RJ -IOC:3rd-Party Stake in E/A Bought @ Bullish Multiple-Dilution overhang eliminated

[Rob Cos]

IOC: Third-Party Stake in Elk/Antelope Bought at a Bullish Multiple 
Analyst(s): Pavel Molchanov
[Industry Classification: Energy/Exploration and Production]

* Following weeks of speculation, the Australian energy company Oil Search confirmed today that it is buying a 22.8% stake in the Elk/Antelope field. The seller is not InterOil directly but rather Pacific LNG, the main third-party owner in Elk/Antelope.

* Oil Search is paying $900 million upfront plus additional variable payments depending on the amount of resource. These variable payments will be calculated at $0.775 per Mcf for any 2C resource above and beyond 7 Tcf. The 7 Tcf figure is based on a year-end 2013 resource assessment by the independent reserve engineering firm Gaffney Cline. This is more conservative than GLJ Petroleum Consultants' year-end 2012 estimate of 9.9 Tcfe. Using the GLJ estimate, the additional variable payments would be around $0.5 billion.

* To be clear, InterOil is not getting any cash from Oil Search directly. But here is why this transaction still carries relevant read-through for InterOil. As has been known since December 6, 2013, the French supermajor Total is in the process of buying a 61.3% stake from InterOil in the same resource base, but almost all of the purchase price is comprised of as-yet-undetermined variable payments pending resource certification. Therefore, it is useful to extrapolate from the Oil Search deal value. Just based on the upfront payment Oil Search is making, Total's 61.3% stake is theoretically "worth" at least $2.4 billion. For context, InterOil's current market cap is $2.8 billion. (Above and beyond the cash it will receive from the resource selldown to Total, InterOil clearly has other assets: the refinery and retail network, which we estimate are worth close to $0.5 billion; InterOil's remaining ownership in Elk/Antelope; the Triceratops gas discovery; plus future exploration optionality.) To state the obvious, what Total will end up paying has nothing to do with how much Oil Search is paying - there is no direct linkage here. But until Total's resource certification process is complete, investors can look to the firmer economics of the Oil Search deal as a kind of proxy.

* The immediate benefit to InterOil - above and beyond the read-through from the deal's bullish resource multiple - is that it eliminates the need for InterOil to buy out Pacific LNG. (A few small third-party owners are remaining, totaling 1.6% of Elk/Antelope.) As such, InterOil's dilution risk associated with the buyout has been eliminated, and this particular overhang in the minds of investors should no longer be a concern.

* Finally, let us address the question about how much of a stake in Elk/Antelope will ultimately be owned by InterOil. Recall that the original plan was for InterOil to retain 30%. That could still end up being the case if InterOil and Total decide to reduce the stake that will be bought by Total. Alternatively, Total can buy the full 61.3% that was already envisioned, and InterOil would retain a proportionately smaller level of ownership. This has yet to be decided.

[Brew Swillis]

* Finally, let us address the question about how much of a stake in Elk/Antelope will ultimately be owned by InterOil. Recall that the original plan was for InterOil to retain 30%. That could still end up being the case if InterOil and Total decide to reduce the stake that will be bought by Total. Alternatively, Total can buy the full 61.3% that was already envisioned, and InterOil would retain a proportionately smaller level of ownership. This has yet to be decided.

Enter Woodside.