TheStreet.com Comments on Seitel

There is an interesting post on TheStreet.com today, by Jonathan Moreland, on Seitel (SELA.ob). Seitel is a holding of ours that we have mentioned several times here. It's worth a read if you have a position in Seitel, though as mentioned below, the analysis is somewhat faulty, in our opinion. We think it is worth discussing since it touches on a few key investment ideas.

The part of the article we'll take issue with is this:

"Although Seitel looks extremely pricey on a P/E basis, cash flow is a more important metric, given its tremendous depreciation and amortization costs. Seitel generated about 75 cents per share in EBITDA last year. Not bad for a $3 stock -- or even a $5 one. EBITDA per share was $1.32 in 2004, but Seitel had double the number of shares outstanding last year. I think the lower number in 2005 was worth the better balance sheet, and I expect solid growth in this metric in the coming two years."

Without getting too deep into valuation discussions, we think that although EBITDA is quite important for some companies, it is an exceedingly misleading metric in many instances, of which Seitel is one. EBITDA, in our opinion, is a good number to use for seemingly under-leveraged companies, where an investor may seek to lever up the company to extract cash (i.e. LBO investors). Seitel, though, is hardly a case of under-leverage having just emerged some bankruptcy quite recently.

In the case of Seitel and in many other instances, Free Cash Flow is the better metric to use. Free cash flow, as we define it for an equity investor, is the cash (cash is real money and all that really matters in a business quite frankly) a company generates minus any necessary capital expenditures it requires to keep the business running and minus any debt servicing the business must pay so that equity holders are not wiped out. Free cash flow determines how much money a company can in theory pay back to an equity shareholder, so it is in our opinion the only really important metric needed in this and many other instances. EBITDA, on the other hand, does not capture this free cash flow number, since it does not take into consideration cap-ex or debt obligations, which are huge in the case of Seitel. So, in our opinion, you should ignore EBITDA when analyzing Seitel (SELA).

Luckily, as we mentioned in this post, Seitel (SELA) makes it quite easy to arrive at a decent estimate of the company's free cash-flow, since it publishes a figure in its SEC filings called the cash margin, i.e. the cash generated by the company minus any cash SG&A expenses. Just subtract from the cash margin any cash capital expenditures (a signifcant portion of Seitel´s capital expenditures are not paid by Seitel, but rather by customers) and debt obligations to arrive at a free cash-flow number for the company. For a quick analysis of SELA's free cash-flow, please read this post. We think that $0.20 per share, not $0.75 per share, is the baseline you need to use when evaluating SELA.

The bottom line is that SELA.ob is not overly attractive at current prices. Nevertheless, we expect the company to report outstanding results throughout 2006, and these numbers could attract a new group of momentum stock buyers who could push Seitel's stock to higher levels.