RayJay

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IOC: Prime Minister Backs 3.8+ mtpa LNG Project, Endorsing IOC's Long-Held View

Recommendation. Our positive stance on InterOil is predicated on its long-term cash flow potential and the expectation of near-term catalysts. This is balanced by the operational, cost, timing, and political/regulatory risks as the upstream assets and processing infrastructure (LNG and condensate) are developed. We see multiple near-term catalysts, including an LNG partnership (incorporating a resource selldown) with an international company, followed by the final investment decision (FID), though we again caution investors from having overly rigid expectations as to timing. We reiterate our Outperform rating.

* It's official: initial 3.8 mtpa targeted. With better than expected refining results, adjusted 3Q12 EPS of $0.05 beat our $(0.16) estimate. Much more impactful news, however, is on the LNG front. In light of the government's plans to purchase an additional 27.5% of the Elk/Antelope resource (see our October 16 brief "Portion of Elk/Antelope Gas May Be Sold to the State for Power Generation", the company is now targeting "foundation" LNG plant capacity of 3.8 mtpa (or slightly larger), rather than the 8-10 mtpa originally planned. A smaller plant has always been InterOil's preference, given the accelerated timeline, comparative ease of financing, and the more competitive bids from potential partners - management noted that this phased approach is favored by all of its potential bidders.

* Prime minister gives verbal approval. One of the most common questions we hear from investors is whether a partnership agreement is needed before getting government approval, or if the reverse is true. While management confirmed (again) that either sequence is acceptable, today they definitively leaned towards the latter, noting that they expect to "select and transact with an LNG partner swiftly following the formal approval." To that end, management also confirmed two rumors. First, Prime Minister O'Neill did indeed verbally approve the project as outlined above, though the formality of full cabinet approval remains. Second, there are at least two confirmed bids from supermajors.

* Drilling update. Rig 2 spud the Antelope-3 delineation well on September 30 and is now down to 5,060 feet. The company is targeting a total depth of 8,366 feet before testing; we expect results early next year. Meanwhile, Rig 3 is currently being mobilized to the Elk-3 delineation location - the last commitment well for PRL 15 - with a spud date targeted by the end of November. A revised resource estimate will be released, as is the norm, in early 2013, and we think it will include some credit for the recent Triceratops discovery.

Valuation. Our "de facto" proved NAV estimate of $98.54 per share comprises a sum-of-the-parts valuation of each of the business segments, as detailed on page 2. Our target price is $100, in line with the NAV. To restate an important point we have often made in the past: the resource value embedded within the NAV ($1.00/Mcf for the Elk/Antelope field's gas resource) is a largely hypothetical "guesstimate" that reflects the absence thus far of tangible market multiples for Elk/Antelope. Once the partnership and associated resource selldown are announced, we will be able to "mark to market" our NAV accordingly.

[Palm]

Nice. Thanks STP