Interoil: A Definite Short

| About: InterOil Corporation (IOC)

A few days ago, I published an article recommending investors exercise extreme caution regarding Interoil (NYSE:IOC) after George Soros disposed of more than two and a half million shares of the company. I noted that, given his track record (30% average return over several decades) investors might be wise to follow his lead and either dispose of Interoil shares if they own them or short the stock. After reading the comments on the article I decided to give readers a taste of what is really wrong with the company (besides of course the fact that it is an oil and gas company with no oil and gas) lest anyone should be duped by impassioned Interoil advocates into buying shares.

Way back in May of 2006, Interoil borrowed a total of $130 million from Merrill Lynch Capital and Clarion Finanz. Two years later, when it came time to repay the loan, Interoil did not have the funds necessary to satisfy the debt (surprise, surprise). To remedy the situation, Interoil arranged for Clarion's portion of the debt ($60 million) to be converted to common stock--Interoil subsequently issued nearly 80,000 more shares to Clarion as a fee for the financing. Unfortunately, Interoil still owed Merrill Lynch $70 million and needed an additional $25 million just to keep the company going. Interoil settled on a private placement of new convertible debt to raise the cash.

This is where things get complicated (and shady) so I will try to keep it as simple as possible. Interoil enlisted the help of two firms in the debt placement, John Thomas Financial and Carey International (CEO Phil Mulacek's brother and Interoil shareholder, Pierre Mulacek had a previous investment banking relationship with John Thomas Financial). Instead of dealing directly with John Thomas and Carey, Interoil chose to hide the relationship between itself and the companies (for reasons that will become clear shortly) by enlisting the help of a so-called 'buffer' firm which turned out to be none other than Clarion Finanz, the same company who had just received common stock as part of the very same loan repayment, the balance of which the new debt placement was attempting to remedy!

Interoil paid Clarion an additional 228,000 shares for its assistance in the matter. It gets better. Clarion agreed to pay Carey International a fee for its assistance in the deal and Carey International agreed to pay John Thomas Financial a fee as well. As it turns out, Interoil ended up simply issuing some of the 228,000 shares it owed to Clarion, directly to Carey and to John Thomas. Now when it came time to file Form D with the SEC which discloses fees paid as part of the debt placement, Interoil simply left out the 228,000 shares (worth nearly $5.7 million) it issued as incentives to Clarion, Carey, and John Thomas. Why is this a big deal? About a year later, Wayne Kaufman, chief market analyst at John Thomas Financial, appeared on CNBC and called Interoil his firm's favorite stock while explicitly denying it had an investment banking relationship with Interoil. Kaufman and his firm continued to promote the stock, driving it's price up while failing to disclose the fact that they had received stock in Interoil as part of the debt placement deal orchestrated the previous year. Let me reiterate: John Thomas Financial lied on national television about its investment banking relationship with Interoil and them subsequently juiced the stock price by aggressively promoting the shares via cold calls and press releases.

It gets still better. The $95 million in convertible debt issued had a stipulation that if the common stock of Interoil traded above $32.50 for 15 consecutive trading days, the convertible debt would be forcibly converted to common stock. Well guess what? After John Thomas Financial appeared on CNBC and subsequently issued a press release reminding investors of how much it loved the stock, the shares rose above, and stayed above, $32.50. Any guesses on how many days after the press release Interoil converted the debt to common stock? That's right, exactly 15 days. In other words, John Thomas Financial's recommendation was (likely) single-handedly responsible for triggering the conversion. Read more on this at, a fantastic site if you want to know more about the Interoil saga.

Now keep in mind that behind all of this, Clarion (the company that served as the buffer between Interoil and John Thomas Financial) initially received common stock worth over $60 million as repayment for the debt Interoil owed. At the time, those shares were worth $22.65 a piece. When the whole elaborate scheme was said and done, the shares had risen over $35. So in sum, everyone (Interoil, John Thomas Financial, and Clarion) came out ahead by participating in a plan to cover up the fact that John Thomas was only bullish on Interoil because of its relationship with the company and with Clarion.

It is hardly surprising that Interoil chose Jonn Thomas Financial as its partner in the above mentioned deal. John Thomas is as suspect an operation as Interoil. The firm's CEO Anastasos Belesis--whose illustrious career includes stints at no fewer than five now defunct chop-shop brokerage firms including "Lew Lieberbaum, one of the most heavily-sanctioned penny stock brokers of all time,"--is widely suspected of "wast[ing] or pocket[ing] nearly half of $13 million [his firm] raised for the company AMBER Ready" (that's right, the company that finds abducted kids).

Interoil has other shady friends. In 2004, the company hired Carl Caserta as an investor relations executive. This was a peculiar choice for one very specific reason: Mr. Caserta was banned from the securities industry for life by the SEC for using clients' money to purchase shares without telling them about it. Now while some (including the blogger ShareholdersUnite) are quick to point out that Mr. Caserta never admitted to any wrongdoing, "he did in fact consent to 'Findings and Order' which found that he 'willfully violated anti fraud provisions of the securities laws'". The real kicker here is that Interoil actually said it had no idea that Mr. Caserta was banned by the SEC when they hired him. I don't think I need to elaborate on just how absurd a contention that is. Now you would think that once the New York Times questioned Interoil about their affiliation with Mr. Caserta, the company would immediately cut all ties. Not Interoil--while the company said it got rid of Mr. Caserta in 2005, he still had an active e-mail address at Interoil all the way through 2009 when it was finally terminated.

Carlo Civelli, Clarion Finanz chief and a 4.56% owner of Interoil stock, has also been investigated by various securities regulators. According to Bronte Capital, Mr. Civelli has involved himself in many a questionable deal throughout his career including the Delgratia deal wherein Civelli invested in a gold company that was adding gold to samples it took from the ground after the fact, Pinewood Resources "a stock which announced large finds and collapsed to pennies," and Arakis Energy which was sold for "15% of its peak price...[after it was discovered that] the quality of its oil finds [in Sudan] was grotesquely overhyped." What do all of these deals have in common? They were all companies which claimed to be sitting on vast stores of valuable resources and they all turned out to be virtually worthless. Now Civelli likes Interoil.

There is an interesting thing to note about Interoil's evolving relationship with Civelli. In 2010, the company took out a $25 million dollar loan from Clarion. While the press release indicates that Clarion is charging Interoil 10%, the actual annualized rate is 19.86%, meaning that Interoil, a publicly traded company with shares trading in the fifties is paying the same interest rate a person with bad credit would pay on a MasterCard, and the financing is coming from its largest shareholder! While that is pretty absurd in and of itself, what is even more disturbing is the fact that, according to the FinancialInvestigator, the loan agreement values Interoil's Elk and Antelope fields at just $1 billion, "sharply below the company' cap,...which is a problem since the properties are Interoil's most important operating assets so it's market cap would obviously reflect the market's assessment of their value." Interpretation: Interoil has succeeded in misleading the market regarding the value of its assets but Civelli certainly knows how much they're worth.

Honestly, this story goes on and on, but this should serve as a nice introduction for investors who are unfamiliar with the back story. One last cautionary reminder to investors: Interoil has a long list of cheerleaders operating in chat rooms, message boards, and pretty much everywhere there are IOC critics. Interoil has, in the past, used blogs run by its affiliates to promote its stock while concealing the fact that the writers work for the company. For instance, Susuve Laumeau, in a blog post hyping Interoil, reminds readers that he is highly regarded PNG journalist who has won awards, but makes no mention of the fact that he works for Interoil, a contention supported by the fact that at the time of the post he had an Interoil e-mail address.

In sum, everything about Interoil is suspect--the CEO, the investment banker, the brokerage firm it used to raise money, it's natural gas finds (remember, the company has no proven or probable reserves despite their claims), everything. After reading this article, I encourage investors to do a bit of research on their own. The company's history speaks (loudly) for itself. While it is difficult to predict just how long this charade will last, you can bet it won't be forever. Oh by the way, Interoil used to be a joint partnership with Enron. Short Interoil or buy put contracts.

Disclosure: Long IOC puts

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