What does the company do?

Pulse Seismic is the largest holder of 2D and 3D seismic data in western Canada with the majority of sales tied to the Alberta region. Seismic data is used to identify oil and gas reservoirs beneath the earth’s surface and improve drilling/well locations. The western Canadian sedimentary basin contains one of the world’s largest oil and gas reserves. Seismic data is obtained through the acquisition of existing libraries and “participation surveys” in which Pulse partners with oil and gas exploration companies to map seismic data in a specific area. When a participation survey is performed the oil & gas company pays for ~70% of the survey cost which allows them to have a license to the data, but Pulse remains the owner of the seismic data and would be paid for any additional licenses. A licensee can use the data as they please, but it is non-transferable and cannot be shared with other parties.  Their customers are primarily major oil and gas companies, but their top 10 customers vary from year to year. 

Sales are broken into traditional sales and transaction-based sales. Traditional sales can occur at any time and are not necessarily event based, whereas there are 3 types of instances that create transaction based sales. The first is when an asset holder creates a partnership or JV, then additional parties are required to purchase a data license, typically at a discount which is determined in the initial license agreement. The second is a merger or acquisition which requires the new company to pay a change of control fee or discontinue use of the data. The third is when property is sold and the purchaser would need to repurchase the seismic data for that area. Again, transaction based sales arise because of the non-transferable nature of the data licenses. 

Market Leader 

Pulse has shown an ability to create value through opportunistic acquisitions and selective investment in participation surveys. This opportunity came recently with the acquisition of Seitel at the beginning of 2019. This acquisition increased Pulse’s 3D library by 126% and 2D library by 84% further increasing their dominance as the #1 seismic owner in western Canada. Sales have fallen for both companies in recent years as E&P spending has declined, however if/when a rebound occurs Pulse would stand to nearly double their sales. 

Accounting obfuscation

Net income is often negative due primarily to the “amortization of the seismic data library”. The amortization amounts are based on historical revenue patterns. This expense can vary significantly from year to year due to acquired assets becoming fully amortized or participation surveys being completed. When a participation survey is performed Pulse amortizes 50% of the total cost immediately and the remaining 50% on a straight line basis over seven years. Pulse typically requires ~70% of the total cost to be funded by the customer prior to conducting the participation survey, then Pulse pays the additional ~30% of the cost. The rational for this is stated in the annual report as follows:

“The assumptions behind the 50 percent immediate amortization on delivery are as follows. The Company’s historical average and its target survey prefunding percentage is 70 percent of the cost of the seismic data shoot. Based on historical performance, the Company usually then recovers an additional 70 percent of the total cost of the survey through recurring sales of the acquired data. After seven years the data sales generally decline. Based on these numbers, the total revenue generated by a particular participation survey historically is 140 percent of cost. Accordingly, prefunding typically represents approximately 50 percent of the total revenue generated by the survey. The 50 percent initial amortization thereby matches amortization to the historical pattern of revenue generation. The remaining costs are amortized on a straight-line basis over seven years.”

As an example, in 2015 Pulse completed a 3D participation survey which generated revenue of $3.2 M and $2 M of amortization expense related to that participation survey. The total cost of $4 M to complete the survey is recorded in cash used in investing activities in the same year.  No participation surveys have been completed since 2015, but new surveys could occur in the future.

When a data library is acquired, its cost is amortized on a straight line basis over a seven year period. Also, over these seven year periods, the assets are tested for impairments based on management’s judgment of the specific assets ability to generate cash flow. As you can see in the table below the amortization expense declined from $4.6 M in Q3 2017 to $1.95 M in Q4 2017 due to the 2010 library purchased from Divestco becoming fully amortized. In 2010, seismic data was purchased for $75.5 M from Divestco and sales from this library have accumulated to $97.1 M through December 31, 2018. 

In order to show results without this obfuscation, management reports “Cash EBITDA” which they believe is a better proxy for current operating results. “Cash EBITDA” is defined as earnings before interest, taxes, depreciation and amortization less participation survey revenue, plus non-cash and non-recurring expenses. 

Cash flow and balance sheet

Pulse had no debt from the beginning of 2016 to the end of 2018, but their acquisition of Seitel’s seismic data library for $62 M (including $3 M of liabilities and $5 M of maximum earn-outs) was paid for using $21 M of cash on hand and $33 M of debt. Since the acquisition $4 M of debt and the maximum $5 million of earn-out have been repaid. As of Q3 2019, debt is made up of a $14.2 M three year term loan with $1.5 M of annual principal payments, $10 M of subordinated debt with a five year term and no required annual payments, and $7.9 M outstanding on a $30 M revolver ($22.1 M undrawn). Below is the list of contractual obligations for Pulse in the period ending September 30, 2019.

Below is Pulse’s quarterly cash flow statement from Q4 2016 to Q3 2019. Cash flow is lumpy due to large sales or lack of sales in a given quarter. The average quarterly free cash flow over this period was $3.8 M which is influenced by the $32.5 M recorded in Q3 2017 and somewhat offset by the $7.5 M cash tax payment made in Q1 2018. Cash flow prior to Q1 2019 was generated with half of the seismic library. The Steitel acquisition in Q1 2019 doubled the size of Pulse’s seismic library. 

Pulse closed on a new bank credit facility when they completed the Seitel acquisition at the beginning of 2019. Below are the available liquidity, debt service requirements for the next year, and longer term debt schedule. 

Management has stated that they are prioritizing debt repayment from cash flow, so annual repayment is likely to exceed maturities until the balance sheet is more flexible. Additionally, the term loan and revolver contain a provision that allows for the extension of its maturity by one year at the beginning of each year, based on the approval of the lender. For example, the term loan and revolver are maturing in 2022, but at the end of 2020 this maturity could be extended to 2023. 

The new debt facility, made up of the term loan and revolver, has lessened the burden of their leverage covenant. Below are their covenants and ratios as of September 30, 2019. 

Covenants use a rolling twelve month adjusted EBITDA in their formula which is defined as “earnings or loss before interest, income taxes, depreciation and amortization, plus extraordinary losses, non-cash losses and expense charges, and any other unusual or non-recurring cash charges, expenses or losses consented to by the lenders, less participation survey revenue, extraordinary gains and non-cash gains and income”. Also, the maximum senior debt to adjusted EBITDA covenant numerator excludes $10 million of subordinated debt and only includes $22.1 million of senior debt. The senior debt to adjusted EBITDA covenant starts at 4.25x and steps down to 3.00x on the quarter ending in December 2020 and remains constant at that level. 

During periods in which senior debt to EBITDA is greater than 2x over 2 consecutive quarters, a minimum fixed charge coverage ratio covenant of 2x is used, but when senior debt to EBITDA is below 2x for 2 consecutive quarters, then a minimum interest coverage covenant of 1.2x is used. Fixed charge coverage is defined as “adjusted EBITDA less unfunded capital expenditures, cash taxes and permitted cash distributions divided by the sum of scheduled principal repayments and interest expense paid in cash”. 

The table below shows the historical adjusted EBITDA and Pro Forma covenant ratios which use actual historical adjusted EBITDA and current debt.  

Why is there value in this company?

Despite the amortization of data library assets being completed within seven years, and the invention of 3D seismic data, the older 2D assets continue to generate sales. 

As further evidence of asset value, data acquired through participation surveys from 2000-2018 cost Pulse $67 M while resale of the data has accumulated $167 M of sales. Also, the before mentioned $75.5 M library purchase in 2010 which has generated $97.1 M of revenue. 

The key to Pulse’s success has come in part from the timing of large data library acquisitions, selective investment in participation surveys and low cost structure which allows for synergies. Data library acquisitions are typically funded by debt and purchased during cyclical downturns when asset prices are attractive to buyers. After an acquisition is made, they prioritize debt repayment. One of these transactions occurred in Q1 2019, which should add further value for shareholders. Participation surveys have also added value, but none have been completed since 2015. From 2000-2018 participation surveys have returned 251% of Pulse’s net cost to acquire the data. When E&P spending rebounds, it would be expected that participation surveys may also be conducted again. 

In general, as E&P companies have shifted their focus to higher profitability and their ability to get more out of data analysis has expanded, the importance of seismic data has increased. However, since Pulse’s seismic library is primarily in western Canada, the viability and interest in exploration in that area is very important. 

Based on the Fraser Institute Global Petroleum Survey, industry participants most notably cited concerns about Canada’s policy environment and regulatory process which have led to a high cost of regulatory compliance. Investment in the Canadian energy sector as a % of total capital investment has declined from 28% in 2014 to 14% in 2018. The oil and gas sector makes up 30% of Alberta’s GDP and 23% of Saskatchewan’s, making this sector very important to those provincial economies. Pressure on the constituents in these areas may push government officials to loosen regulation or change policies in order to aid this industry in the future. 

Part of the issue for Canadian oil and gas is due to lack of economical “transportation” of their product to market. The government stepped in at the end of 2018 and announced production limits to support prices since the amount of oil produced in earlier months exceeded pipeline and rail capacity. This supply glut could be alleviated with the construction of additional pipelines. Several pipeline projects have/are being attempted in the area but have been fraught with legal trouble. The most promising project is the Trans Mountain oil pipeline which has been taken over by the Canadian government from Kinder Morgan in order to help ensure its completion. This pipeline would significantly improve capacity and pricing competitiveness, but it is not expected to be completed until the second half of 2022. 

Also, LNG export businesses are being developing in western Canada. Thirteen long term export permits have been issued, but none are currently in operation. One notable facility, primarily owned by Shell, is being built by Fluor in Kitmat, British Columbia which is expected to be in service in 2023 and export to Asian markets. The expansion of this “new” industry is expected to lead to increased upstream production levels and therefore exploration. 

While the current Canadian oil and gas environment is less favorable, changes can be made by policy makers to improve Canadian economics and pipelines are being built to help relieve the current supply glut. While waiting for the market to improve and the full value of this company to be realized, Pulse continues to generate positive free cash flow and repay debt. 

Operational cash costs are very low at $7.2 M YTD through the end of Q3 2019 and they have essentially no CAPEX. These low cash costs are due to the absence of a need for equipment or a significant number of staff. Operational costs arise from executive pay, marketing, and maintenance of the data library including cyber security protection. Cash costs are low, and progress is being made on debt repayment allowing for investors to be patient with this investment.

Since the beginning of 2011 the company’s total payout has been $0.52 of dividends and ~$0.83 of share repurchase or a total of ~$1.35 per share. After paying down debt, I believe that returning cash to shareholders could continue. 

Valuation

Over the past 10 years free cash flow has averaged $28 million, but have only produced $9.5 million of free cash flow over the past twelve months. The recent acquisition has no led to higher cash flow in the near term in part due to higher interest expense ($2 M LTM). However, over the past year Pulse has significantly increased their data library which should allow for higher free cash flow going forward. 

I use a range free cash flow in the range of $17-20 million in the near term before growing $17 million at 2% essentially into perpetuity and discount it back at 10%. This leads to an intrinsic value per share of ~$3.75 relative to the current $2.09 price. Even at $10 million of free cash flow with 2% growth into perpetuity and a 10% discount rate the IV per share is ~$2.31.