Daily Distortions on InterOil no 5

This series is both sad and funny. It’s sad to see people making a full-time job out of distorting anything they can lay their hands on, but the efforts are often quite funny as well. You can find our first two examples here, the next two here. Now, the next instalment.

Distortion #5

We already mentioned it in the previous episode:

  • “Actually Wayne had an IOC price target of 100$ 3 years ago.” Since 7.5% of Elk was sold a year ago for a price that implies a lot less than $100, I’d say that this means he’s not credible. [Bostonkenmore]

We’re not sure about that old Wayne Andrews (the analyst from finance house Raymond James that follows InterOil) price target of a $100 (we think it might have been as high as $70, the present target is $65), but the relevant part here is that supposed sell-off of a 7.5% stake in Elk.

Here is the initial post:

  • On May 24th 2007, a little more than a year ago, Interoil released an option agreement with investors led by Clarion selling 7.5% of Elk for $57.5. This was an option contingent on a successful drill at Elk2. The drill wasn’t successful so the agreement was never signed.
  • For those of you counting at home this would value Elk at $766M. Of course Interoil would owns about half of Elk so that means a $383M valuation for Elk.How can Interoil be worth more than three times that? Never mind the several times that that $60 implies? Inquiring minds want to know. [Bostonkenmore]

And we promise you, inquiring minds are about to find out, and it will show that this person is once again, how shall we say politely, wide off the mark. It’s not surprising. His guru Jaxson905 writing at the value investors club (VIC), those with the $0-3 price prediction and that odd ‘collapsing well’ theory, was on it as well.

That Jaxson905 actually calculated what he thought would be the implied value for IOC:

  • Based on the VERY SPECIFIC ownership interests given here, this deal values IOC at $13/share [Jaxson905]

Here is the actual press release, May 24, 2007 —

  • InterOil Corporation (TSX:IOL) (AMEX:IOC) (POMSoX:IOC) today announced that it has signed option agreements with a strategic industry partner and a financial investor covering a combined 7.5% participation interest in the Elk gas discovery (“Elk”) and 5% participation interest in a proposed liquefied natural gas (“LNG”) project, all located in Papua New Guinea. Entry into final agreements is contingent upon confirmation of the Elk gas reservoir through successful drilling and testing of the Elk-2 well that is currently being drilled.
  • Under the option agreements, the companies have agreed to deposit funds totaling $57.5million into escrow accounts as a sign of good faith to secure the right to negotiate definitive agreements for the interest in Elk, the LNG project and LNG supply.
  • “We have a preliminary understanding with both parties, including terms, and the next step is to negotiate definitive agreements,” InterOil Chairman and CEO Phil Mulacek said. “We expect to conclude the negotiations and have final agreements documenting the terms and conditions over the next several months.”
  • The industry partner, who has extensive LNG experience, has agreed to deposit $42.5 million, in escrow, for the option to purchase a 5% interest in Elk, a 5% interest in the LNG project and rights to a portion of the LNG supply. Clarion Finanz A.G., a Swiss investment firm, has agreed to advance $15.0 million for the option to acquire a 2.5% interest in Elk. In the event that final agreements are not signed, the deposited and escrowed funds will be refunded. All the dollar amounts in this news release are stated in U.S. dollars. [Sedar.com; you have to click the May 24 2007 entry]

Now, the only way Jaxson could arrive at an implied value for IOC of $13 per share on the basis of this agreement is to take the deposited money ($57.5M) as representing a 7.5% value in Elk. You end up at roughly $766M and deduct third party interest in Elk and then devide by the number of outstanding shares (he attaches negligeable value at IOC’s other assets).

Now, read again the PR carefully:

  • It says ‘option agreement’, what these investors are buying is a right to negotiate
  • That $57.5M in escrow is in no way related to the terms (these hadn’t even been concluded at that time), it’s just a sign of good faith, basically, it’s a sign that these investors are serious, it’s money that gives them first place in line for negotiation
  • Valuing Elk, which at that time had an estimated gas between 3.1 and 15.7Tcf at $766M (and getting a 5% stake in the proposed LNG facility to boot) is, well, quite ridiculous. Taking the low end of that estimate (3.1Tcf) and valuing it as low as, say $1 per Mcf (while other deals in the area go for $4.75 per Mcf and gas trades in Asia close to $20 per Mcf) one would arrive at $3.1B.

So we once again see, these people like to distort. We’ll have another example of that in the valuation of IOC’s 9M acres with 40 promising drilling sites. Even before finding any gas, investors paid $125M for just 25% of 8 out of those 40 drilling prospects. Doing some sums on that is pretty interesting.