InterOil: The Final Chapter
Jan 28, 2013 5:52 AM
InterOil (IOC) announced last week that the "final binding bid solicitation period for the partnering process currently being undertaken will close on February 28", uncharacteristically transparent guidance for the company. Though the market construed the release positively, the implications could be much more significant than investors are contemplating for the following reasons:
1. InterOil must have considerable clarity and optimism on the outcome of the bidding process, as its latest release leaves little room for a deferral of the sell-down. InterOil has always been vilified for its vague commentary, unwillingness to provide specific targets, and excuses for pushing out timelines. The specificity of last week's press release implies that InterOil strongly believes it will be able to report the selection of an accretive binding bid in the first half of March. After prolonged discussions with many prospective partners, their continued involvement in the bidding process bodes very well for InterOil shareholders. As CEO Phil Mulacek indicated, "The interest demonstrated by major oil, national oil and global utility companies remains strong, and bodes well for the conclusion of our sell down of interest in the Elk and Antelope fields and partnering in the Gulf LNG Project".
2. The bids that are due prior to February 28 are binding, and hence InterOil's selection of the winning bid will be the final substantive step required for closure. Though the company previously acknowledged that it had received bids for its Project, there was no indication that these bids were binding; hence unlike the bids that are due by February 28, the previous bids may have been subject to further negotiation, resulting in a prolonged deal process. InterOil's three investment banks would not have furnished prospective partners with a firm date by which binding bids must be submitted unless they were certain that the interest would support a positive outcome.
3. The PNG government is supportive of InterOil's project. In its press release, InterOil stated, "We are pleased to have the continued support of the PNG Government during the conclusion of our partnering process". Perplexingly, InterOil's stock is still trading 20 points below its price at the time of the initial WSJ leak on the structure of the NEC agreement. Reports that the government may take its 22.5% of the resource in kind for domestic use indicates that InterOil could control 100% of the Gulf Project's first train, which is the Project's most valuable segment and the component which majors are obviously most interested in buying into. Unfortunately there aren't active sell-side analysts to highlight this point, but the resulting dislocation will dissipate with the announcement of a deal in the next 45 days.
The most relevant recent LNG transaction was arguably Marubeni's acquisition of a 1% stake in the PNG LNG project through its purchase of a 20% stake in Merlin Petroleum for $297.96 million in November of 2011. The stake equates to ~$3 per mcf of reserves, or in excess of 5X InterOil's market cap assuming no additional resource upgrade from the successful drilling of Triceratops-2 and Antelope-3 last year.
InterOil's short interest has been consistently appreciating towards an all-time high, and it's now 11.48 million shares, 23% of its outstanding shares. With the company having one of the best projects and lowest cost natural gas resources in the world in close proximity to Asia's largest import markets, LNG prices at their highest levels ever and surging LNG demand, majors' cash balances at unprecedented and bloated levels, PNG undergoing a period of unprecedented stability and economic prosperity, and significant risks developing in the global LNG supply picture, there has never been a more compelling time for InterOil to close its sell-down and maximize the value attained for its resource.
The majors recognize the risk of a significant deficit emerging in the LNG market, as production estimates from regions like East Africa, Australia and the US are increasingly at risk. According to a Bloomberg article published on Friday, for example, "The U.S. may export 50 metric million tons a year of LNG by the end of the decade, or about 10 percent of the projected world market, [Royal Dutch Shell CEO Peter] Voser said today in a Bloomberg TV interview in Davos, Switzerland. That's below the 120 million tons a year he said is predicted by some forecasters and less than Qatar's current annual production of 77 million tons." According to another recent article, "A strong ongoing environmental protest movement in New South Wales and Queensland against coal seam gas (CSG) projects is threatening to cripple the development of Australia's liquefied natural gas (LNG) industry".
As this Oxford Business Group Review highlights, PNG has been increasingly attracting the majors' attention as a result of its unprecedented political stability, world class unexploited resources, and proximity to Asia. The $19 billion Exxon (XOM)-led PNG LNG Project is coming online next year and is expected to generate $6.2 billion per year in revenue for the government for the next 28 years; Shell (RDS.A) recently reentered the country and expressed interest in building a hydrocarbon resource; Total (TOT) just struck a JV with Oil Search to explore for prospects in the Gulf region, which is where InterOil's acreage lies; Last May, the PNG National reported that "Chevron Niugini (CVX), one of the United States' petroleum and gas giants, is returning to PNG to partner with InterOil to develop the second Gulf LNG project, Treasury minister Don Pomb Polye has revealed… He said he met with the representatives of Chevron Niugini yesterday who were here to look at the InterOil Gulf LNG project".
The only remaining short case may revolve around the cynic's arbitrary expectation that a deal may involve little upfront cash or that the price will disappoint investors. Given how excessively capitalized the majors' balance sheets are at this juncture, however, it seems probable that the transaction will contain a significant upfront cash component. The most important point that the cynics have not yet grasped is that irrespective of the size of the cash component, the consummation of this deal will result in an imminent FID and a bankable resource. The stock's valuation will be increasingly predicated on the NAV of the resource, which I estimate is well in excess of 4X the current market value of the company. The company's cost of capital will be significantly reduced, liquidity will be plentiful, and the NPV of the aggregate payment to InterOil will establish a much more realistic benchmark by which the stock market will establish a worst case valuation for the stock. With InterOil's stock trading at less than $0.40 per mcf on my estimated year-end 2013 resource estimate and with confirmed interest in InterOil's project by majors, national oil companies and global utilities, it will take a miracle for the short thesis not to be obliterated in the coming weeks.
Disclosure: I am long IOC.
Sentiment: Strong Buy