Whitney Tilson Talks His Book on InterOil

Aug.25.10 | About: InterOil Corporation (IOC)

But it looks like he's going too far. He sounds exactly like those other shorts (Minkow's FDI) who are now investigated by the SEC.


In an article by the notorious Henry Blodget, Tilson is quoted extensively arguing the follies of message boards, as an anonymous poster thought he'd gone long. Now, the Yahoo message board in general (and the InterOil (NYSE:IOC) one in particular) is indeed notorious (see here for some of the worst offenders), but for a hedge fund manager to start commenting on message board posts, isn't that stretching it a bit? The post got echoed widely (for instance here, here, here, here, here, and here).

One can perhaps be forgiven for taking the figures from Nasdaq.com at face value, as they indeed state that Tilson was long 10,400 shares (but it's not complete, shorts don't have to be filed and put options didn't appear, you can find his complete filing here). So it's a pretty lame affair for Tilson to cry victory here.

What's more, in the same article he argues some very questionable stuff:

there continues to be no proven or even probable reserves – just more hype and gibberish like this from the earnings release:

The Antelope 2 horizontal well confirmed a higher condensate-to-natural gas ratio of 20.4 barrels per million cubic feet of natural gas, 27% higher than observed at the top of the reservoir. The horizontal well also demonstrated dolomitization and higher porosity deeper in the reservoir than previously modeled.

We fail to see the hype in reporting drilling updates and feel compelled to point out the following about a rival project (by Exxon (NYSE:XOM) and OilSearch) on Papua New Guinea (PNG):

When a positive Final Investment Decision is made, Oil Search will move approximately 580 million barrels of oil equivalent (mmboe) from its 2C resource to the 2P reserves category, more than eight times the Company’s current 2P reserves of 67 mmboe. [From 2008 annual report]

So, OilSearch had only 67MMBOE of 2P reserves when the FID was taken, certainly not enough (on paper) to supply any LNG facility. But taking the FID turned a large part of their resource into reserves.

Turning back to Tilson's comment, InterOil finding an extra 1460ft of dolomite (which is some of the best reservoir rock) in the horizontal will only increase the size and quality of the resource, so that's not hype nor gibberish. We might also point out that InterOil has a joint-venture agreement with Mitsui from Japan about monetizing those liquids.

So that condensates ('liquids') to gas ratio is highly relevant. They can be processed in InterOil's own refinery (it has enough spare capacity), and the profitability is, well, quite interesting:

The currently proposed Condensate Stripping Plant is planned to have initial capacity of 9,000 b/d, but management has often noted a future production goal of 60,000 b/d. In the current market, we believe this operation could readily generate a pretax profit of $60-$70 per barrel.[Monness, Crespi, Hardt and Co.]

Or one might have to remind Tilson of the enormous size of the Antelope wells:

  • Antelope1: 2277ft of NET pay with 8.8% average porosity
  • Antelope2: 1175ft of NET pay with 14% average porosity

These are quite staggering numbers (witnessed by the flowrates which established respective world records of 382 and 705MMcf/d respectively), when anything over 20ft produces already excitement in the US.

Now, any oil & gas explorer will burn cash, but Tilson doesn't improve when quite overstating the cash burn at InterOil:

Over the past four quarters, net income is -$1.3 million and free cash flow is -$181.9 million (cash from operating activities minus "expenditure on oil and gas properties" and "expenditure on plant and equipment, net of disposals", broken down as follows:
Q3 09: -$48.6 million
Q4 09: -$40.7 million
Q1 10: -$28.5 million
Q2 10: -$64.1 million
TOTAL: $181.9 million)

This has met with some stiff opposition from the same message board:

The $96.4 mil. unrestricted cash figure from 6/30/09 was just after receipt of offering proceeds and just before paydown of an unusually high accounts payable balance, a balance in fact about $70 mil. higher than those of 12/31/09 or 6/30/10. He cites a supposed "cash burn" of $45.5 mil. "each quarter", and yet unrestricted cash of $31.7 mil at 6/30/10 is down less than $15 mil. TOTAL in the six months since 12/31/09, an average of $7.5 mil. "each quarter", using that all-inclusive approach, without considering the additional $25 mil. now being received.

He gets the $45.5 mil. per quarter specifically by citing for the last four quarters a "net income" of "-$1.3 mil." and some net "expenditures on oil and gas properties and plant and equipment" total of $191.9 mil. However, if you compile data from the latest Statement of Cash Flows, you get a different picture of the latest situation. Second quarter net income was $7.8 mil., and six months ended 6/30 was $4.7 mil., while cash flow from operating activities before changes in working capital was $19.1 mil. for the quarter and $22.6 mil. for the six months.

Net expenditures on oil and gas properties and on plant and equipment, BEFORE applying any of the operating cash flows, were $30.6 mil. for the second quarter (net of $11.5 mil. after operating cash flows), and $34.0 mil. for the six months after $13.9 mil. proceeds from sale of exploration properties (net of $11.4 mil. after operating cash flows for the entire six months). Any way you look at it, there's no way "they're burning an average of $45.5 million of cash each quarter". That is a gross distortion or just a plain lie [Getitrt2 on Yahoo]

Even long-time critic UCLA lecturer and accountant Eric Sussman calculated the cash-burn much lower than Tilson's $45.5M per quarter, at $15-$25M. However, when it was pointed out to him that this was strangely at odds with his eulogization of Tilson just minutes before that, he got all defensive and upped his own calculations. What was $15-25M became "around $25M" and then "more than $25M"(and not defending Tilson) within minutes. Hilarious stuff (or rather embarrassing, depending who you are).

There were more inadequacies in what Tilson had to say in that article:

Issuing stock and conversion of debt ($12.8 million over the past 12 months), resulting in the diluted share count rising 16.1%.

This seems to argue InterOil issued approximately 5M shares at $2.40. Far from it. The last time InterOil issued shares it was at slightly above market price, and it later turned out that George Soros bought the lot.

In his annual letter to shareholders, Tilson said:

InterOil (IOC): Tilson has been bearish on this name for a while and argues that all their press releases (there's a lot of them) have artificially lifted the stock higher on no substantial news.

No substantial news? Judge for yourself. We would argue that stuff like getting third party resource estimations and then a huge increase in that the next year to 8.2Tcf and 156Mbbls in condensates is pretty substantial, we would say (we could cite numerous other examples, like NYSE listing, Morgan Stanley's coverage and gradual price target increases, government approval of the LNG project, reducing debt, etc. etc.).

Perhaps it is because Tilson isn't, as far as we know, versed in oil & gas exploration and he hasn't been to PNG or seen the proprietary resource data. He shares this with other notorious InterOil shorts (Barry Minkow, Sam Antar, Henry Blodget) who frequently wrote similar stuff. It has gotten the first two into trouble, as the SEC has opened an inquiry into their activities and they haven't written anything since early May and even took their website (internooil.com) down.

We have covered some of that in the past (see here, here, here, and here), and for Blodget see here and here. (Our view on why InterOil is a good long-term investment can be read here). Lobdell from iBisuness Reporting (a website paid for by Minow's FDI) argued similarly that InterOil only produced fluff PRs:

An iBusiness Reporting analysis of a half-dozen other publicly-owned oil and gas exploration companies’ press releases in 2008-2009 show they rarely issued media statements solely to tout potential finds, but instead mainly publicized proven resources—commercially viable oil and gas.

We have a feeling it would get awfully quiet when oil & gas explorers only report proven reserves.

Needless to say, all of the (implicit or explicit) backers of InterOil, like George Soros (IOC is his third largest holding), Raymond James (analyst, market outperform, $109-$129 NAV per share), Morgan Stanley (analyst $125 price target), Wayne Andrews (geologist, gave up good job at RJ to work for InterOil), Henry Aldorf (gave up good job at Marathon (NYSE:MRO) to work for InterOil), GLJ (resource evaluator: 9.1TCF), Knowledge Reservoir (resource evaluator), Schlumberger (NYSE:SLB) (log analysis), Wheatherford (doing the flow testing) have such knowledge or background, they have been to PNG and had access to all the proprietary data. Perhaps Tilson can learn a bit from them in stead of reading message boards.

Disclosure: Long IOC