Raymond James on InterOil, September 30


IOC: It`s Official: Major Strategic Partner on the Way – Get Ready For Selldown [IOC093011b_093732];
Analyst(s): Pavel Molchanov, Cory J. Garcia; [Industry Classification: Energy/Exploration and Production];

InterOil Corp. – Outperform 2;
Companies Mentioned – IOC

* Rumors confirmed, bringing in strategic partner. InterOil has announced that it is soliciting proposals for an operating and equity partner in its LNG project, concurrent with a selldown of a stake in its Elk/Antelope resource base. The news confirms rampant speculation over the past week that began when PNG’s Sunday Chronicle reported that supermajor Shell (RDS.A) was attempting to strong-arm its way into the project by exerting its influence on key members of the government. While the rumor mill has obviously led to heightened investor uncertainty over the past week, the confirmation that a major partner will be brought into the project is objectively a positive development. And no matter the timeline of the project or what shape it ultimately takes, as the owner of the underlying resource, InterOil remains in the driver’s seat with regard to monetization.

* Capitulation? Actually, this had been the original plan. Press reports suggest that Shell has been attempting to undermine InterOil’s position since April. This pressure seems to have been effective in convincing PNG officials that InterOil should bring in a project operator with prior LNG management experience. However, it doesn’t substantively matter whether InterOil is bringing in a major partner under political pressure or doing it voluntarily – whatever the motive, the end result is a monetization of the underlying gas resource. In fact, investors will recall that the company’s original LNG development plan (throughout 2009) had been to bring in a major oil and gas company that would operate the LNG project and would take a sizable (25-35%) stake in the gas resource. After Henry Aldorf came on board, the strategy shifted, and InterOil decided to stay on as operator.

* Focus on the resource value. PNG is not Venezuela – the government has consistently supported InterOil’s resource development, and it is inconceivable that the gas would be confiscated or nationalized. (We are making this point to directly address concerns we heard from some shareholders.) The government is well within its rights to impose conditions on the project’s approval, such as the requirement that a project operator with prior LNG management experience be brought into the picture. Although that requirement seems to be new, it is not an unreasonable request. The government is not demanding that InterOil partner with any specific company (Shell or otherwise), which is why there will be a competitive process. If Shell (or any other company) wants to buy into the resource, they’re welcome to bid, and ultimately the two sides will have to agree on commercial terms. As we’ve often noted, gas resource transactions in Asia-Pacific have typically been done at $2.00/Mcf and up. Meanwhile, IOC shares are currently pricing in under $0.50/Mcf of 1P resource, and in our “de facto” proved NAV, we apply a conservative multiple of $1.00/Mcf. Thus, the intrinsic value of the resource is substantially higher than what is currently being priced in, and a major LNG partner writing a check to InterOil would provide tangible, unambiguous validation.

* Timeline risk. As we noted in our company brief from Tuesday, the only downside to bringing in another partner is a pushout in the project timeline. (This wouldn’t be unprecedented: remember, the FID deadline was moved following an agreement with Energy World and again after Samsung/FLEX). A delay in that key catalyst (officially targeted by year-end) is obviously unhelpful for investor sentiment, but again, it doesn’t alter the value of the gas. And FID may still happen by year-end, particularly if the strategic partner wants to be able to book the underlying reserves this year.