One of the great things about writing an investment blog is getting feedback from many smart investors who may see your thesis from a different angle. Last month I wrote up one of my core positions, Pulse Seismic (PSD.TO $4.09, PLSDF $3.89), and the response I received was phenomenal, with many targeted questions about the business model and the valuation I presented. As can often be the case with our core investments, the analysis I presented was seen by many as a bit too optimistic. So with that said, I think it may be a good time to look at Pulse under a different lens.
The primary concern readers had was how my normalized library sales number could be above $50MM when Pulse’s core sales had never reached this level in a single year. The idea here was Pulse doubled in size with the Divestco acquisition, but we have not seen the true earning power of the transformed business due to the depressed climate in the last few years. My method was the do the analysis on a $/km, $/km2 basis and apply this ratio to Pulse’s current library size. I must confess this method is a bit confusing, so let’s look at in a more straightforward fashion by working up pro-forma financials to include Divestco’s historic library sales:
Image may be NSFW.
Clik here to view.
Here we see that in buoyant market conditions, like those seen in 2007, Pulse in its current form would be capable of generating nearly $90MM in single year library sales. Average these core sales over the cycle, and you arrive at nearly the same number used in my original analysis.
This however bring up another question that has been weighed on me since my initial post – is it correct to assume 2005-2007 represented typical up-cycle conditions or were these extraordinary times for which a valuation should not necessarily be based on. Concerned about this question, I decided to ask CEO Neal Coleman himself on the 3Q conference call (thank you Seeking Alpha for absolutely butchering my name..):
“Brendan Maggie – Private Investor
If I strike out the large transaction in Q1 of last year and look at this quarter library sales and kind of a $1 per kilometer, a $1 per kilometer square basis. Looks like 2D sales are running about 30% of 2007 levels, 3D sales with about 50% in 2007 levels, and the question is does it make sense to think about sales on kind of a dollar per kilometer, dollar per kilometer square basis? And if so do you think we can ever get back to 2007 levels?
Neal Coleman – President and CEO
I believe 2007 we had a very — we sold a lot of 2D in 2007 I think I believe one of the main reasons for that was we had higher commodity prices, we had higher gas prices that led to the financing of a lot more junior companies. If we take a look at our customer profile in 2007 we sold a lot more data to junior companies. What I mean by that is startup companies or companies really from zero to 10,000 Boe a day. And there has been obviously a shift from 2007 to today where we sell more data to intermediate and major customers. So I believe that if to sell more 2D and if it’s used more for the exploration side of the business that we would need to see higher gas prices.”
(You can read the full transcript here)
Neal’s candid answer certainly casts doubt that we will be returning to pre-crisis levels any time soon, particularly with regards to 2D license sales. In light of this, I would like to introduce a new scenario into the analysis:
The “New Normal”– no we are not talking about Mohamed El-Erian lamenting on CNBC about the Fed’s easy money policies. We are talking about the idea that the advent of hydraulic fracturing techniques forever changed the landscape of the natural gas industry and $10 natural gas will likely never occur again. Moving forward, Pulse’s business will be driven primarily by 3D data sales to larger customers and corporate transactions revenue, but 2D data sales will be significantly impaired.
Perhaps the easiest way to model this new scenario is to forget all about the heady times experienced in 2005-2008 and average core sales since the crisis:
Image may be NSFW.
Clik here to view.
Repeating the same valuation gives us a significantly lower intrinsic value range:
Image may be NSFW.
Clik here to view.
I have kept transaction revenue unchanged as well as maintenance CAPEX. A reader correctly pointed out to me that Pulse paid net $20MM for their most recent survey campaign, but I take this to be an extraordinary amount – it is more than the last 5 years of net spending combined and Pulse won’t spend anywhere near this in the upcoming campaign. Given these facts, I think $3MM is an appropriate basis moving forward. Lastly, note that I have eliminated cash taxes as Pulse hasn’t paid these in last 12 years and their business model just about assures they won’t in the future.
We now find a significantly lower mid-point valuation in the $6.00 range, still offering 50% upside from current levels. I am once again reminded of the importance of leaving a margin of safety, as my estimates were revised significantly downward and the stock still looks like an attractive purchase. Acquiring a wonderful compounder at a 33% discount is move I’d be interested in any day.
Lastly, I would like to address a concern cited in this excellent write-up on Pulse by the Punchcard Investing Blog. In the post, the author concludes that Pulse’s “uneven results make it too difficult for me to project a forward growth rate.” No argument can be made against Pulse’s wildly inconsistent results but I think it important to recall that the engine behind Warren Buffet’s compounding machine, “super-cat” reinsurance, is perhaps the most erratic business known to man. As Buffet points out in his 1996 Chairman’s Letter to Shareholders:
“Gyrations in Berkshire’s earnings don’t bother us in the least: Charlie and I would much rather earn a lumpy 15% over time than a smooth 12%.”
I feel much the same way about my investment in Pulse Seismic. Much thanks to all for the feedback on this idea.
