Thursday, July 11, 2013

Whitney Tilson's Short Thesis for Interoil

I believe InterOil is one of the largest promotions of all time – but unfortunately (so far) for anyone short the stock, it’s also one of the cleverest. The company, which has all sorts of associations with questionable characters (and pretty much every other red flag a short seller looks for), has been drilling for natural gas in Papua New Guinea for well over a decade and has repeatedly claimed to have found the mother lode – only to disappoint investors again and again (see Appendix B for a remarkable and telling series of unfulfilled promises from the company and its founding CEO, Phil Mulacek, dating back to 2007). One would think investors would finally wise up, but to date they haven’t, as the company currently sports a $3.4 billion market cap.

This valuation is based on the expectation that InterOil has discovered one of the world’s largest natural gas fields and that current negotiations with ExxonMobil will result in an extremely lucrative deal for InterOil. I think the odds of this are close to zero.

To be clear, nobody – not InterOil’s management nor any outsider – knows with certainty whether the company has a real resource discovery or not. This isn’t a fraud like Bre-X (for those of you with long memories) because there really is some gas in InterOil’s fields, which makes it almost impossible to disprove the company’s claims. Instead, one has to analyze geological reports, look at the track record of the company’s promises, examine the background of the key people, and then apply common sense.
Here are the key facts: after 15 years of drilling, InterOil still has no proven, probable or possible reserves (nothing but a "contingent resource estimate" by a company well paid by InterOil); its founding CEO unexpectedly quit recently (when was the last time this event was followed by great news?); the company continues to burn enormous amounts of cash; and after hyping a -8-

bidding war among multiple major oil companies, is currently only negotiating with one, ExxonMobil (think about who’s likely to have the upper hand in those negotiations…).
Here is my analysis of what InterOil told its investors in a presentation at its annual meeting on June 24th:

 What the company said: "Monetizing sufficient resource to cover our share of infrastructure costs and fund exploration while retaining maximum upside for IOC equity interest."

What I think it really means: ExxonMobil will take a huge amount of the upside from whatever InterOil might have in exchange for a small amount of money to cover InterOil’s ongoing "infrastructure costs and fund exploration."

 What the company said: "Post-negotiations, InterOil and Pacific LNG have clear path to resource monetization."

What I think it really means: ExxonMobil only agrees to pay InterOil anything material if it’s actually discovered a major field.

 What the company said: "There will be staged payments before and after production commences to compensate for resource revisions."

What I think it really means: Nobody knows how much natural gas (if any) InterOil actually has so, again, ExxonMobil will only agree to pay InterOil anything material if it actually has a major find.

 What the company said: "The purchase of an interest in PRL 15 is not contingent on resource recertification."

What I think it really means: ExxonMobil will take a stake in InterOil’s resource now, prior to resource recertification, most likely in exchange for a de minimis amount of money.

 What the company said: "The resource recertification will be used to determine the economic interest in the license and to allocate upstream capital costs."
What I think it really means: There will definitely be a resource recertification and all of the economics of the deal will be contingent upon what it shows.

Overall, this makes it clear that ExxonMobil has little confidence that InterOil has discovered anything, but is happy to get a nearly-free call option in the (very small) chance that InterOil really has discovered a huge resource.

Appendix B: Endless False Promises from InterOil and Its Founding CEO, Phil Mulachek
We are in discussions, a vast number of companies on at least three continents have expressed interest joining our acreage following the Elk-1 discovery and flow test.

- Mulacek April 4, 2007

"Strategic industry partner…who has extensive LNG experience" will deposit $42.5mm for 5% of LNG project.

- InterOil Press Release May 24, 2007

Over the next quarter, going forward, we look to close the farm-in of our first strategic LNG partner.

- Mulacek Aug. 14, 2008

Detailed discussions continue with potential strategic investors as we target a sale of 20% to 25%.

- Mulacek Feb. 25, 2009

European partners have been talking to us.

- Mulacek Feb. 25, 2009

A number of Japanese companies approach[ed] us, and we are in discussions... over the next two to three months.

- Mulacek May 20, 2009

We [gave] access to 30 companies interested [in the project]. We are now trimming [them] down to a few groups.

- Mulacek July 9, 2009

We are now in the final qualification and final scoping phase of our LNG program with strategic partners.

- Mulacek Aug. 9, 2009

It [InterOil] aims to find a partner to back the project "over the next couple of months" and to make a final investment decision in about a year.

- Wayne Andrews via Bloomberg Dec. 24, 2009

We have a number of options in place or under discussion on financing, most of which are tied to our strategic partnering process.

- Mulacek March 2, 2010

We expect (to) start construction this year after FEED and FID are agreed.

- Mulacek Aug. 4, 2010



We target FID on the condensate plant by the end of the first quarter of 2011 and the LNG plant by mid-2011.

- Mulacek Nov. 16, 2010

The current LNG schedule is aiming for FID to occur simultaneously for both the proposed LNG plant and condensate stripping plant by midyear with a proposed combined startup of both operations approximately 30 months thereafter.

- Mulacek March 23, 2011

The LNG project schedule for FID is prior to year-end, and all the proposed LNG plant and condensate stripping plant activities.

- Mulacek May 12, 2011

The investment banks have also updated the transaction to a large number of community ministers and department heads here in PNG and we are all on track to achieve our transaction goals by the end of this year.

- Mulacek Nov. 15, 2011

Most bidders are in the final stages of due diligence and we see the culmination of these bids during the second quarter of this year.

- Mulacek March 19, 2012

We are now set to engage with a shortlist of significant LNG industry participants with a view to concluding discussions and entering into an agreement this quarter.

- Mulacek May 13, 2012

With the sound backing of the new administration in PNG, we are continuing to work with our advisors to finalize selection of an LNG equity partner.

- Mulacek Aug. 14, 2012

We expect to finalize our LNG partner agreements immediately after we conclude with the state.

- Mulacek Nov. 15, 2012

Now that the Government’s position has been clarified, InterOil anticipates being able to conclude an agreement for a sale of an interest in the Elk and Antelope resource in Petroleum Retention Licence 15 and the first 3.8 million tonnes per annum Gulf LNG Train to a partner or partners in the coming weeks.

- Mulacek Nov. 16, 2012

We’re now in the final stages of our partner selection.

- Mulacek Feb. 28, 2013

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