Description

Overview:

Seitel represents an interesting special situation opportunity to invest in the equity of a bankrupt company. Berkshire Hathaway is currently attempting to acquire 100% of the company through the bankruptcy process. As I will discuss below I think there may be substantially more value than initially ascribed by Berkshire and as a result could result in a greater than 100% gain in the current equity of Seitel.

Background:

Seitel was formed in 1982 and offers a library of onshore and offshore seismic data for license to oil and gas companies. Seitel’s library includes both 2D and 3D data covering extensive parts of the Gulf of Mexico shelf and certain deep water areas in the central Gulf of Mexico and offshore Texas. Essentially, oil and gas companies outsource their seismic data operation to Seitel in order to help them find and locate oil and gas fields.

So how did Seitel end up in this situation? Early in 2002 Seitel got into some trouble relating to its accounting. In addition, Seitel defaulted on certain senior note covenants. As a result, the company and its bondholders engaged in a long period of negotiations over the terms of its financial restructuring. In May of 2003 negotiations stalled due to various disagreements between the creditors and Seitel. During this same time period a large amount of creditors sold their bonds to Ranch Capital who subsequentially sold the bonds to Berkshire Hathaway. As a result of this large transfer of ownership negotiations broke down.

On June 6, 2003 bondholders, who had not sold to Berkshire, filed involuntary Chapter 11 petitions against Seitel. It’s not completely clear but Berkshire eventually acquired close to 100% of the bonds of Seitel at prices ranging from 71 cents to par.

Bankruptcy Proposals:

Berkshire has filed a plan of reorganization in bankruptcy court that gives Berkshire 100% of the pro forma equity in the reorganized company. However, due to a valuation dispute the old Seitel equity holders do not agree with Berkshire. They argue that Seitel is worth so much that not only can Berkshire get 100% back on its debt and accrued interest but it can also leave substantial value to the current Seitel equity holders.

Specifically, Berkshire’s plan provides for Berkshire to retain a 100% pro forma ownership in Seitel. In addition, it would offer a $10 MM distribution to current equity holders which turns out to be about $.40 per share ($10 MM / 25.38 MM shares = $.394 or ~$.40 per share).

The current equity holders are currently fighting to reject Berkshire’s plan and have presented their own plan. Their plan is to reinstate the current debt and give the new equity to the old equity holders. As an additional safeguard they have offered to fund some type of extra financing like a rights offering whereby the company can be assured of handling its current capital structure.

In the disclosure statement submitted by the debt holders there are projected financials. In summary, they show EBITDA – CapEx of: $45 MM, $60 MM, $63 MM, $67 MM and $71 MM in 2003, 2004, 2005, 2006 and 2007 respectively. As a result of this expected financial strength, Seitel’s equity holders feel there is more than adequate value for them.

Valuation:

There are about 25.38 MM shares outstanding currently at a current stock price of $1.12 for a current market value of $28.4 MM. There are currently about $280 MM of debt claims on the company and about $41 MM of cash resulting in a current enterprise value of $268 MM.

So how can we make money from this information? Given the above discussed financial projections, if we apply a more than conservative 5x multiple on 2004 EBITDA – CapEx this would result in a current equity value per share of $2.40 per share or 114% gain from current levels. If we just change the multiple slightly to 6x we get a $4.77 per share or 326% gain from current levels. So we have an opportunity get more than a 100% gain while limiting our downside to $.40 per share, the amount offered under the Berkshire plan.

As a result of this valuation dispute, Berkshire recently offered an amended plan of reorganization to include an auction process to guarantee the maximum recoveries for creditors and shareholders. Berkshire is basically saying that rather than having a theoretical valuation debate let’s just see if there is someone willing to offer more than we are, which is $.40 per share plus the $280 MM for the debt. The parameters of the auction have yet to be finalized. The equity holders hope to implement their plan or something similar to it in the auction process.

Catalyst

Approval of equity holders plan which could result in greater than 100% gain in equity value.