Thanks! First, let me say that my calculations don't account for the time value of money. Theoretically, one should make an adjustment, but we are talking only 1 year of time value and interest rates are low, so I decided to keep the analysis simple and ignore that aspect.
That said, the implied probability is calculated by dividing the "Implied Option Value (aka CVP payment)" by the "Additional Payment" for any particular resource scenario. For example, let's use the 7.2 Tcfe scenario. If we knew with 100% certainty that the certification could result in 7.2 Tcfe of resource (no more and no less), the market should theoretically value the Option Value (or CVP) at $7.07 per share. And IOC should be trading at $52.07 per share today...
But IOC is not trading at $52.07 per share today. It's only trading at $49.20. So that means that the market is only ascribing $4.20 of value to the Option Value (= $49.20 - $45 base payment). And because $4.20 is less than $7.07 (the 100% certain scenario above), we know that the market is pricing in a probability that is less than 100%. To figure out the exact probability, we divide $4.20 by $7.07 and get 59%. Hope that helps!
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Sage - thanks for the reply. Rates for time-value can be many things - bank interest rates, cost of capital, alternate investments and others. Considering risk, I would, for myself, use 15%. But that's me. Many blue chip companies-Exxon, Proctor& Gamble. IBM, etc, have returned about 12-18%/year for the past 20 years (dividends re-invested). I'm in the stock now, so as an alternate place for that money, I wouldn't use current interest rates. However, as you point out, it's only a year or so, presuming A7 isn't lost, blows out or even gets drilled timely (no board room fights). Still, there's some significance between $7.07 and $6.14(7.07/1.15)
As to probabillities, the $4.20 is the market's discounted(present value), risked sum of ALL outcomes. In your example, if $4.20 is the result of a 59% probability of 1T, why does the market give no value to the other 41% better outcomes - 2T, 3T, 4T?
In fact, I don't think it's possible to assign probabilities, a priori, just from the stock price premium. However, I like the concept. It's a good way to think about holding or buying the stock for the CVR. Even if your probabilities are wrong, they're not bad as a POSSIBLE distribution. Exxon, I'm sure, have already got it cold in terms of possible outcomes. Of course, they have their own maps, they've reprocessed the seismic with superior technology, they've re-interpreted the whole thing.
We, on the other hand, have zip. Still, there are some minor clues - Botten's remarks and the 10.2T cap, indicating results in A7 could give a good uplift in resources. Or they could be smoke.
A key issue is WHEN we get the Exxon stock. My assumption is when the deal closes, we get Exxon stock and a non-tradeable CVR, then wait for the CVR to mature. I don't mind holding a $4 CVR if I like my chances, but if I'm required to hold $49 for a long time, my return changes a lot. Does anyone have any insight?
