InterOil's Increasing Value Proposition

| About: InterOil Corporation (IOC)

The three investment banks assisting InterOil (NYSE:IOC) in selling a part of their Elk/Antelope resource confirmed last Friday that they received several binding bids from parties wanting to participate in the project of monetizing the gas (and possibly the liquids, although InterOil already has an agreement with Mitsui of Japan for this in place, the outcome of which depends on the conclusion of the present deal).

The simple but near inescapable reality of this is that InterOil will have an LNG project partner in the very near future. There are several important conclusions to be drawn from that simple fact. Even a "disappointing" deal would result in:

  • De-risking the whole LNG project substantially
  • Setting the clock ticking towards first monetization of gas and liquids
  • InterOil will receive funds for greatly enhanced exploration and appraisal of other, already discovered resources.

But we're sure the deal will not disappoint. These investment bankers have been busy for more than a year. Any short-infused doubts about resource continuity has been blown out of the water by the results of the Antelope 3 well. There are at least two supermajors bidding, according to CFO Colin Visaggio:

While there are at least two LNG-savvy supermajors involved, a consortium of Korea Gas Corporation, Japan Petroleum Exploration and InterOil's Japanese condensate stripping plant partner Mitsui is also in contention.

We asked the company whether they still stand by that description and they confirmed. We believe there are at least four bidders. This is a competitive process. The Elk/Antelope resource on offer is vast, of high quality and it has a favorable location (just 80km of pipeline necessary compared to 700km, partly sub-sea for the Exxon/OilSearch project, also on PNG), close to Asian markets where demand for LNG is booming and LNG is fetching record prices (over $20 per MMBTu recently).

Smoke and mirrors from the shorts
There is one further important implication from the reception of binding bids:

  • A deal shows the sheer amount of nonsense the shorts have been putting out for years is just that. Sheer nonsense.

We've followed this company for seven years now, and we've seen it all, the ever shifting "arguments" of the shorts, aided and abetted at times by people with dubious pasts (Minkow, Blodget) and a barrage of message board trolls that incessantly bombard Yahoo with non-stop barrages of lies and nonsense. As to not to be drowned out by the sheer volume of the latter, we even started our own message board.

If you don't believe the amount of nonsense put out by the shorts, just look here. We've seen it all. InterOil couldn't get the refinery to PNG from Alaska, it would never discover anything, the geology of PNG is heavily explored, that geology is such that the wells will "implode," IOC will never get analyst coverage (and when they did, these were ridiculed), PNG approval, or third party resource vetting (and when it did, the company, GLJ of Canada, was of course no good according to the shorts).

According the shorts, InterOil is perennially running out of cash (the reality is that for an exploration company, debt levels are low and InterOil has been rather conservative with issuing new shares). There isn't a possible short "argument" that hasn't been made, but the history of events has shown that one by one, these are just smoke and mirrors. When one argument has been disproved by events, the shorts effortlessly move to the next "argument," even when these contradict previous ones (the shorts are fond of arguing the Elk/Antelope resource is under-appraised while they also argue IOC should have done a deal years back, these can't both be right at the same time, for instance).

The ever-shifting arguments show another thing, rather than "conviction shorts," as one of them put it (shorting InterOil because they "believe Japan will crash," or something to that effect), the shorts are revealed as naked opportunists. Throwing a barrage of "arguments" at the wall simply to see what sticks, even if nothing really sticks they can still call the company "controversial" with their ever shifting barrage of "arguments."

By now, it should be clear that it isn't InterOil that is "controversial," it's the shorts themselves, and that's putting it rather mildly. Seeking Alpha contributor Treasure Hunter already did us the favor of deconstructing their latest salvo of "arguments," so we're not going to do that twice.

Anyone who still gives these short "arguments" any currency should know better. They should also know that IOC's big institutional investors have not exited, quite the contrary. They clearly see through all the ever changing smoke and mirrors being thrown up by the shorts.

If you still doubt that the shorts standing naked in front of us, just look what happened last Friday. Andrew Left of Citron Research put out scary-sounding short reports out on InterOil years ago, but credit to him, he stopped doing that and admitted that there wasn't much point in shorting InterOil after they discovered a reef at the top of the Antelope 1 well.

Another skeptic in those pre-Antelope1 days was Ross Smith Energy Consultancy, but they as well admitted that if there was a reef, or dolomitization, they would be wrong and both would be positive. As it happened, there is both reef and dolomitization in Antelope (despite some of the shorts claiming, without any data, that there isn't). Even the geologist hired by them and Minkow, Bertoni, admitted as such.

So for years Andrew Left from Citron remained quiet on InterOil, until last Friday, when he tweeted:

$IOC maybe the end is finally near for this promo...have to give them credit, lasted a lot longer than we ever imagined

A tweet completely devoid of any data, facts or even arguments. In fact, it was tweeted after the investment banks confirmed the existence of several bids. So how the end for InterOil can be near we'll leave for Andrew Left to explain. Somehow, we didn't think he meant the end of InterOil as an independent company because of a take-over bid, although that's way more likely than InterOil's demise as a result of any "promo."

When some of the shorts make totally ridiculous comparisons with Bre-X, we ask you, what promo, in fact? All the well testing and resulting data are produced by third parties like Schlumberger and Weatherford. InterOil's resources has been vetted by not one, not two, but three different independent resource vetters (GLJ, Gaffney Cline, and Knowledge Reservoir). GLJ is their official (and by Canadian law, the only one IOC can report) resource evaluator and they just increased their assessment to over 10Tcf.

Any notion that GLJ isn't a serious company (another short favorite "argument") will have been given another blow (if at all necessary, considering GLJ's premier client list) by the low initial estimate of Triceratops, an InterOil resource that is not part of the deal that is on the desk of the investment banks and InterOil board.

The funny fact is that Triceratops has already received interest, leading to an excellent deal with Pacific Rubiales (NYSE:PRE). The appraisal of Triceratops is in a very early stage and although the geology seems to be more complex than at Antelope, seismics show an extensive field and the possibility of another reef.

With amazing speed Andrew Left's empty tweet about the demise of InterOil being near showed up in the InterOil news headlines on Yahoo's newsfeed. Since when do stock tweets, especially such vacuous ones as this one, end up under company news of any half serious financial news portal?

We'll invite the reader to locate any other tweets in similar news reels. We think this is a very rare event indeed. Considering the amount of stock tweets, a near infinitesimal fraction of these (if any) end up in the news reel of a financial porter. This tweet didn't feature in Google finance, nor Reuters, nor CNBC. It reminds us of the time that one of the Yahoo message board trolls managed to get a particular item on top as special feature, where it stayed for months.

It reminds us of the message board trolls that Yahoo aids and abets, allowing them to carpet bomb the message board daily, no, hourly, with endless drivel and creating multiple identities and impersonations of bona-fide posters.

The shelf
Also on Friday, InterOil filed a $1B mixed securities shelf. Needless to say that this, like everything, was used by the shorts to argue that the bids aren't any good and InterOil will issue shares to go it alone and partner with EWC of Australia. Apart from the fact that even in that case we would have a timeline towards monetization (a pretty fast one as EWC builds LNG modules from off the shelf parts from the likes of Siemens and Chart), this is simply more nonsense.

One might want to consult the Q4 2012 conference call notes (February 28 2013). Here is InterOil CEO Collin Visaggio explaining:

Our previous shelf expired in September 2012, and like all prudent companies, we'll be looking at replacing it, given the open debt levels, as this will add to our financial flexibility.

We asked the company whether they have any plan issuing any shares. The answer was a rotund no. It is simply a replacement for the expired shelf, and one cannot file a shelf offering without recently filed audited financials, which is done once a year.

The company might issue some debt as a bridge until the cash from the sell-down kicks in. That said, a $56M installment payment from Pacific Rubiales expected within days. Together with the $99M in cash the company has, there is no immediate need for a debt bridge either, if ever.

Wrong, but big
While these shorts are wrong, they've put out an endless stream of ever shifting rationalizations in order to taint the InterOil stock brand with doubt and controversy but in the end, few, if any of the short arguments have any merit.

Wrong as they might be, the shorts have a strong influence on the stock price. The past has shown that the shorts are really not averse to playing dirty, considering the consecutive years that InterOil shares have been on the RegSHO list (indicating naked shorting) and the up to 6M undelivered shares until June 2008.

Since IOC hasn't been on the RegSHO list since, there might be other forms in which they manipulate the share price. However, there are some inescapable facts here which we invite everyone to contemplate:

1) InterOil's value proposition is ever increasing.
InterOil continues to find more gas and liquids, the Asia/Pacific prices for LNG is sharply increasing, InterOil continues to build more infrastructure (as one can read in the latest CC notes), and the profitability of their downstream businesses is increasing steadily with the GDP growth in PNG and the increasing capacity utilization of the refinery. A deal for the LNG plant and part of Elk/Antelope is of course a next big step, and bids have been confirmed already.

2) The shorts have to short ever more to keep the share price in check.
We are at record short levels. It's surprising that the shorts are able to manage to locate incremental shares for shorting, if indeed that is what they do. But the simple fact is that there is a rapidly growing disconnect between the share price and InterOil's growing asset value.

3) The big institutional investors are not selling.
In fact, they're adding. The top holders have sat through much worse turbulence, like when PNG politics turned into a problem in 2012. and there was a good deal of uncertainty. Recent filings show many of the top holders adding to their positions.

4) The risks and costs of shorting is ever increasing while the possible return is decreasing.
Shorting is neither costless nor risk free. With a record amount of shares short (30% of the float), it takes an ever increasing number to achieve ever less. These shares have to be located and borrowed, but the shorts run big risks:

  • A deal announcement can come at any time, nobody knows the time line with any amount of certainty
  • The shares can easily gap up, as the de-risking of the project as a result of the deal is likely to attract additional coverage and institutional buying
  • InterOil has a vast prospect portfolio. They have 40+ prospects with at least 10 reefs identified on seismic studies, the odds for additional big finds are rather good.
  • Institutional longs, which might be tired of all the short nonsense, could call in the shares they've lent out, provoking a massive short squeeze as the forced buyback, especially when accompanied by positive deal news and other funds sniffing the inherent weakness of their position. This would wreck havoc on the shorts.
  • Last but certainly not least, it is not unlikely InterOil will attract a buyout offer anytime from now through the closing of the sell-down transaction.

InterOil's value proposition
The Elk/Antelope resource contains 9.45Tcf of gas and 143.6MBls of condensate, 58% attributable to InterOil. InterOil's market cap is $3.2B, which amounts to 55 cents per Mcf. These is a resource with a favorable location and highly productive wells, just 5-11 are needed for exploitation. This isn't shale gas where wells have to be made to flow and thousands have to be drilled and treated, requiring an extensive gas gathering infrastructure, not to mention the personnel required and the waste water disposal problems.

This is also a good time to remind people of how Elk/Antelope stacks up against the competition:

Click to enlarge

These costs are on a par with the large Arun field, that set Indonesia on the map as the largest LNG producer in the world until recently, as the resource is running dry after decades of production and export contracts expire in 2014. Here is what authors from the James A. Baker III institute had to say about the Arun field (Pdf):

The Arun natural gas project in Northern Sumatra has been perceived as the most lucrative LNG operation in the twentieth century.

Now, the Arun field is bigger (17.1Tcf), but it's also significantly deeper with an average depth of 3048 meters (just over 2000 meter at midpoint for Antelope) and significantly thinner. Average net pay thickness varies from 102 to 316 meters, versus 2088ft (551m), 1465ft (446m)en 1810ft (551m) of net pay for Antelope 1&2&3 respectively. Arun also has a higher CO2 content (15%, versus 5-6% for Elk/Antelope).

The Arun field has been able to feed a 6 train LNG facility with a 10Mtpa capacity (although not lately as the resource is almost depleted after decades of production). It shouldn't be difficult to feed a one train 3.8Mtpa capacity LNG plant for Elk/Antelope.

Elk/Antelope is comparable in size to what the other LNG project by Exxon/OilSearch on PNG has, but it's development cost are way lower. This reflects more productive resource (wells flowing at a substantially higher capacity) and much more favorable location. You can see the difference reflected in the graph above.

The five Exxon/OilSearch resources are located in the highlands, needing a 700km pipeline, while Elk/Antelope is a single resource which needs only a 80km pipeline running through easier terrain in the Gulf. Development costs are estimated to be less than half the $18B of the Exxon/OilSearch LNG project.

Disclosure: I am long IOC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.