Henry Aldorf, the former President of Marathon International who was responsible for facilitating the Equitorial Guinea project 6 months ahead of schedule and under budget, delivered a cogent presentation on InterOil’s Liquid Niugini project last week at the 15th Annual Asia Upstream LNG Conference that highlights the minimal execution risk in monetizing the project and the extraordinary returns that the project will generate. At the heart of the presentation is a statement, “Some market voices said ‘Right project wrong Company’, They will be proven wrong again!” As the market begins to recognize the validity of this statement, InterOil's stock should initiate an ascent towards the $350/share that I believe it’s worth. www.liquidniuginigas.com/uploads/Asia_LN...
Many skeptics have argued for years that InterOil’s gargantuan goals are unfeasible for a company of its size and experience, yet the superior attributes of its project and resources imply an almost certain probability that its goals will soon be achieved. The project’s liquids backbone mitigate the hurdle of attracting upfront equity from strategic partners, as early cash flow from condensate production will provide returns on invested capital in the next ~18 months. Aldorf is contemplating a ramp towards 60,000 bbls/d of gross condensate production. Assuming two 9,000 bbls/d trains come online each year between 2012 and 2014 up to an aggregate capacity of 54,000 bbls/d, $750 million of capex for each of two 3-train stripping facilities depreciated over 10 years, a constant $85/bbl condensate price, 10% operating expenses, a 30% tax rate, and an 8% discount rate, THE NPV OF THE CONDENSATES NET TO INTEROIL IS ~$55 PER SHARE, IMPLYING THAT THE COMPANY’S SHARE OF 8.2 TCF OF NATURAL GAS IN ELK/ANTELOPE, ITS 52.5% STAKE IN LIQUID NIUGINI, ITS DOWNSTREAM OPERATIONS, AND ITS ~4 MILLION ACRES OF EXPLORATION ACREAGE WHICH MAY BE SATURATED WITH REEFAL STRUCTURES ARE BEING VALUED AT $16 PER SHARE, A SUBSTANTIAL DISCOUNT TO THE $300+ THAT I BELIEVE THEY’RE WORTH.
Assuming a 25% strategic partner contributes $2 billion of equity towards the purchase of a stake in InterOil’s project (which is less than half of the total purchase price that I expect a partner to pay for its stake), the strategic will generate cash flow yields of 6.3% in year 2, 12.6% in year 3, and 18.8% in year 4 and beyond just from the condensates according to my analysis. While strategic investors in CSG projects must wait for first gas in ~5 years to attain any return on their invested capital, InterOil’s investors will benefit from early liquids cash flow that derisk their investments. Another way to think about it is that InterOil’s strategic partner will generate enough cash flow from the condensate alone to fund its entire portion of the LNG project by year 4 even if it commits equity of 50% and only finances the other half of its share of ~$6 billion in capex.
An unexpectedly positive projection submitted on page 15 of Aldorf’s presentation is first LNG from a floating facility by 2013/2014. Hence by the time the first onshore train produces first LNG in 2015, InterOil’s 25% partner will likely have already generated >$1 billion of cash flow from the resources.
The tremendous discount to NAV at which InterOil’s stock currently trades can only be attributable to skepticism over the company’s ability to sell a stake to a strategic and monetize its gas. What the market fails to recognize, however, is that the project has been completely derisked by the liquids backbone, and the current stakeholders of Liquid Niugini can fund the entire development of the liquefaction facility with cash flow from the condensates alone (though selling a strategic stake will accelerate project development and exploration activity). With an FOB gas price of only $0.70/mmbtu needed for Liquid Niugini to generate a 12% return according to the presentation, there’s no risk of declining LNG prices causing the project to be uneconomical. In fact, there seems to be a floor of $10-11/mcf at which LNG demand hits maximum elasticity, as consumption in India could overtake that of Japan by 2015 at these prices ( http://www.orissadiary.com/Shownews.asp?id=17428 )
In conclusion, the extraordinary valuation gap of InterOil’s shares and the low risk trajectory towards monetizing its resources and closing that gap make buying the stock a truly unique opportunity that probably won’t be available much longer.
Disclosure: Long IOC common stock, Long IOC call options