Teasing out a pattern, wagers, incentives and rights to first born..

We wrote, after an exposé of a highly appreciated poster on Yahoo, about Civelli’s rather cheaply gotten 2.5% option on Elk/Antelope in exchange for $25M in cash, 2.5% of the yet to be build LNG plant, and a pro-rata part of the exploration cost (a grand total of $29M). It is difficult to have an opinion on matters if one doesn’t have all the facts, but after exchanging ideas with people and reflecting on it, we do think we can discern something of a pattern.

Two issues seem to play a central role, one pretty obvious, the other perhaps less so:

1. Risk/reward. Clarion has been an early investor putting his capital on the line
2. Clarion seems to be in a bigger hurry than InterOil

Let us explain. Clarion Finanz has put capital on the line from an early stage, when InterOil was a very risky position. It is quite common for early stage investors to take a significant part of the spoils. This is all risk/reward. You as a shareholder might not like it, but that’s how it is. Someone compared it to a Venture Capital fund, and that doesn’t seem unreasonable to us.

One also has to keep in mind that at least on one occasion, Clarion was absolutely fundamental in saving the company when Merrill Lynch put on the squeeze on InterOil (the maturity of a large loan was approaching fast) and also when ML, when the credit crisis hit and they were taken over by Bank of America, backed out altogether.

Now, the second issue is quite a bit more sketchy and speculative, but we’ll have a go at it as something of a pattern is emerging. The 2.5% option (originally on Elk alone) was exercised on favourable terms, but that’s partly the result of the fact that 2.5% in an LNG plant that only existed on paper wasn’t worth very much.

However, if that LNG plant gets to be build, such a 2.5% share is worth a lot more, so the deal won’t nearly be as onerous. Apart from that, the more interesting part to take away in our view is that it served as a bit of a wager.

It seems like Civelli saying to Mulacek something like “hey, ok buddy, if you’re so certain that LNG plant gets to be build here is the deal. You gave me a 2.5% option on Elk back in 2007. I saved your ass a couple of times and since most of the gas (96%, according to a knowledgeable poster, based on the GLJ report) sits in Antelope rather than Elk, it’s only fair to change those option terms. And if you’re so certain that LNG plant gets started, I’ll give you a 2.5% stake (and $25M) in exchange.”

The reassuring thing is that Phil took this wager.

That there recently has been a similar kind of wager reinforces this interpretation (although it doesn’t elevate it into the realm of certainty, only into the realm of the probable). Clarion lent InterOil $25M recently, on rather onerous terms (which amount to almost a 20% interest rate). If that loan is not repaid by Januari 31 2011, Clarion has a right to the collateral, another 2.5% stake in Elk/Antelope.

We think Mulacek didn’t want to go to the capital markets as he expects money from deals comes in sooner rather than later, so he was looking for some kind of bridge loan, and Civelli once again seemed to have called his bluf. “Hey, if you’re so certain, you won’t mind putting a 2.5% stake of your fine resources on the stake. And while you’re at it, give me a 10% rate and a $1M fee as well.”

And once again, Mulacek took the bet. “I’ll show you. You’ll just wait and see..”

For those who think this is improbable, we have two arguments:

1. It’s two events that are, in essence, very similar. Civelli calling Mulacek’s bluff, and Mulacek taking up the wager. Although already quite strong, it also reinforces Mulacek’s incentives to ‘get on with it.’
2. What’s the alternative explanation? That InterOil is so desperate to get finance that they had to run to Clarion and give them these onerous terms. That’s what the shorts want you to believe, but one look at InterOil’s balance sheet and an even perfunctory reading of GLJ’s resource assessment will rubbish such reading. We can’t think of any other reading.

Now, you might not like this as a shareholder (and we have some reservations as well, to be honest), but we don’t think it will come to giving Clarion another 2.5% stake in Elk/Antelope. Why?

• Mulacek, at least, is confident he will have a deal providing finance before January 2011, otherwise he would not have taken this wager
• Even if that doesn’t happen, InterOil has other means to get finance. Facing the choice of using the recently extended shelf-finance and forking over another 2.5% stake in the crown jewels, surely the former route will be taken..

We think  timing of deals, which depend on negotiations, the outcome of which are uncertain is difficult, but at least Mulacek seems to be confident. Keep in mind that missing self-imposed deadlines is not the disaster as some try to portray, it’s only missing a self-imposed deadline, nothing else. The Elk/Antelope resource is good enough for third parties to have a strong interest in, we haven’t seen any, let alone convincing, argument against this.

Why does Mulacek seem so confident he can do it before January 31 2011? Here’s one idea. What if InterOil auctions off a couple of those 2.5% stakes, or drilling rights? Isn’t that a near surefire way to have almost guaranteed finance?