Daily Distortions no.18. After we discussed two research companies came up with a valuation in the mid 60s (Raymond James) and the mid 40s (Nataxis Bleichroeder), we thought it might be a good moment to compare that with our distorting UCLA professor Eric Sussman. He didn’t disappoint us..

He likes to have a go at analyst Wayne Andrews from Raymond James (RJ):

• Whatever. He really has no credibility when it comes to IOC at this point. He issued a super strong buy (again, I don’t ever recall such a bullish announcement from an independent analyst) BEFORE the disappointing Elk-2 results were released, made no subsequent change whatsoever to his rating or model, and has not issued any additional reports on the company in how many months? It’s not a question of issuing reports “every time” the stock moves. It’s been months and months and months.
• The news that has been released, both in terms of Elk-2 and the additional (dilutive) financing, has not been positive. And he has nothing to say to investors? I guess the good news is that the stock is now trading at 25% of his conservative NAV! And if it was a super strong buy at 23, it must be a super-dee-dooper-super-super strong buy at these prices. [Eric Sussman]

We might have to remind people about those ‘disappointing’ Elk2 results:

1. They confirmed meaningful porosity and permeability at a place other than Elk1 putting ends to thoughts that the Elk1 results were due to natural fracturing because it’s located on a fault line
2. As a result of which, they could increase the resource estimate from 3.0-15.5Tcf to 3.5-18.8Tcf
3. The disappointing part of the results is that the flowing limestone was below the water contact (it flowed 40.000b/d of heavily gas saturated water in a DST)
4. T Boone Pickens, industry legend and in possession of a masters in geology thought these results were good enough, apparently, as he bought 3M shares after these results were released.

So was there much reason for Wayne to downgrade? Not really. We also have to stress that Wayne’s valuation method is rather straightforward (see here for an extended treatment), although Sussman either doesn’t get it or doesn’t want to. RJ’s valuation, in short:

1. RJ uses a net asset valuation (NAV) method based on the midpoint of the gas estimates (6.9Tcf deliverable)
2. He deducts third party claims, risks it (50%, no less), so ends up valuing the gas at 37.5 cents per Mcf. Doing so RJ arrives at roughly $65 value per share (it’s now $63 because of some dilution)
3. Nobody can argue that this valuation metric (37.5cents) is nothing but conservative, gas reserves (with equal time scale for marketization) in the area go for almost $5 per Mcf.. It shows that there is, how shall we put it, significant upside if IOC’s reserves get a more official status..
4. Sussman (and others) slams him because IOC has not reached that valuation (and price) target, but all RJ argues is: we think there is at least a 50% chance (the risk factor) the gas is there, and we value it at 75 cent (unrisked) 37.5 risked
5. The delay is caused by the fact that (apart from possible short manipulation) the market is not convinced the gas is there (or wants to be assured), RJ has access to all the data, they think it’s there. We’ll see who’s right in the near future, but since RJ’s valuation is more than a year old, now that IOC has found a second resource, Antelope, he increasingly looks vindicated..
6. We also have to stress that the RJ valuation doesn’t include anything for the profitable retail business, the turn-around in the refinery, a possible liquids plant, 40+ other drilling prospects in land with two big finds already..

So to slam RJ for not hitting his target yet is a little premature, to say the least. It doesn’t stop Sussman:

• Yes, I am short a lot of calls in IOC, though I have stopped writing them lately. IOC might get a pop here with some good drilling news. But I think Wayne Andrews is profoundly whacked out of his mind with his NAV and price targets. He is out of his mind, all’s I can say. He has been for months and months and months and months, and he continues to pound the same drum. I really wonder what would cause him to reassess his model and analysis… [Eric Sussman]

We asked him once, after he posted another bash at , what he thought IOC was worth

• Anyhow, you asked me in one of your recent posts what a certain amount of gas is worth. That is an impossible question to answer with any precision, since it is completely theoretical at this point. IOC has no gas to sell, so the value is really the option value of what their studies, reports, etc. show right now. And, that in turn depends on any number of possible variables that are really impossible to quantify. IOC is a total and utter gambler’s stock. You, Getdirt, and the others like to gamble…or have other interests here. [Eric Sussman]

Whether it’s theoretical or not depends on the geological interpretation, we merely asked if they had gas, how much would it be worth. Let the geologist fight over how much gas there is (it’s almost certainly a lot), the valuation process itself is very simple. Not according to Sussman:

• And anybody in finance would tell you that the valuation model used would include many, many assumptions, and be very, very sensitive to the assumptions used in such circumstances, necessitating sensitivity analyses (could do a Monte Carlo simulation for different possible outcomes).
• We are talking about a multivariable, binomial (or lattice-based) model, like that used to value options, since that is what we are dealing with at some level. I assume your background is not in finance, stp, so perhaps you might want to ask someone who works in finance how they would value something like this, where there is not a ready market. And I am not talking about Getdirt, or any other long here, but someone in finance, and see what they say… [Eric Sussman]

Well, Sussman is in finance, and this is what he argued. However,  we think other specialities are called upon:

1. Geology to determine how much gas is there
2. Energy industry experts: how are these valued in comparable situations

We have a feeling that both arguments favour RJ…

It also seems to have escaped Sussman’s attention that energy companies are largely valuated based on their reserves. All that RJ did was, based on the geological data, say that they tought there was a 50% chance of IOC having 6.9Tcf of gas. Valuing that is quite simple.

And even Nataxis Bleichroeder, who doesn’t use an NAV model which Sussman so abhors, comes up with a $45 price target..

Sussman has strong beliefs though, you cannot fault him for a lack of these:

• I do not believe that IOC and its ML partnership will ever build an LNG plant in PNG, and that IOC will eventually file for bankruptcy. That is what I believe. I think your “if-then” statement is about as profound an oversimplification as I can imagine. Unfortunately, we may have to wait until 2015 to know for sure…though I have this feeling we won’t have to wait that long. [Eric Sussman]

A man of strong convictions! The question is, on what are they based? Surely not Monte Carlo simulations..