Here it is, highlights are from us.

IOC: Back-to-Back Profitability in 3Q08; New Year Brings Plateful of Newsflow

• As was pre-released in October, InterOil reported its second straight profitable quarter in 3Q08 – posting operating earnings of $0.20 per diluted share, handily beating our estimate of a loss of $0.14.  The upside this quarter came by way of nearly zero exploration expense, as well as lower G&A costs due in part to some favorable derivative gains.  Reported net income of $0.22 per share included a gain from the sale of non-core assets.
• The refining and downstream segments drove companywide EBITDA of $15.8 million (inclusive of corporate overhead, and emerging liquefaction and upstream business segments), just shy of last quarter’s record of $17.1 million, but more than double the 1Q08 level of $7.1 million.  Despite plummeting crude oil and refined product prices and hence volatile global refining margins during the quarter, the refinery delivered record EBITDA of $17.5 million, inclusive of a $7.6 million downward inventory revaluation. The company achieved record sales in its downstream segment, generating positive EBITDA of $600,000, also inclusive of a $4.2 million inventory revaluation.
• On a trailing 12-month basis, the refinery and distribution business combined to generate EBITDA of $65.8 million. Importantly, this exceeds our earlier assumption of an annual EBITDA run-rate of $60 million, which was the basis for the $16 per share “base case” valuation for the two cash-generating segments.
• Turning to the balance sheet, InterOil exited 3Q08 with cash on hand totaling $78.7 million ($31.8 million restricted), and the debt-to-cap ratio was 35%.  In addition to the prospects of continued positive operating cash flow, InterOil’s liquidity remains in excellent shape as the company moves toward the monetization of its world-class hydrocarbon discovery at Elk/Antelope.
• This was another strong quarter for InterOil, supporting our view of the value within its refinery and downstream business segments.  While drilling at Antelope-1 remains on track, we are looking toward a number of upcoming catalysts heading into 2009.  Our target price of $45.00 is conservative compared to our risked NAV per share estimate of $62.24. We reiterate our Strong Buy rating.
• Balance Sheet Update
• InterOil had cash on hand totaling $78.7 million at  the end of September – of which $31.8 million was restricted cash, mainly relating to its working capital  facility.  Alongside the emergence of profitability, the company entered into a number of transactions this year (detailed below) aimed at enhancing its financial flexibility, thus freeing up capital for its high-impact exploration program.
• In May, InterOil announced the conversion of $60 million of its previous $130 million credit facility, which was owed to Clarion Finanz, into common stock.  Shortly following this transaction, InterOil announced the close of a $95 million convertible offering to institutional investors, with the proceeds used to fully repay the remaining amount ($70 million) on this credit facility.
• In July, InterOil filed a shelf registration statement with the SEC (equivalent to a preliminary base prospectus in Canada) for the issuance of up to $200 million in debt, common stock, or preferred stock.  While not signifying an immediate offering, the filing provides the company the flexibility to issue securities at any point over a two-year period.
• Also during the third quarter, InterOil completed the renewal of its midstream working capital facility with BNP Paribas.  The overall facility limit was increased from $170 million to $190 million.
• On October 24, InterOil secured a $57.5 million revolving working capital facility from two local banks (Bank of South Pacific Ltd. and Westpac Bank PNG Ltd.) covering its distribution business segment.  We view this development as a sound vote of confidence from the local PNG banking system in the long-term viability and profitability  of InterOil’s refining and distribution business segments.  A further and potentially more significant benefit from the new credit line is the freeing of formerly restricted cash required  by the creditors of the company’s refinery inventory working capital facility.
• On October 30, InterOil announced an agreement in which Petromin PNG Holdings Ltd., a government-mandated investment entity, exercised the right to directly participate in the company’s Elk/Antelope field.  Through this deal, Petromin will not only provide an initial deposit to InterOil (which should be released from escrow in the coming weeks), but will also fund 20.5% of the costs during the development of the field.  Importantly, we believe this is the first time that the Papua New Guinea government has ever acquired an economic interest prior to the actual start-up of a project – a ringing endorsement of the government’s view concerning the viability of the Elk/Antelope field. The government’s participation in the field also has positive implications with regard to the prospects of closing the liquefied natural gas (LNG) project agreement by year-end.  Moreover, in the eyes of a potential strategic partner, the economic support (aligning of interest) of the PNG government in the development of  the field could be viewed as a comforting vote of confidence in the project.
• Upstream Update
• The highlight of the quarter came from the record flow  test at Elk-4, recording a flow rate of 105 MMcf/d of gas and 2,000 bpd of condensate from the well in early September.  The completion of production testing at Elk-4, alongside the boost in deliverability from the well, served to enhance our thesis that InterOil has discovered several billion dollars worth of hydrocarbons. At the moment, the reservoir data continues to be analyzed by a duo of third-party engineering firms, with final results anticipated by year-end and potentially dovetailing with the initial results from the Antelope test currently underway.  The company is furthering its appraisal of the resource potential at Elk/Antelope in order to improve the likelihood that it may receive a sales price comparable to recent transactions in the region, which have valued reserves in the ground on a 3P (possible reserves) basis in the range of $1.60-2.50/Mcfe.  For reference, the benchmark transactions came from ConocoPhillips (COP/$49.08), which purchased an interest in Australian-based Origin Energy; as well as the recent sale by AGL Energy of its 3.6% interest in the ExxonMobil-led (XOM/$72.65) PNG LNG project.  In other words, we believe that two wells in the Antelope fault block would serve to materially increase the 2P (probable reserves) estimate for the structure and dramatically enhance the overall value of any transaction with a potential strategic partner.
• Following a multi-phase sale consisting of a 20-25% interest in the Elk/Antelope reserves and a 10% interest in the LNG project, as indicated by management, we believe InterOil would have sufficient capital to fund further exploratory and development drilling operations for the next several years.  Additionally, this transaction has the potential to create an implied “industry” valuation several-fold higher than the market’s current valuation of IOC shares.
• As year-end approaches, we should also gain greater clarity into the various monetization options for the high condensate levels encountered in the Elk and Antelope fault blocks, namely the prospects of a liquids stripping facility. While looking at a 2013/2014 time line of the LNG project, the construction of a liquids stripping plant (with a 12-18 month lead time) would greatly accelerate near-term cash flow for the company.  Lastly, we look forward to further drilling reports from the company’s Antelope-1 well, as well as further delineation and exploration plans for the next several wells.
• Finally, while everything seems to take longer in Papua New Guinea, we have become increasingly positive regarding the progress made by the company and value creation in the upstream and liquefaction business segments.  However, the stock continues to trade at a discount to our “base case” valuation of the refining and distribution business segments, despite the demonstration of profitability over the past few quarters.
• With plenty of cash on hand, government support on  domestic energy projects, and anxious industry partners making sizable investments in LNG infrastructure and upstream ventures, we believe InterOil will be able to successfully unlock the value of its PNG assets through its monetization efforts.  As such, we reiterate our Strong Buy rating and $45.00 target price.