purpose” drill bit fitted with jetting nozzles and polycrystalline diamond compact cutting structures that readily adapts to typical conventional drilling rigs.

The system will be provided and operated by Particle Drilling as a service to the oil and gas company for drilling certain rock intervals (specifically in wells where hard and/or abrasive formations result in penetration rates averaging ten feet per hour or less).

The PID system is designed to connect to and service an operational well in progress with minimal interference to normal drilling operations. All PID System equipment is either mounted on trucks or trailers, and the Company expects that the system can be installed on a rig during a scheduled bit trip. A good portion of the PID System may be mobilized and rigged up offline so as not to interfere with the drilling operation in progress. Once the operator is finished with the PID System, it is expected that it can be taken offline in one to two hours and demobilized with no further interference with the drilling operation. Management believes this operational transparency is extremely important for industry acceptance of the PID System.

Test applications—to date—have demonstrated that the PID system is capable of drilling through rock formations at rates from two to four times faster than current conventional techniques. Depending on the volume of shot introduced into the drilling mud, the number of shot strikes on the formation is in excess of four million per minute, thereby yielding a higher rate of penetration than conventional roller cone rock bits (reducing the amount of time the operator spends on location to drill the well). The result is a much more efficient and cost-effective drilling process—generating savings in labor, fuel, rentals, rig time and other variable well costs.

The reduction in drilling time and reduction of other drilling problems resulting from the utilization of the PID system represents estimated savings between 35% and 50% of conventional drilling costs.

Financial Analysis

To date, the business has not generated any revenue from its operations.

As of June 30, 2006, Particle Drilling had approximately $5.1 million in cash, current liabilities of $1.6 million, and neglible long-term debt.

The accumulated deficit was $17.3 million.

Current monthly operating overhead is approximately $660,000 (excluding non-cash expenses such as depreciation and stock-based compensation) as compared to $240,000 in FY 2005.

In order to enter the oilfield services market on a full-scale basis, the Company must successfully complete additional research and development, the cost of which will exceed the amounts management has budgeted in its operation’s plan.

The financial condition of the Company has improved, however, for on October 19, 2006, the Company completed a private placement of 5.0 million shares, at a per share price of $2.35, which raised net proceeds of about $10.7 million. These monies will be utilized by the Company to manufacture additional PID Systems, to fund the development of a new particle injection system, to fund additional research and development, and for general corporate purposes.

[Ed. note. As the Company has yet to generate cash flow from operations, and until revenues commence, the Company is highly dependent upon debt and equity funding. Ergo, stockholders should expect further dilution, for additional funds will have to be raised in the future, too.]

Valuation Analysis

How does one value a development company with no current revenue? On a relative basis, with no operating cash flow, earnings, or terminal growth projections, the intrinsic value of Particle Drilling is limited to its liquidation value—about 50 cents per share.

After the recent announcement by management that it has suspended a commercial trial of its drilling technology due to the failure of a frac pump transmission, expected revenues of $16.3 million in FY 2007 are probably premature.

The price of the Common Stock of Particle Drilling has plunged 58.9% since late January 2006, as investors showed their disappointment in commercialization delays by selling en masse.

It is difficult to value Particle Drilling utilizing a going concern approach given: (1) no history of positive earnings and (2) the Company’s assets are not earning much in the way of return(s).

Nonetheless, the 10Q Detective is willing to go with The Rules-of-Thumb Approach, which can indicate certain measurable criteria that can be assessed and applied to “potential value.”

Recent acquisitions in the drilling equipment universe provide a comparable valuation analysis for Particle Drilling’s future valuation prospects:

1. Tenaris S.A. (TS), a leading global manufacturer and supplier of tubular products used in the drilling, completion and production of oil and gas wells recently acquired tubular steel maker Maverick Tube Corporation for (US) $65.00 per share in cash, or 10.8 times trailing EBITDA of $288.0 million.
2. Downhole instrumentation maker Sondex plc. has entered into an acquisition agreement with a leading Canadian manufacturer of downhole tools and equipment used in the oil & gas sector, Innicor Subsurface Technologies. Under the agreement, Sondex will acquire Innicor for approximately (C)$72.8 million, or about 10 times trailing EBITDA.
3. Shares of NQL Energy Services, a leading independent supplier of directional & performance/straight hole drilling tools for oil and gas fields, was recently acquired by Houston-based energy drilling services company National Oilwell Varco Inc. (NOV) for (C)$345 million, or about 9 times trailing EBITDA.

The 10Q Detective went into our Due Diligence of Particle Drilling thinking that it had some “sizzle” to smell. Sadly, there just is no meat to be found. Even assuming the Company were to successful bring to market the PID System in 2008, based on the aforementioned comparables, the stock price—optimistically—is probably worth no more than $1.00 per share. [This target is based on shares outstanding of 40.0 million, little cash/debt on the balance sheet, and 2008 EBITDA of $3.0 million. As such, (even without using an appropriate risk discount, for Particle is a fraction the size of its comparables) the $1.00 price target would still value Particle Drilling at a slight premium over recently acquired drilling equipment companies.]

Catalysts for a turnaround in Particle Drilling’s stock include (i) the Company’s ability to produce a successful commercial field test and (ii) negotiations of commercial contracts with potential customers.

The Company has experienced leaders at the helm to deliver the goods. Chairman Ken R. LeSuer came onboard after retiring as Vice Chairman of Haliburton Company (HAL-$32.15) in 1999; Jim B Terry, CEO since January 2006, was formerly the Vice-President, Oilfield Drilling Services for Weatherford International (WFT).

The Company’s initial target customers will be oil and gas operators drilling onshore wells in geologic basins of the U.S. known to have hard rock and/or highly abrasive formations.

Management intends to initially focus its marketing and sales efforts on operators with multi-well drilling programs centered in a single U.S. basin.

Investment Risks & Considerations

Particle Drilling has a limited operating history and no revenues and is subject to risks inherent in a new business enterprise. Buying its Common Stock is a highly speculative investment and there are no assurances that the Company will be successful in achieving profitable operations, additional financing, or continue as a going concern.

The Company’s cash flows used for operations are primarily affected by its research and development progress and business development. Net cash flows used for operations during the nine months ended June 30, 2006 were $(5.2) million. Working capital since inception (June 9, 2003) has been fully funded from cash flows from financing activities.

Our biggest concern is that the Company—like down on his luck farmer, Jabez Stone, in Steven Vincent Benét’s “The Devil and Daniel Webster”—might have sold away its soul to the Devil.
The Company—in Off-Balance Sheet Arrangements—is obligated to make certain royalty payments that will limit its profitability:

• Particle Drilling has agreed to make certain royalty payments to ProDril Services (PSI). Particle Drilling is obligated to pay a royalty on a quarterly basis equal to 18.0% of its earnings before EBITDA derived from the use of the PID technology for such quarter until an aggregate of $67.5 million has been paid to PSI.
• Under a separate agreement with ProDril Services International, Ltd. (PSIL), the Company is obligated to pay PSIL a royalty on a quarterly basis equal to 2.0% of EBITDA derived from the use of the PID technology for such quarter until an aggregate of $7.5 million has been paid.
• There is an additional royalty agreement that requires Particle Drilling to pay a total of 4.0% of its quarterly gross revenue derived from the use of the PID technology to certain entities from which the Company acquired the PID technology [Curlett Family Limited Partnership, Ltd. & CCORE Technology and Licensing, Ltd.].

Harry Curlett founded ProDril as a Texas corporation in May 1992 for the purpose of developing oil and gas drill bit and served as CEO, president and board chairman.

Potential Parker Drilling investors ought to note that in late 2002, ProDril ran out of financial resources—still having not brought to market the hard-rock drilling technology

In October 2005, Curlett and three other individuals (William D. "Dan" Elsom, David A. Nall and Justin C. Nall) were indicted for conspiracy to sell unregistered securities. According to court documents filed in February 2006, Curlett and the others "induced at least 400 individuals in Wyoming and Texas to invest about $6.4 million in shares of ProDril Services stock." The shares or securities were neither registered with the U.S. Securities and Exchange Commission nor deemed exempt from such registration, the indictments stated.

Through the plea bargain process, Curlett is currently serving a four-month federal prison sentence (conspiracy to sell unregistered securities). The two other ProDril executives, Elsom, and David Nall, each pleaded guilty to one felony charge in the case and are currently under house arrest.

The price of the Common Stock of Particle Drilling might get a (short-term) boost when the Company announces a new commercial test for the PID system. Still, in our view, investing monies in Particle Drilling is no better than throwing your dollars down a sinkhole.

Editor David J Phillips does not have any financial interest in the stock of Particle Drilling Technology.