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InterOil versus Oilsearch

November 4th, 2008 · No Comments

If you ever wondered why Merrill Lynch is fighting to stay into InterOil’s LNG plans, read the following below, with some VERY interesting valuation implications.

AGL’s PNG Sale Good News For Oil Search
By Chris Shaw

  • As has been expected for some time, AGL Energy (AGK) has reached an agreement to sell its gas interest in Papua New Guinea for $1.1 billion net of hedges, a price as much as $150 million more than some in the market had expected. While this is clearly good news for AGL it is also a positive for Oil Search ((OSH)), as the AGL sale makes it easier to put a value on what Oil Search’s PNG assets are worth.
  • As Credit Suisse estimates, the AGL sale implies a full value for the PNG LNG project of around $24 billion, which means Oil Search’s stake is worth around $8.1 billion or in the order of $7.25 per share. Merrill Lynch is even more positive with its valuation, with the broker estimating the PNG project implies a fair value for Oil Search of $8.16 per share, while UBS’s valuation on the stock has increased to $9.20.
  • In Merrill Lynch’s view, the news validates the project and this means it is now all but certain to go ahead. It also makes Oil Search a potential takeover target, according to the broker, as the price for AGL’s stake implies an amount equal to a long-term oil price of US$70 per barrel, while the current Oil Search share price is equal to a long-term price of closer to US$50 per barrel.
  • Supporting its case, the broker points out Oil Search currently holds a visible resource of around one billion barrels of oil equivalent in PNG, which in enterprise value to barrels of oil equivalent terms equates to just US$3.30, which compares to a cost of around US$18 per barrel of oil equivalent to find and develop a resource. Given it is much cheaper to buy reserves than to develop them, the broker sees the company as a potential target, notwithstanding the PNG Government’s 17.6% stake.
  • Even those less bullish on the Oil Search story such as GSJB Were see the AGL deal as providing a valuation uplift, as its see through valuation is now in the range of $6.75-$7.75 per share. Although, risk remains to the upside given Oil Search has a larger and therefore potentially more valuable stake in the project than what AGL has agreed to sell.
  • Where the broker differs from others in the market is that while it agrees the deal signals an appreciation by the buyer of the long-term value of the project, it doesn’t expect this will be priced into Oil Search in the shorter-term. As a result, the broker retains its price target of $4.80, which is by far and away the lowest in the FNArena database.
  • The average price target for Oil Search according to the database is $7.03, with Merrill Lynch leading the way with its $9.09 target. The broker points out any takeover for Oil Search could see an even higher price achieved, while even without this it estimates the company should be able to deliver a steady 10% in annual share price appreciation as it gradually monetises its PNG resource.
  • As Citi summarises, the AGL deal increases the value of Oil Search by lifting the value of its PNG gas assets, while it also reduces the equity risk associated with the project and with corporates clearly taking a long-term view of the value of such projects investors should ignore it at their own risk. This fits the general view of analysts, as the FNArena database shows nine Buy ratings and only GSJB Were with a Hold recommendation.
  • Today, shares in Oil Search are unchanged in a weaker overall market and as at 11.15am the stock was trading at $4.30, which highlights the upside potential given an average target of more than $7.00. As an example of this, the stock is currently more than 40% below Macquarie’s price target of $8.18. Over the past 12 months Oil Search has traded between $2.95 to $6.93.

Some interesting implications:

  1. OilSearch LNG project has yet to start construction, yet already valued at $24B (or even higher by Merrill)
  2. 1B BOE is equivalent to 6Tcf of natural gas reserves, this is something IOC might very well be able to match shortly (or exceed if things go well at Antelope1)
  3. InterOil’s two wells already flow more gas than all of OilSearch combined and can already provide up to 40% of an LNG facility. For instance, Marathon has an LNG facility in Equatorial Guinea that produces 180Bcf of LNG a year. Elk1&4 produce 200MMcf+ a day, easily 1Bcf in five days, so that would be 75Bcf a year already.
  4. OilSearch might be ahead in terms of securing finance for the LNG and proving reserves, but once IOC secures those, the valuation gap wich is almost ten times in OilSearch favour (and if you read the above article, there are many that say that OilSearch is heavily undervalued as it is) will close rapidly, especially considering the fact that Elk/Antelope is condiderably cheaper to develop because it’s a lot closer to the planned LNG facility and the wells flow at much higher rate, making far less wells necessary.
  5. Do people notice that a mere 3.6% stake in a yet to be build LNG facility on PNG sells for hundreds of millions today. They haven’t even started construction. As it happens, IOC holds a 30% stake in just another of such planned facilities..

Tags: IOC