Not mutually exclusive, it’s what we did at first as well..

• Following yesterday’s 12% sell-off in InterOil shares – not prompted by any drilling or other operational announcements – we take this opportunity to provide an explanation of what we think happened. Recall that last Friday, InterOil announced that it is now able to force-convert its 8% convertible debentures into common stock, given that the shares had traded above $32.50 for 15 days. While the company has not provided a specific timetable for conversion, we would not be surprised if at least some of new shares have already been issued. Given that some selling by former bondholders associated with the conversion process is to be expected, that would certainly help explain the unusual weakness in the shares. And there is also the possibility that the initial weakness may have triggered some technical selling activity, which of course would only accelerate the decline.
• Conversion involves the issuance of 3.16 million common shares, but here’s the key point we would underscore: There is no increase in the fully diluted share count, because it has already included these shares. The basic share count will increase, but because it’s the fully diluted share count that we (and most investors) use for financial modeling purposes, there is no incremental dilution. From a balance sheet perspective, InterOil’s leverage metrics will decrease after conversion. For example, the long-term debt-to-cap ratio declines by half, from 34% as of 1Q09 to 17% on a pro forma basis.
• In addition to the direct financial benefit to the company – saving cash on interest expense of roughly $6.3 million per year based on the $79 million of debentures that were outstanding – one other benefit of conversion may be to reduce short interest in the stock, given that in the past a sizable portion (we would argue the majority) of the short interest was associated with the convert.
• The conversion process should not distract investors from the much more fundamental near-term (three- to six-month) catalysts that we foresee. Over the next several weeks, we expect to get final testing data from Antelope-1, providing further clarity not only on the oil potential but also the high condensate levels, including the prospects of a liquids stripping facility. This will be followed by the drilling of Antelope-2. Of course, an asset monetization transaction remains on the agenda, though naturally, there is no firm timeline for it. That said, we think the process (ultimately involving multiple partners) should wrap up by year-end, with initial announcements made as early as this summer. Following a multi-phased transaction, we believe InterOil would have sufficient capital to fund further exploratory and development drilling operations for the next several years. We reiterate our Strong Buy rating.