RJ – IOC: 3Q11: Talks with Strategics Continue on Selldown and Project Operatorship
Recommendation. Our positive stance on InterOil is predicated on its long-term cash flow potential and the expectation of near-term catalysts. That’s balanced by the operational, cost, and timing risks as the upstream assets, condensate plant, and LNG plants are developed.
We see multiple near-term catalysts, including the final investment decision (FID), additional offtake deals, and the spudding of the Triceratops-2 well, though we would again caution investors from having overly rigid expectations as to timing. We reiterate our Outperform rating.
♦ Inventory charge leads to 3Q loss. While quarterly earnings are irrelevant at the current stage, the 3Q11 loss of $(0.41) came in below our estimate of $(0.15). Solid downstream results offset weak refining margins; the main delta came from a non-cash inventory charge due to the decline in oil prices toward the end of 3Q. Now on to the fun stuff.
♦ No substantive update on partnership talks. Heading into the call, it would appear that some investors anticipated that this would be the “big day” – i.e., the announcement of a major international energy company being brought into the LNG project as the operator.
To be crystal-clear, we had no such expectation. In fact, it has never been InterOil’s modus operandi to use earnings calls as a forum to make big announcements. Similarly, we are not surprised that management refrained from providing details on the ongoing talks with prospective partners (other than reaffirming the target for reaching FID by year-end).
We are not naïve – we understand that the market wants more information, and frankly so do we. But it’s simply not realistic for InterOil – or any other public company – to provide a “play-by-play” update on sensitive, confidential negotiations.
♦ Resource selldown: key milestone coming up. At the risk of rehashing old news, let’s recap. On September 30, InterOil announced that it is seeking proposals for an operating and equity partner in the LNG project, concurrent with a selldown of a stake in the Elk/Antelope resource base.
It doesn’t really matter whether InterOil is doing this under political pressure or doing it voluntarily, as long as the end result is a monetization of the resource. As we’ve often noted, gas resource transactions in Asia-Pacific have typically been done at $2.00/Mcf and up.
Just yesterday, in fact, Japan’s Marubeni bought a 1% stake in the PNG LNG project operated by ExxonMobil for $298 million, valuing the project at ~$30 billion. Meanwhile, IOC shares are currently pricing in under $0.40/Mcf of 1P resource, and in our “de facto” proved NAV calculation, we apply a multiple of $1.00/Mcf.
Thus, the intrinsic value of the resource is substantially higher than what is currently being priced in, and a selldown would provide tangible validation.
Valuation. IOC is currently trading at 44% of our “de facto” proved NAV per share estimate of $104. While recognizing that valuation is not very meaningful until FID and/or a resource selldown, the 44% figure can be loosely compared to a median of 160% for mid and small-cap production-stage E&P companies. Our $60.00 target price is based on a ~40% discount to our de facto proved NAV per share estimate, which comprises a sum of the parts valuation of the business segments, as detailed on page 2.