Pulse Data Could Join The Seismic Rally

If you have followed this blog for some time, you know that I´ve been quite bullish on the seismic sector since late last year. As my two seismic picks, PGS and SELA.ob, have continued to soar  based on  industry consolidation, greater than expected cash-flow growth at each company, and still relatively reasonable valuations, I´ve been searching diligently for another investment in the seismic sector. Well after alot of digging around, I think I have found a decent "gamble" in Pulse Data (Toronto: PSD.TO or PLSDF.PK) at C$3.10.

As the rest of this post will explain, Pulse Data appears to have little downside risk at current prices and potentially offers 50% upside price appreciation  in 2006, should the company follow in the footsteps of competitors SELA.ob and PGS by reporting outstanding financial results and guidance in the coming months. Importantly, Pulse also pays a yearly dividend of $0.15 per share providing investors with the safety of a nearly 5% dividend yield on top of any share price increases.

Background

First off, it is important to note that Pulse Data is a Canadian company and as such all the numbers in this post reflect the Canadian dollar. Also, the company´s stock trades on the Toronto Stock Exchange under the symbol: PSD.to. Investors in the US can also buy the shares on the pink sheets under the symbol: PLSDF.PK. Remember to use a limit if you intend to buy this stock via the Pink Sheets!

Now for some background financial data:
Shares Outstanding: 47 million
Current Market Price (Toronto): 3.10
Market Value: $145 million
Cash: $12 million
Debt: $20 million
Enterprise Value (Value of a company minus cash plus debt): $154 million

So what does Pulse Data do? Well, the company is almost a complete smaller clone of Seitel (SELA.ob), with the vast majority of its revenues generated by the licensing of 2D and 3D seismic data. The difference between Seitel and Pulse is mainly related to the size of their seismic databases (Seitel´s is much larger) and the geographic positioning of the companies (Pulse sells in Western Canada, while Seitel is focused primarily in the US). If you are unfamiliar with the seismic business, I highly recommend that you read over Pulse´s 2005 Annual Report, which can be found at the company´s website at this address: http://www.pulsedatainc.com/ir-reports.asp

In all, Pulse Data Seismic's library currently consists of approximately 240,000 net kilometres of 2D data and more than 9,300 net square kilometres of 3D data.

In addition, to the seismic data business, Pulse data also owns two other related businesses. One is Terrapoint, a LiDAR (Light Detection And Ranging) data provider in the world. LiDAR data is used to produce survey-quality 3D digital elevation models. The other is Trango Technologies, which provides seismic data management products and services to the North American oil and gas industry. Trango provides the technology that allows clients to better exploit their seismic, well, geological and related data.

Is Pulse Data´s Stock Undervalued?

My main method for computing a potential fair market value for Pulse Data was to do several comparisons with Seitel, the leading pure play seismic data company. Under two such scenarios, Pulse Data appears to be significantly undervalued as compared to Seitel.

Method #1 (Bearish): Book Value of Databases: Implies About 10% Downside
It is exceedingly difficult, if not impossible, for an outside investor to ascertain the "true" value of Pulse´s seismic data library, to help in estimating potential downside in the stock. However, I figured somewhat "foolishly" that a comparison of database costs and market values should give some indication of the value in Pulse´s stock.

This method is bolstered by the fact that Seitel (SELA.ob) management has mentioned on various occasions, that 2D seismic data is still in very high demand and despite the fact that the company has already completely amortized vast portions of it´s 2D seismic database. This implies that the value of seismic databases does not actually decrease with time, as the amortization and book value of these databases implies, a situation somewhat analogous to the accounting treatment of real estate holdings.

So taking this view into consideration, I figured that one can look at the total cost of both Pulse´s and Seitel´s data libraries and then compare current stock market values to get a sense of any potential value discrepencies. From this perspective, I estimated that Seitel is currently trading at an 85% value to its total seismic database costs ($990 million), while Pulse is trading at about 90% of its total seismic database costs ($170 million), implying that Pulse is about 10% overvalued as compared to Seitel. This of course is a very simplistic analysis, since it fails to take into consideration various obvious aspects of the seismic data business, but I think it  does gives some indication of the comparative value here between SELA and Pulse, at least from a bearish viewpoint as it pertains to Pulse.

Method #2: Enterprise Value to Cash Data License Sales Implies 90% Upside for Pulse
Another way to value a seismic data company is to price it off of sales. The only truly important metric for seismic data companies sales is cash data library license sales from existing databases.  Utilizing this valuation method, it appears as if Seitel is currently trading at an 8.5X 2005 Cash Data Sales ($97.5 million) vs. 4.4X for Pulse Data (2005 Sales of $35 million). Pulse would need to trade at  about $6 to match the valuation of Seitel.

Method #3: Enterprise Value to Seismic Cash Flow Implies 75% Upside for Pulse
Perhaps the best way to value a seismic data company is to price it off of seismic cash flow, which equals cash seismic data minus cash expenditures (i.e. SG&A etc.).  Utilizing this valuation method, it appears as if Seitel is currently trading at an 11.7X 2005 Seismic Cash Flow ($72 million) vs. 6.7X for the similar data at Pulse Data (2005 Cash Flow of $23 million). Pulse would need to trade at  about $5.50 to match the valuation of Seitel.

In sum, by using various valuation scenarios, it appears that Pulse Data is on average 50% undervalued as compared to its peer Seitel.

Why is Pulse Priced Low?

Perhaps the easiest explanation for the seeming undervaluation of Pulse shares is that this a micro-cap stock trading on the Toronto Exchange. As such the stock has limited visibility with investors and is probably virtually unknown to many small cap O&G investors (i.e. I just found it about two weeks ago).

Another potential reason for the undervaluation of Pulse is that it is conceivable that its seismic database has less growth potential and value than that of Seitel´s. I cannot speak to this negative view of the company, since I´m not an oil insider, nor am I even close to an expert when it comes to seismic databases. My only answer to this concern is that Pulse´s financial results and divident payouts imply that the company continues to generate significant cash-flow from its databases and that therefore its databases are clearly considered quite valuable by oil companies in Canada. I expect that Pulse will report stellar earnings throughout 2006, further highlighting the value of its seismic databases.

A final reason for the undervaluation of Pulse may be related to the fact that the company is not a pure play seismic data company. As noted in the background section, aside from the seismic business, Pulse also owns Terrapoint, a LIDAR data company (for those who are interested, Pulse has a good background on LIDAR in its annual report), and  Trango, a  oil industry-focused software company. Without getting too deep into  these businesses, it is important to note that both businesses have been underperforming in recent years. In particular, Terrapoint has been losing money, decreasing cash-flow for Pulse as a whole. In sum, the losses at Terrapoint have hidden the stellar results at Pulse Seismic, and investors have therefore not assigned a fair value to Pulse´s stock.

However, management at Pulse has indicated that they have successfully restructured the Terrapoint business with the aim of leading it to profitability this year. At the same time, Pulse is seeking to sell its Trango subsidiary because it does not have the neccessary resources to expand this business. I expect that as losses at Terrapoint  are minimized and the company is successful in selling Trango, investors will get a clearer picture of the  substantial cash-flow  generated by Pulse´s seismic business and a higher valuation will be accorded to  Pulse´s shares.

What are the Risks in Investing in Pulse?

The major risk you face when investing in Pulse is that you take on "oil price" risk. That means that if oil prices drop significantly, demand for seismic data will also fall off dramatically, and Pulse´s cash-flow and share price will decline. However, the recent consolidation in the seismic industry (i.e. SLB´s purchase of Western), as well as the excellent financial results and forecasts from SELA and PGS, imply that there is little business risk for the seismic industry out to 2007. As such, I think that the "oil price" risk is substantially mitigated for Pulse investors. Other than oil prices, I do not see any other major business risks for Pulse in the year ahead.

In sum, I believe that as Pulse reports significant top and bottom-line growth in 2006 because of increasing seismic data sales and decreasing losses at its Terrapoint subsidiary, Pulse´s stock can appreciate by up to 50% from current levels, thereby lessening the valuation gap between it other peers, such as Seitel.

Please Note: We hold a position in Pulse Data. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.