Earlier this year, we initiated a short position in Core Laboratories, a $5 billion market capitalization oil services company, and we added to our position during the quarter. We suspect investors in Core Labs believe they own a “safe,” high quality business that is experiencing temporary cyclical pressures, allowing them to participate in meaningful upside when oil prices eventually recover. Remarkably, this optimism has kept the stock at roughly the same price as October 2014 when oil prices were almost double current levels and Core Labs’ 2016 earnings were expected to be four times greater than current 2016 forecasts. Although you wouldn’t know it by looking at the stock price, times are tough at Core Labs – so tough in fact, the company recently completed a surprise $200 million equity offering to ensure that it would not trip any debt covenants. At 60x EBIT and 80x earnings, investors are paying a steep price in anticipation of catching the rebound. We believe the pressures facing Core Labs are not going away anytime soon and investors are highly likely to be disappointed in the coming quarters.

Core Labs’ largest segment and crown jewel is its reservoir description business. The company takes rock and fluid samples and analyzes them for customers to quantify the level of hydrocarbons, measure how quickly those hydrocarbons can flow and determine the mix of oil, gas and water in the reservoir. The business has historically grown at reasonable rates with solid EBITDA margins. The next largest segment is production enhancement, a business largely driven by the sale of perforating guns and charges that are used to blast through well casings. The segment is highly dependent on North American shale activity and saw strong growth until 2015. This business

 has now fallen by more than 90% from its 2014 peak. The final segment is a small business that mainly helps customers study new prospects and is currently experiencing limited profitability due to its heavily discretionary nature.

We believe the company’s reservoir description business is facing multi-year pressures that investors aren’t appreciating. The business actually began to see slowing revenue growth in 2013 and early 2014 with EBITDA margins declining from their peak levels of 2012 even before oil prices started declining in late 2014. We believe Core Labs is facing increased competition from larger oil services peers, the in-sourcing of work by major customers and a general slowdown in ongoing usage of Core Labs’ services by customers who are looking to cut ongoing operating costs given the commodity price environment.

The production enhancement business is facing pressures from a decline in onshore shale activity and increasing competitive activity. Many oil services companies offer competing products, and larger players like Schlumberger and Halliburton include these products as part of broader completion work, offering them advantages over Core Labs. Our research indicates the market is very challenging with products being commoditized and sold at roughly cash breakeven.