Another nice research update here..

Sal Ilacqua: IOC Update

InterOiil Corp (IOC – BUY – $37.06): On June 4, InterOil announced the sale of 2,013,815 shares of common stock to institutional investors at $34.98 per share in a “registered direct” offering. Proceeds of $70.4 million will be used to accelerate development of the Elk/Antelope gas condensate field and other corporate activities.

Investors should look upon this cash infusion as another step in the continued strengthening of IOC’s overall finances that should lead to an acceleration of both drilling and other corporate activities. Both a second drilling rig and a workover rig are planned for the near future. A strong balance sheet should also enhance the company’s position in the ongoing negotiations with numerous potential strategic partners in a proposed LNG export facility in Papua New Guinea. There is considerable industry interest in both the development of recent discoveries as well as the exploration potential in IOC’s extensive acreage interests.

In our opinion, the basic financial and operating situation at InterOil has improved dramatically over the last twelve months, and the potential for incremental growth in hydrocarbon reserves appears better than ever. For the first time in recent years, IOC will have ample cash resources on hand as well as access to additional outside finances if needed. The recent retirement of $79 million of convertible debentures will reduce annual interest costs by about $6 million. Refining/ marketing activities may well continue to generate $10-$15 million per quarter, about in line with this year’s first quarter.  As of March 31st, the company had $42.6 million cash plus $17.1 million restricted. Add about $70 million of new cash and the till is temporarily overflowing. The current debt to capitalization ratio should be in the low teens, as opposed to 68% a year ago.

Recent drilling results continue to be very promising. The upper portions of the Antelope I well flowed an impressive 382 million cubic feet of natural gas equivalent per day on test, and in the lower part of the well, two separate side tracks have encountered considerable oil. The oil content of these side tracks as well as the acreage separating the wells have yet to be fully tested, but the preliminary indications appear to be very encouraging. We look for additional test data within the next few weeks.

Overall, we believe IOC has now accumulated the equivalent of about 5.0 trillion cubic feet of natural gas, which in a stranded location like PNG, could be valued at $1.00 per MCF or $5.0 billion. We assume that IOC’s total drilling outlays to date have been in the area of $150 million which underscores the risk/rewards that flow from a successful frontier discovery.

While the above noted valuation attached to a gas condensate discovery is noteworthy, any meaningful oil discovery would change the valuation dynamics because of the much smaller lead time to attain some production cash flow. A natural gas liquids stripping operation would seem a minimum expectation in 2010 and there could be more.  In our opinion, the longer term open ended possibilities at InterOil continue to be compelling.