Description
Pulse Data (TSE:PSD OTC:PLSDF) is a small, highly profitable (8 P/E and 5 P/FCF) seismic data library company. It has conservative financial management (debt = 20% of capital), all of its data covers highly desirable areas of Western Canada, and Pulse has recently entered a complementary terrain mapping business that has tremendous growth potential. Good news in several areas over the next year should reassure investors about PSD’s value and prospects.
PSD BUSINESS MODEL
Previous VIC write-ups on Seitel (posted as SEIEQ, now trading as SELA), Veritas DGC (VTS) and Petroleum Geo-Services (posted as PGEJF, now trading as PGEOY) provide a good overview of the seismic industry. Pulse (like Seitel) concentrates on acquisition and management of a data library while subcontracting the capital intensive and lower margin work of data collection (VTS, GGY, and PGEOY have suffered due to overcapacity in these functions). The concentration on data library minimizes PSD’s overhead and insulates the company from the severity of weak markets.
PSD MAJOR SOURCES OF REVENUE:
1) Data library sales: Customers (E&P companies) purchase non-exclusive non-transferable right to access a particular set of data. The cost of maintaining the data library is extremely low and over time PSD can resell the same data to multiple buyers.
2) Multi-client survey sales: PSD funds new seismic surveys in conjunction with one or more E&P companies. The E&P partners have exclusive use of the data for 6 months after which Pulse can resell the data. Multi-client surveys are a crucial way for seismic companies like PSD to increase their data library and future potential revenues, but in the initial period they consume cash (PSD’s portion of the capital expenditure) even as the company reports positive revenue and income. It’s important to understand the cash flows associated with this business so I have included an accounting discussion at the end of this report (Jump ahead if you can’t contain your excitement!).
3) LiDAR sales: In May 2004 PSD acquired Mosaic Mapping, a leading terrain mapping business. Currently almost all Mosaic revenues are contract sales where clients pay the entire cost of a survey plus a profit margin. This market is experiencing rapid organic growth and PSD will expand profitability by building a library of data for repeated resale (similar to the seismic data business model).
PSD MINOR SOURCES OF REVENUE:
1) Trango Technologies. This division of Pulse sells software used in accessing and analyzing seismic data. Some E&P companies keep proprietary seismic data libraries that are not marketed for sale. Trango has recently worked on other applications for the same customer base, including new software for management of production well data.
2) Seismic Program management. Major companies hire Pulse on a fee basis to manage proprietary seismic surveys that will not be marketed for sale.
THE VALUE OF SEISMIC DATA:
The library itself has proven long-term value. For example, 85% of PSD’s 2D seismic data sales this year have come from data shot before 1990. Several factors support the value of PSD’s database:
1) It covers areas of Western Canada that have remained highly desirable for exploration. These are close to markets, have good infrastructure, and a friendly government. The region’s rocks have multiple potentially oil/gas bearing strata. Over time the same areas are re-examined in light of new commodity pricing, new extraction technologies, and increasing regional experience in those rock strata.
2) Exploration rights on Canadian crown lands expire after only 5 years if there has been no significant development. This ensures a high level of lease turnover and new potential buyers for existing data. In comparison US Gulf of Mexico and onshore BLM leases are good for 10 years.
3) Many independent E&P companies are active in Western Canada so there are many potential customers for seismic data. Good infrastructure and availability of capital make it relatively easy for small companies to develop, prosper, and buy seismic data.
4) There’s an active market for sales of productive Canadian properties. The seismic data license is non-transferable so new owners of a field are very likely to purchase the applicable seismic data survey.
5) Canadian exploration is continually moving into areas of greater environmental and cultural vulnerability. Seismic surveys need approval from environmental regulators, native peoples, and private landowners. Regulators consider both the initial impact of the survey and also the cumulative impact of all activity over time. In practice, this means that most areas are surveyed only once. Pulse’s database therefore has a high degree of exclusivity.
THE POTENTIAL VALUE OF LIDAR DATA:
Terrain surveys are approximately a $900mm business. New technologies such as Lidar (Light Detection And Ranging) are capturing a growing share of the market and expanding the market to new applications that would previously have been uneconomical. PSD's Mosaic division uses airborne laser surveying equipment to capture and analyze detailed data about terrain, buildings and vegetation. Most of the current revenues come from natural resources companies. Energy companies want to match surface maps with underground seismic data (perfectly complementary to PSD’s existing business) and also plan access, well sites, and pipelines. There is also a growing LiDAR market in civil engineering and environmental management. The Mosaic Mapping website has interesting examples of how clients are using its information.
The significant differences between the Mosaic business and PSD’s seismic business are:
1) The terrain business owns its surveying equipment. Mosaic conducts the surveys whereas the seismic surveys are fully subcontracted. Mosaic earns a gross margin of about 50% while PSD’s seismic gross margin is over 80%.
2) Clients are normally charged 100% of the terrain survey costs and PSD can often retain rights to resell the data. In contrast PSD must fund part of the capital cost of new multi-client seismic surveys.
3) Mosaic is a leading LiDAR company in North America. The addressable market is large and growing. In contrast, PSD’s seismic business is concentrated in a single region, a highly desirable region, but a single region.
Investors have not given PSD credit for the high potential of the terrain business, but in 5 years Mosaic could be worth more than PSD’s current market value.
PSD FINANCIAL RESULTS
In C$ 2002A 2003A 2004E 2005E
Revenues:
- Multi-client 13 13 22 25
- Other 19 23 29 39
EBITDA 24 29 36 46
Capex 15 22 24 30
PTFCF 9 7 12 16
Earnings 6 6 7 9
Market Cap 48 61 75 75
Net Debt 17 12 12 4
EV 65 73 87 79
P/E Ratio 8 10 10 8
EV/FCF 11 12 7 5
P/E and EV/FCF are the most useful ratios for comparing seismic companies. FCF should equal EBITDA minus capex (because multi-client capex is directly linked to current period revenues). Note that I have used pre-tax FCF because it is useful for comparison against other companies. Pulse management reports define FCF as after-tax.
I expect PSD to generate an improvement of $2.5mm in FCF from LiDAR, moving from a drain in 2004 to a surplus in 2005. PSD is also highly likely to earn improved cash flow as this year’s multi-client programs exit their exclusivity period. PSD should also benefit from the very strong outlook for exploration and drilling in 2005.
COMPS
SELA
2004 P/E = loss
2005 P/E = loss
2004 EV/FCF = 13
2005 EV/FCF = 10
VTS
2004 P/E = 20
2005 P/E = 17
2004 EV/FCF = 8
2005 EV/FCF = 6
Pulse compares favorably against Seitel in nearly every way. Seitel bears heavy high-interest debt and, as mentioned in several VIC threads, Seitel’s data library is relatively low quality. In Canada, Seitel has a significantly larger library than PSD (about 3x as much kilometer coverage), but most of Seitel’s data was originally shot by Amoco and targeted a single productive zone. If the results were favorable then Amoco likely drained that field. In contrast Pulse’s data was designed to capture a broader range of data with detail on multiple potentially productive strata. Pulse believes that its smaller database earns higher revenues and profits than Seitel’s Western Canada business.
Veritas has the potential to deliver strong results because it has a lot of data for GOM leases that will be expiring in the next few years. Veritas performs a lot of its own surveys: it owns US$127mm of PP&E, employs over 3000 people, and earns a consolidated gross margin of 50% (before D&A). In comparison PSD owns only C$15mm of PP&E (mostly for the LiDAR business, seismic PP&E is less than C$1mm), employs only 24 people in its seismic business, and earns a gross margin over 80%. VTS is probably still a good investment at $20, but I believe that PSD has more appreciation potential and less risk if industry revenues turn down.
CATALYSTS AND 2005 OUTLOOK:
I believe that good news in these areas should lead to increased PSD shareholder value in 2005:
Drilling: Demand for seismic data correlates well with oil and gas drilling. Approximately 22000 wells will spud in 2004 and projections are for up to 25000 wells in 2005. A majority of new Canadian wells are drilling for natural gas. The combination of declining US natural gas supply and increasing demand create a favorable outlook for natural gas prices for several years. In addition, rising Canadian natural gas demand should reduce the price differential between the prices paid to Canadian producers vs. the prices for users at the end of pipelines in the US. A couple of factors are behind this demand: 1) gas used in oil sands projects, 2) replacement of old dirty coal power plants with new natural gas plants. Even a substantial decline from the current spot price would still leave attractive margins for new wells.
3D sales: The high cost and limited history of 3D data sales makes investors cautious about the value of PSD’s database. Most of PSD’s 3D data is less than 5 years old, but the volume of resales is increasing. Pulse says over 30% of 2004 TD sales are 3D data; management is very encouraged about sales interest and increasingly confident in the value of this data. Management also says 3D programs shot over the past year have had very strong sales interest as their initial exclusivity period ends.
Mosaic: Investors treated this acquisition with skepticism. In the first few months Mosaic has been a drain on management and cash flow. However, conversations with management suggest that Pulse is becoming increasingly enthusiastic about this acquisition and it could contribute $2mm of free cash flow in 2005. That would be a fantastic initial return on this year’s $9.7mm investment.
Trust Conversion: PSD’s low fixed costs and high free cash flow generation make it an excellent candidate for conversion into a high yield income trust. Income trusts generally avoid corporate level income tax and trade at higher valuations than ordinary corporations. PSD has openly discussed this with shareholders and received conversion presentations from investment bankers. Management believes that PSD will eventually convert into a trust. However, management feels the company’s current small size and wide variations in quarterly revenue would become a burden in the trust format. So I don’t expect any short-term conversion news, but in the long-term conversion will help shareholders realize the fair value of PSD’s cash flow and asset value.
RISKS:
I think the current price of PSD shares provides a large margin of safety in the event of disappointments, but these are the areas of potential problems:
1) Energy price collapse. Any nat gas price over US$5 is extremely favorable for producers and they will expand as rapidly as possible. A price below US$4 per mcf would start having a significant adverse impact on drilling and exploration.
2) Data Acquisition. PSD is always ready to buy the right set of data at the right price. The market might react coolly to the uncertain impact of an acquisition although it might be accompanied by positive news about trust conversion
3) Uneven revenues. PSD’s quarterly results can be quite unpredictable. Completion of surveys can be affected by weather conditions. The choice to participate in a single multi-client program can have a large impact on short-term profits and cash flow.
ADDITIONAL INFORMATION:
Websites:
http://www.pulsedatainc.com/
http://www.trangotech.com/
http://www.mosaicmapping.com/
Investor Relations:
CFO Doug Cutts 1-877-469-5559
Comps:
VTS: http://www.veritasdgc.com/bins/index.asp
SELA: http://www.seitel-inc.com/
Olympic Seismic (Seitel in Canada): http://www.olysei.com/index2.htm
CGG: http://www.cgg.com/
BONUS COVERAGE: ACCOUNTING FOR MULTI-CLIENT SEISMIC SURVEYS
A seismic data library can generate wonderful low-risk low-cost long-term returns, but the unusual accounting can lead to exaggerated enthusiasm for the business. Here’s an example of the entries associated with a new $10mm data set:
$8mm Client investment – Pulse looks for client commitments of at least 75% of the program cost - the higher the better. PSD has no obligation to participate in any surveys and declines a majority of the programs it is offered.
$2mm Pulse investment – PSD normally invests where it expects to recover 250% of its cash commitment from data sales within 12 months (after the exclusivity period ends).
$8mm Revenues
$4mm Initial amortization (approximately 40% of program cost)
$4mm Pretax income
$1.5mm Income tax (at 40%)
$2.5mm Net income
$6mm investment in multi-client data ($2mm commitment + $4mm recognized as current income) – PSD normally invests where it expects to recover 250% of the balance sheet commitment within 11 years.
Danger obviously results from the fact that the current period income is completely offset by the balance sheet investment. If a seismic company commits too aggressively to new programs then it can consume so much cash that the survival of the company is endangered. If a seismic company commits to new programs at the same time that it must bear high fixed costs, interest expense, or dividend obligations then the survival of the company is endangered. I believe that PSD has been managed very conservatively and the company has consistently generated genuine free cash flow after capital commitments.
Catalyst
1) continued strong exploration market in 2005
2) increasing investor confidence in value of 3D data library
3) increasing confidence in the value of the terrain mapping business underlined by strong cash flow generation in 2005
4) conversion into a high yield income trust