InterOil (Amex: IOC) has sold off on the year end results while the figures were actually surprisingly good. There are two possible reasons, both of which seem to hold little ground.
The first just have to do with the impatience of investors running out as it became clear the all important results of the drilling at Elk4 would be delayed. It’s likely that the large short parties in IOC take advantage of this as well, it’s difficult to arrive at another conclusion if you, as we are, watching the price development closely.
Every time there is some buying, selling appears from nowhere, as if they are lying in wait in ambush. While we’re all waiting for those drilling results, and they will come in a couple of weeks if there are no other problems with the drilling, there is a second explanation for the sell-off.
The second reason is more fundamental. IOC owes Merrill Lynch $130 Million, and that amount is due early next month. That sound serious as IOC does not have enough money to pay them back. Things could potentially get nasty if Merrill would call in it’s loan. Nasty enough for the IOC accountants to put a ‘going concern’ warning in it’s year-end report.
But how likely is it that Merrill is going to call in that loan? Actually, that wouldn’t make any sense. Now, we realize that it is not out of the question that investment banks do things that don’t make any sense, just ask Bear Stern’s CEO. However, Merrill is quite involved with IOC, and stands to win a lot when IOC succeeds.
For instance, it’s a partner in the upcoming LNG (liquid natural gas) project, a multi-billion dollar project to monetize the gas found at Elk. Merrill is 1/3 owner, and the gas will be sold through its network of contacts, as Merrill Commodities is an important player in the LNG market.
It’s important to realize that the last time this loan came up for repayment, Merrill just simply extended it for a year at it’s surprisingly generous interest rate of 4%. We don’t really see any reasons for them not to do something similar now. If you don’t believe us, we’re not the only one thinking this way.
We manage to find a quote in a Raymond James report just after the results of the last well (Elk2) were announced and discussed in a conference call (October 2007). It seems Raymond James, also expects Merrill to keep supporting IOC:
“Based on yesterday’s conference call, along with further discussions with management, we believe that InterOil’s partners are encouraged by the final test results from Elk-2 and the continuing process of delineating the structure. This can be evidenced in the fact that all of the company’s exploration partners have maintained their ownership stakes in the exploration program, along with full participation in future wells.
On the liquefied natural gas (LNG) front, the latest results are viewed favorably by InterOil’s partners in the LNG project, given that the higher resource estimate goes even further in underpinning at least the first LNG train. With many concerns from investors surrounding the company’s liquidity position, we would point out that a large portion of its short-term debt is a term loan to LNG project-partner Merrill Lynch.
Merrill has been very accommodating in the past and could possibly be willing to restructure InterOil’s current debt obligation. Furthermore, we would argue that the sale of a portion of InterOil’s interest in either the LNG project or the Elk prospect would generate enough capital to support InterOil’s exploration activity for years to come” (End of quote from RJ 6/10/07 p2).
So, we think the markets is wrong, for now. Of coarse, it’s terribly important what the results of Elk4 will be, but on that score we’re quite optimistic still. We maintain that IOC is a buy, but hedging would be a smart move. Although a positive result is way more likely than a dry hole (Elk4 is not drilling in unknown territory, to say the least), success is never guaranteed.