Description

To understand Seitel’s business model and the compelling current valuation, its helpful to think about the business model of major Hollywood motion picture studios.

Based in Houston, Seitel is a leading provider of seismic data and related services to the petroleum industry. The company owns and licenses what is the largest nonproprietary seismic data library in North America.

Like Hollywood Studios who embark on a new movie, Seitel embarks on “data surveys”. Like movies, these data surveys are expensive. Unlike Hollywood, Seitel does not embark on a “shoot” until atleast 65-75% of the cost of the survey is covered by entities with an interest in the data. Typically there is more than one entity paying for the shoot. Seitel retails all intellectual property rights to the shoot while giving the data to the participants for their internal use only. Imagine a movie studio that got 75% of its production costs back even before they began shooting the movie.

Further, the company has a 100% outsourced business model. They do not own any of the expensive infrastructure required to do a data survey. When they have a committed project, they bring in their “contract crews” to do the survey. The good news is that there is no utilization issue with “infrastructure” as there is none. This year they’ll generate $200+ Million in revenue with about 125 employees. So this is a movie studio with no “expensive studio infrastructure” that get 2/3 of its production cost paid in advance.

For the oil companies, the prospect of dealing with Seitel is very compelling. The surveys usually cost a given entity about 1/3 to 1/5 of what they might if they did it themselves. Plus Seitel does this for a living and its staff scientists/geophysicists add significant value add to the data survey.

Historically seismic surveys were 2D, but recently 3D and 3D/4-C surveys have been developed and are being done because they provide more relevant data about deposits in a given area. Seitel has over 1.1 million linear miles of 2D and over 19,200 miles of 3D seismic data in its libraries. 2D data is not obsolete. 3D data is better, but much more expensive. Generally users will buy 2D data and then determine if a 3D or 3D/4-C survey is warranted.

In addition to selling data, the company participates directly in oil and gas project as a co-owner. It brings its seismic expertise to the party and for it gets an equity participation in over 100 oil and gas companies. Average ownership is 31% and of the 325 wells it has participated in, 224 were commercially productive for a 69% success rate. They filed a registration in Dec. 1999 to spin off DDD Energy (the oil exploration subsidiary), but never was able to do the IPO due to market conditions.

Seitel stock is cheap relative to its intrinsic value:

25.7 Million Shares outstanding
Market Cap: $321.76 Million
Price: $12.52/share

Seitel has a book value of $11.52 which I believe is understated as it values its library at just $345 Million.

Seitel has been a consistent performer. Revenues have grown from $28 Million in 1991 to $200 Million expected this year. It has been profitable since 1985 and except for a drop in earnings in 1999, revenues and profits have always exceeded the previous year. They have a solid business model with the company building more and more value through its libraries.

Taking a very long term view, the company becomes more and more valuable as petroleum reserves start depleting in the next decade or two.

Seitel has three distinct revenue streams and each needs to be analyzed to get a good handle on the company’s intrinsic value. These are:

1. New Seismic Surveys
2. Seismic Library Sales
3. Oil & Natural Gas Properties

The Estimated Revenue Breakdown on these is (in ‘000)

Q1-Q32001 2000 1999 1998

New Seismic Surveys $49,077 $42,000 $48,361 $83,782
Seismic Library Sales $73,729 $97,376 $61,310 $45,081
Oil & Natural Gas Prop. $17,969 $24,435 $19,036 $18,994

TOTAL $140,775 $163,811 $128,707 $144,857

“Loss” on New Surveys ($21,034) ($28,105)($79,833) ($35,385
Non-Cash Sales ($39,410) ~($10,000)~($10,000) ~($15,000)

The company has explicitly stated that their objective is to “milk” the seismic library as much as possible. There is a marked change from 1998 and earlier. Beginning in 1999, the company began to focus on library sales vs. new surveys. Library sales grew 36% between 1998 and 1999 and another 59% from 1999 to 2000! New seismic surveys dropped over 50% between 1998 and 2000. Thus there is dramatic growth taking place in library sales – which is high gross margin and highly profitable.

Non-cash sales are high in 2001. They represent a sale of existing data in exchange for new library data from the buyer.

It looks like Library Sales may top $100m this year and grow 20+% annually thereafter. If one looks at the $100M revenue that the $345M library is generating, the rate of return even after pro-rata SG&A is very healthy. For example, in 2000, the $97.3M in library sales cost the company under $30M (incl. pro-rate SG&A, corp. overhead, interest and cost of sales). In other words the company generated $67M in free cash flow from 2000 library sales.

If the library is worth over $700M, then the depreciation of the library is real economic terms is zero. The cash flow dictates that the libraries are significantly undervalued on the balance sheet.

Looking at the entire seismic division with the year 2000 as a reference, the FCF for the seismic division (with pro-rate corp. overhead) is $97.7M less the $70.1M for new data acquisition or $27.7 Million. With the 20+% annual growth, this division should trade for atleast $550M or $22/share. An alternate valuation is to look at the value of the library at present. Anything that generates $67M in FCF is worth north of $500M – closer to $1B. My guess is that in a private sale, this division is worth over $1 Billion (or $39/share)

The company says that the carrying value of Oil and Natural Gas Division on it balance sheet is its market value. The $118M is value is worth another $4.60/share, for a combined value of $26.60/share or $43.60/share in an acquisition.

Negative: Excessive Management Compensation

Seitel’s management compensation structure is unusual and excessive. Let me state at the outset that I’m not a fan of managements like Seitel that are doing daylight robbery from shareholders in this fashion. I do believe that their compensation is excessive.

Having said that, if I were to only invest in companies where I was in agreement with management compensation AND where I believed I could expect outstanding returns on my investment, I’m afraid I’d be sitting mostly in cash. We live in times where outsize compensation is, unfortunately, the norm.

The issue is the outsize bonuses to senior management. They reduced this from 17.5% of pre-tax income to 8.5%. Seitel claims that their base salaries are low and the company wants to focus mgt. on selling existing data which has very high gross margins. Comp. is high and is one of the reasons for the low stock price. The bonus program will net management a total of under $10 Million annually over the next 3 years. Even with is shareholder robbery factored in, the value remains compelling.

Catalysts:

Catalyst

The company wants to sell or spin off its natural gas division. Any transaction would create a pure play and unlock value. Also, as the company executes its harvest strategy and throws off cash, the street will eventually recognize it. In addition, the entire sector is currently out of favor. As it comes back in favor, Seitel will rebound. Not to mention that they keep widening their moat with every new survey.