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Given the volatility in IOC shares and all of the noise on the InterOil story (i.e. political noise, Soros sale, LNG supply glut, etc.), I thought it might make sense to take a step back and try to look at InterOil objectively. In the following analysis, I attempt to look at InterOil from a few different angles to provide readers some insights or at the least, some entertainment. Admittedly, the first two of these angles are inter-related. However, for the sake of simplicity, I have attempted to analyze them on a standalone basis. Please also note that I tried to show various resource and valuation scenarios to give readers a sense of IOC’s potential. I know some of the numbers are big assumptions, but I thought some readers might appreciate the analyses nevertheless.

Angle #1 – Mergers & Acquisitions (M&A)

With respect to historical M&A activity, InterOil looks very cheap. Historical M&A in various LNG natural gas assets has been done at an average valuation of $2.20 per mcf (per Morgan Stanley). And the November 2011 transaction in Exxon’s PNG LNG project was done at approximately $3.18 per mcf. Currently, IOC shares are pricing in $0.60 per mcf.

What does this mean? Well, it means that historically industry players have ascribed much more value to LNG natural gas assets than the market (aka financial players) is currently ascribing to InterOil’s natural gas assets. In theory, the industry players should have a much better understanding of the value of the assets given that that they should be much more intimately familiar with similar assets. In InterOil’s case, I’m guessing this should hold true.

So the natural question is “What would prompt financial players to value InterOil’s natural gas assets more in line with industry players?” The answer here is simple, “A sell-down by InterOil of its Elk-Antelope project.” If InterOil can complete a sell-down at a valuation of around $2.00 per mcf, I think the market will finally acknowledge that IOC’s stock price is baking in too low of a valuation for its natural gas. Of note, a $2.00 per mcf valuation implies that IOC shares are worth $213 per share. Also noteworthy is the fact that a sell-down would most probably cause an instantaneous re-rating of IOC shares.

To further simplify this analysis, let’s assume that we know that IOC’s natural gas is worth $2.00 per mcf and the only question surrounds whether a buyer can be found. Moreover, let’s assume that if IOC cannot complete a sell-down, the stock is worth zero (which is a pretty ridiculous assumption). Taking those simplistic assumptions and the fact that IOC is pricing in $0.60 per mcf (whereas the gas is worth $2.00 per mcf), one can infer that the market is only pricing in a 30% chance that IOC completes a sell-down at $2.00 per mcf.

Given all of the LNG offtake deals in recent months, sustained high prices for LNG into of Japan, rising demand from Japan and China, the increasing dayrates of LNG transport vessels, among other facts, it seems that the 30% implied probability seems too low. Add to that that Kogas was recently reported to be joining forces with Mitsui and company to make a bid to InterOil, the 30% probability seems that much more inappropriate.

Note: The analysis above assumes zero value for IOC’s condensates, its refining and distribution assets and its acreage position.

Angle #2 – The “InterOil Discount”

As I already mentioned, InterOil shares are currently pricing in $0.60 per mcf and the recent transaction involving the small stake in Exxon’s LNG project was done at ~$3.18 per mcf. So essentially, the market is discounting IOC’s project by 81% simply because it is an InterOil project and not an Exxon project. Does an “InterOil discount” make sense? I guess it does given that InterOil doesn’t have the deep pockets that Exxon has, nor does InterOil have the LNG operational expertise. But it’s debatable whether the 81% discount is appropriate or excessive.

That said, I thought it might be interesting to look at the valuation disparity a different way. In theory, InterOil’s natural gas valuation can increase by a factor of 5.3x if the “InterOil discount” goes away. That begs the question, “What can eliminate the InterOil discount?” The answer to this is easy, “A partnership with a super major (SM) oil and gas company.” That super major would undoubtedly have better access to project funding and operational expertise and the “InterOil discount” would no longer be warranted.

Most of us know that InterOil is on the cusp of bringing on a “world-class” LNG partner. When this happens, I would expect IOC shares will not reflect a valuation of $0.60 per mcf anymore, but instead something much higher. My personal assumption is that the signing of a SM partner will cause IOC shares to reflect a valuation of between $1.50 to $2.00 per mcf. That translates into an IOC stock price of $160 to $213 per share.

Taking into account that IOC shares are pricing in $0.60 per mcf and assuming that InterOil’s natural gas should be worth $3.18 per mcf if InterOil can get a SM partner with LNG expertise and completely eliminate the “InterOil discount”, one can see that the market is implying that the chances that the “InterOil discount” is eliminated is only about 19%. Given the fact that InterOil has hired Morgan Stanley, UBS and Macquarie to find it a partner and that InterOil management has stated repeatedly that there have been strong indications of interest, 19% seems excessively low to me.

Notes: To simplify the analysis above, I omitted the fact that InterOil’s project has much better economics than the Exxon project and that Exxon’s project is further along than InterOil’s project. I also omitted the fact that InterOil project does not have the landowner issues that the Exxon project has.

Angle #3 – Triceratops-2 (T-2) Re-Rating Potential

For this angle, let’s assume that the market is correct and InterOil’s natural gas is only worth $0.60 per mcf for whatever crazy reason you want to make up.

GLJ’s independent engineering evaluation concluded that the best case estimate for contingent resources for the Elk-Antelope field was 8.59 Tcf. Knowledge Reservoir (KR) has estimated that the reservoir that Triceratops-2 is targeting contains 4.59 Tcf in the “most likely case”. If KR is correct, InterOil will soon have a total of 13.2 Tcf of natural gas resource. Applying a valuation of $0.60 per mcf would imply a stock price of $99 per share for InterOil. (Applying a $1.50 per mcf and $2.00 per mcf valuation would result in a stock price of $245 and $235 per share, respectively.)

Should T-2 be successful and add another 4.59 Tcf to contingent resources, the likelihood that IOC’s stock price does NOT move is extremely low in my opinion. If InterOil is found to have 13.1 Tcf and the stock price stays at the current level of about $67, the implied valuation for the natural gas would be only $0.40 per mcf. I think that is highly-unlikely when considering that the average valuation for InterOil’s natural gas over the last year has been $0.54 per mcf ($59.30 per share). As a reminder, the last 52-weeks harbored Greek / EU crisis / panic, the PNG Prime Minister debacle as well as a PNG mini-mutiny. At the 52-week low of $34 per share, IOC’s natural gas was valued at $0.30 per mcf. Assuming 13.1 Tcf of resource is valued at $0.54 per mcf, I calculate a stock price of $89 per share.

Note: KR’s assessment of the T-2 reservoir was made before the Phase 3 seismic on the reservoir was completed and analyzed. Based on commentary from IOC and some speculation, some believe that T-2 could be 2-4 times as large as Elk-Antelope. If one assumes that T-2 results in 2x times the natural gas resource of Elk-Antelope, total natural gas resource would total about 25.8 Tcf. At $0.60 per mcf, IOC shares would be worth $192 per share. At $2.00 per mcf, IOC share would be worth $633 per share. If T-3 is 4x the size of Elk-Antelope, there would be 43 Tcf of natural gas and IOC shares would be worth $318 per share (@$0.60 per mcf), $790 per share (@$1.50 per mcf) and $1,053 (@$2.00 per mcf). Clearly these numbers are mind-boggling and based on some very big assumptions. Nevertheless, I thing the figures give us a sense of the magnitude of upside in InterOil shares.

Special Thanks

Thanks to Shareholders Unite and petreng1 for some the information and data I used in the analyses above.