Is InterOil a Bargain After Its Recent Fall?

A value investor can't help but examine a sharply falling stock. InterOil (NYSE: IOC  ) recently saw a one day share-price decline of more than 30%. The value investor is driven to know whether or not that drop created a bargain.

Estimating a fair business value, or what a roughly similar enterprise would sell for on a private basis, can be a helpful tool for discovering value. If the current share price is meaningfully lower than fair value, it might mean a good buying opportunity. Can a fair value for InterOil be determined? Let's give it a try.

What's InterOil and why did its shares drop?
InterOil is a start-up energy exploration and production company. Though it owns refining and distribution facilities, these operations will not be a significant driver of the company's worth. The value will ultimately depend on its oil and gas exploration success.

InterOil owns more than 3.9 million acres in Papua New Guinea and is currently in prospecting and development mode. With five exploration licenses and six appraisal wells but no meaningful production, the company was looking for help in developing its two best finds -- the Elk and Antelope fields. InterOil initiated a competitive bidding and evaluation process to find a deep-pocketed partner.

The company's recent share-price decline seems due to investor displeasure with the bidding process result. Total SA, a major international oil and gas company, acquired a 47.5% interest in InterOil's petroleum license 15, the one holding the Elk and Antelope fields. The winning bid, an upfront cash price of around $900 million, suggests the complete project is worth around $1.9 billion; a figure that disappointed the market, which apparently was looking for a significantly larger amount.

An initial estimate of InterOil's fair value
So how can all of this information help us determine InterOil's fair value? One quick calculation is simply to form an estimate of the company's exploration potential based on this deal. InterOil's remaining 30% interest in PRL15 is worth roughly $570 million based on Total's initial buy-in. If InterOil's other four licensed developments were priced similarly, the oil explorer would have an approximate $2.9 billion fair business value, or roughly $59 per share.

Though this figure does not consider new InterOil licenses, it also assumes the other current projects will be as lucrative as PRL15, which is unlikely. For example, Pacific Rubiales Energy, a Canadian-listed oil and gas company, paid $116 million for a 10% interest in the license 237 project; giving that development, which includes the company's third-best Triceratops field, an implied $1.2 billion value.

Recent industry sales provide an additional view
While the quick value calculation is useful, it's clearly not very persuasive. Some recent industry property sales, on a barrel of oil equivalent per day basis, might offer some additional insight.

Large energy producer Hess (NYSE: HES  ) announced the sale of its Indonesian assets. Hess, whose shares have risen more than 50% year to date, has been divesting non-core properties after some activist investor prodding. It already jettisoned a Russian subsidiary, interests in the North Sea, and U.S. Eagle Ford assets earlier this year.

The company, whose shares look reasonably priced trading at an enterprise value (market capitalization plus debt) of around 3 times expected 2014 sales versus an industry average of roughly 3.3 times, received $1.3 billion for its properties in Indonesia. Based on an average production of 15,000 boepd, the value of those fields comes to about $87,000 per boepd.

Newfield Exploration (NYSE: NFX  ) , a smaller independent oil producer, also provides some useful information. Newfield recently sold its Malaysian assets for $898 million as part of a plan to concentrate on U.S. production. The company also has its Chinese properties, expected to fetch around $600 million on the auction block.

These Asian locales produced a combined 27,000 boepd in 2012 but due to reservoir depletion are only expected to generate around 20,000 boepd this year. If Newfield can receive the anticipated $1.5 billion, its foreign holdings would be worth around $75,000 per boepd. The discount, relative to Hess' take, likely relates to concerns about the long-term viability of the reserves.

Newfield shares, pretty much flat year to date, seem to embody a parallel caution. Trading at a discounted enterprise value of 2.8 times expected 2014 revenue, the stock suggests minimal optimism about the company's transformation plan. 

The resulting InterOil fair value estimate
InterOil's three main fields (Elk, Antelope, and Triceratops) are thought to have "best case" total recovery potential of around 1.7 billion barrels of oil equivalent; best case being at least a 50% probability that the quantities recovered will equal or exceed the estimate.

On that basis, production would average roughly 236,000 boepd on an assumed reserve life of 20 years. At a Hess achieved value of $87,000 per boepd and expecting InterOil will need to cut deals similar to PRL15 to ensure full production, the company's 30% stake in the total future value of those fields would be around $6.2 billion. 

Final thoughts
This work on InterOil's valuation is obviously not very precise nor conclusive. Luckily, it doesn't really need to be. The resulting $59 to $63 per share fair value estimate meets the goal of finding a reasonable benchmark, based on some factual evidence, to judge whether the current stock price may be offering a bargain. An InterOil market price, meaningfully below fair value, only suggests that an investor should look for as much further evidence as possible to confirm that a share purchase would likely end up being a nicely profitable one.

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  • Report this Comment On December 09, 2013, at 3:44 PM, yieldhawk wrote:

    Your numbers are seriously off base. GLJ's best case resource estimate for E/A is 9+ tcf. At that size, total is paying 4.7B for a 47% share in the field. (That is the initial payment and the resource payment.) That puts the value of E/A at about $100mm for each percent of ownership and the value to IOC's retained 30% at $3B. Even after paying off the minority 19% owners at the same price IOC is receiving for the sale, IOC would keep $2.8B of Total's payment. Thus, the deal values IOC's interest at $5.8B (3 + 2.8). With less than 50M shares outstanding, that would be more than $100/sh. That number clearly has to be discounted for time and risk, but not to $63/sh. Moreover, that number includes no value for the rest of IOC's exploration potential, which might well fully offset any reasonable discount.

  • Report this Comment On December 09, 2013, at 4:43 PM, grahamsway wrote:

    Hi yieldhawk,

    You do make a good point about the future payments. It may be a windfall for IOC but it's tough to figure how much of it do you consider a lock.

    There's certainly no problem considering full or nearly full amounts in a high-end valuation estimate but if an investor was in a position to buy out the whole company today, what should he or she want to pay now for a potential variable payout in 2015 or 2016 at the earliest?

    When I do my fair value, I try to be fairly conservative and use comps heavily. For instance, a company not in the article which I follow is Noble Energy. It has a 36% stake in the Tamar Field near Israel which I've seen estimated with proven reserves around 7Tcf to 9Tcf. Yet based on last qtrs. production of around 294k boepd, it's market cap of about $25B also comes to roughly $85k per boepd.

    My strategy for IOC or like company would be to pay hopefully less than the comps which roughly looks around $80k to $90k per boepd, all other things being equal. Then count on any future contingency payments or significant finds as possible upside.

    But your point about the potential inherent in the resource payments is a good one and definitely needs to be considered.

  • Report this Comment On December 09, 2013, at 8:52 PM, yieldhawk wrote:

    We do not "know" how much recoverable gas there is in E/A. We will not know until it is all withdrawn. So we have to assume that the estimates of the reservoir engineers are close to correct. That is why I used the GLJ best estimate. If we reject the reservoir engineer estimates, then we have no idea how large the resource is and no basis on which to evaluate the sale because we have no idea how much gas is being bought and sold. I believe the GLJ estimate is the latest one,using the most information.

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