Mean reversion can create opportunity. The set up of an established business with experienced management coupled with very low expectations looking ahead can create opportunity. I have had some success with mean reversion in cyclical industries. It can be hard to think that the current out of favor companies will see brighter days ahead (at some point).
Enter Pulse Seismic
It’s been about 3 years ago since I owned Pulse. Here is a quick update from the summer of 2017.
Pulse recently released their Q1 2020. Top line was weak. Who would have thought that record low oil prices coupled with the covid lockdown would have led to the lowest utilization of their data library for as long as I can remember. During Q1 they and to negotiate the covenants on their debt which sent the shares up over 50% initially. Shares are down 50% and 60% ytd and over the last year. At $0.96/share Pulse has a market cap of just over 50mil and an EV of just over 80mil (CAD).
Since then, the company has had a rough couple of years. Last year they had the opportunity to purchase their largest competitor (Seitel) in the WCSB. The purchase price was very attractive given the cost to shoot new data.
See below for a statement on the deal from the 2019 President’s Letter. Highlights are mine.
For many years Seitel Canada Ltd. provided Canada’s largest library of licensable seismic data, growing aggressively by shooting its own 3D data in active play areas. Pulse had wished to acquire Seitel for quite some time. I would say that the combination of the extended industry downturn and a change in ownership of Seitel’s U.S. parent company last year improved the prospects for a transaction.
Pulse’s overarching desire was to position itself for a longer-term industry recovery, at valuations that would set us up for success in the emerging environment. Bluntly, while others appeared to be giving up on Canada, we were casting a vote of confidence in the producing sector’s long-term future. This was, for us, the optimum set of conditions to bring home the deal.
We did, however, expect the short term to remain difficult, probably as bad as last year and perhaps even worse. So we structured the acquisition financing to have low principal repayments and favourable debt-to-EBITDA covenants. Combined with our absence of debt going in, our strong cash position, low costs, lack of a dividend and continued shareholder free cash flow amidst record low sales, we were confident that we were properly managing
the acquisition’s financial risk.
For $53.6 million cash (plus up to $5 million more based on sales over the next two years), we have acquired 36,354 net square km of 3D seismic data, enlarging our most valuable asset by 126 percent, and 379,207 net km of 2D seismic data, increasing our 2D data by 84 percent. (For further details please see the January 15, 2019 press release or the MD&A for the year ended December 31, 2018.) The 3D data, from which most of the revenue will likely be generated, is complementary, having minimal overlap with Pulse’s 3D data, while the widely spread 2D data is also complementary for the most part, with slightly more overlap than the 3D.
The valuation is very favourable, with the price per square km being approximately one-third the price Pulse paid in its Divestco acquisition in 2010. The Divestco metrics amounted to an estimated 10 percent of the costs of shooting new data. The valuation of the Seitel acquisition, at $1,600 per square km (with zero value assigned to the 2D data), amounts to perhaps 3-5 percent of shooting costs. While the two libraries have been largely depreciated in balance sheet terms, their replacement value is, therefore, in the billions of dollars. We formerly provided an estimated replacement value for Pulse’s data library, but the figure for the combined library would be so large that it no longer sounds credible. Certainly, replicating Pulse’s data library would take decades of work. And a quick reminder for newcomers to the Pulse story: our seismic library consists of data–pure information — not software. It does not become obsolete, deteriorate or expire, and it can be relicensed and reused an indefinite number of times.
Read that again, the deal was done at 5% of shooting costs. That’s crazy. Having capital at the right time in the cycle can be very lucrative.
Covid and oil prices
If you have been under a rock during lockdown, your internet was cut off and you have made zero effort to pay attention to economy; you would have missed oil trading below zero and making headlines. Thankfully, the same people who seen the trade war, flash crash and the pandemic coming came out during the oil price crash and told everyone what they should have done. Nonetheless, activity in the WCSB is at an all time low. Active rig count is a good proxy for activity in AB and WCSB. Below is a 10 year chart.
They now have over double the revenue generating opportunity with very low incremental operational costs. This was already a business that generated substantial cash for shareholders over the entire economic cycle, and now it’s pretty much twice the size. The replacement cost of the assets is easily worth more than the market cap of the company and they are still producing cash at this level of activity. Since 2008, their average quarterly EBITDA and CFFO was 7.4mil and 6.9mil or just under $30mil and 28mil annually. They are now twice as big. If they can even get back to that level of activity with twice the data library then they are trading at about 1.4x EV/Average EBITDA and 1.5x EV/Average CFFO. I believe that EBITDA and CFFO are decent metrics for what the business can generate for the owners and feel comfortable using them.
Again, they have almost doubled the size of their data library without materially increasing opex. Management has proven to be make shareholder friendly decisions in the past with dividends, buybacks and debt reduction.
Low risk, high uncertainty for sure.
Disclosure: The author is not long shares of $PSD.to at time of writing, but I may initiate at any time.