And yet another research outfit gives its verdict…
IOC: What Investors Should Focus On in a Prospective LNG Partnership
♦ Following last week’s preliminary works agreement between InterOil and Mitsui for the condensate stripping plant, management’s focus can now shift entirely to the ongoing LNG partnership discussions. In our company brief on April 15, we outlined three key questions investors should focus on when evaluating an LNG partnership announcement, whenever it may come. Today, we elaborate on those three points and add a fourth one.
♦ Will it be a firm agreement? Perhaps the most overarching question is whether a partnership announcement represents a firm (i.e., definitive) agreement or only a tentative one. For example, a memorandum of understanding with Mitsui was signed in 4Q09, and it took four additional months to get to the preliminary works agreement. (Strictly speaking, what was signed last week is not a definitive agreement to proceed with the project – that will only come as the final investment decision is made in late 2010 – but it’s a considerably more tangible step than a memorandum of understanding).
♦ What multiple will be placed on the resource? From the standpoint of calculating a market-based NAV for InterOil, this is a central question. The simple reality is that there are very few transaction comps (either in PNG or elsewhere in the South Pacific) that are directly applicable to InterOil’s pending asset monetization. Furthermore, no two LNG projects are identical in terms of size, specific geography, economics, etc. Our current “de facto” proved NAV for IOC shares assigns a value of $1.00/Mcf for the gas resource, but as we’ve continually pointed out, it’s a mere placeholder. While the quantity of the Elk/Antelope resource is known from the third-party (GLG) report, the valuation that a prospective partner will be willing to place on the resource remains a question mark.
♦ Will InterOil receive cash upfront? In addition to the underlying valuation, it’s important to see whether a prospective partner will be willing to make an upfront cash payment to InterOil (as distinct from funding certain future costs along the way, as is the case with Mitsui). A cash payment would be seen as a positive in two ways: (1) it would represent a public vote of confidence in the project, above and beyond the partnership agreement itself; and (2) more substantively, it would provide the capital for InterOil to deploy its recently acquired second drilling rig.
♦ What are the partner’s capabilities? When thinking about who any given partner is, there are aspects that are highly relevant and others that are much less relevant. The most relevant aspect, in our view, is whether the partner has prior experience in operating an LNG liquefaction project. This is a skill set that, by definition, InterOil does not currently possess, and that therefore a partner would ideally bring to the table. The size and flexibility of a partner’s balance sheet is naturally an important point as well, since this will influence the project financing process. On the other hand, we don’t think the partner’s place of origin (e.g., China, Japan, U.S., Europe, etc.) is a major point. Also, insofar as the substantive capabilities are comparable, we don’t think it matters much whether InterOil partners with a private-sector company or a state-controlled enterprise.
♦ Our Market Perform rating continues to reflect our positive stance on InterOil’s long-term cash flow potential and likelihood of near-term catalysts, balanced by the substantial operational, cost inflation, and timing risks as the upstream assets, condensate project, and LNG plant are developed over the next five-plus years.