When a billionaire investor like George Soros makes moves, people notice. The hedge-fund king famously shorted more than 10 billion British pounds in 1992 before a 3.4-billion-pound loss by the U.K. treasury, and in the 31 years up to his effective retirement in 2000, his picks returned an average of 30.5% annually.
After coming back in 2007, he's bet big on natural gas, taking large stakes in Westport Innovations (Nasdaq: WPRT), a company that designs natural gas engines, and InterOil (NYSE: IOC), a vertically integrated Australian energy firm looking to export natural gas from Papua New Guinea. Shares in both companies have more than doubled since Soros first started buying.
But the Hungarian billionaire threw fellow shareholders a curveball last month when he dumped the majority of his InterOil holdings at a price of $74.73. His sale of 2.56 million shares of InterOil cut his position from about 12% of the company to less than 4%, and the market has responded, sending the stock down almost 20% since then.
InterOil certainly evokes strong opinions among investors. The company has struggled to turn a profit over the years, and development of its gas resources has been painfully slow. The energy company receives just one star (out of five) from our CAPS community, has significant short interest, and has drawn the ire of famed T2 fund manager and Warren Buffett disciple Whitney Tilson.
Tilson vs. Soros
In 2010, Tilson took out a large short position against InterOil and blasted the company in a fiery e-mail, saying: "This is a company that has NO RESERVES -- not proven, probable, or even possible; just a 'contingent resource estimate' from a firm that InterOil paid, and has NEVER delivered on its countless promises of huge natural resource finds. Sure, there's gas there, but we think there's only a fraction of what IOC claims."
Soros has been quieter about his investing thesis, but he's clearly gotten the better end of the bet so far. The founder of the Open Society Institute first began buying InterOil shares in early 2009 when they traded at around $33, while Tilson initially shorted the stock in April 2009 at $30. InterOil now trades around $60.
What is InterOil, anyway?
InterOil's prospects may not be as dire as Tilson makes them seem. For the first nine months of 2011, it posted a net income of $4.5 million on revenue of $829 million, but with a market cap of $3 billion, the company needs those numbers need to improve for that valuation to be justified. Of InterOil's three divisions, its Midstream (Refining and Liquefaction) and Downstream (Wholesale and Retail Distribution) have been most profitable, bringing in $32.5 million and $6.7 million, respectively, in 2010.
What's given investors headaches and fueled Tilson's fire is InterOil's Upstream exploration and production division, which is focused on properties in Papua New Guinea that have, in fact, yielded natural gas. The company is still working to evaluate the size of those finds so that they can be considered "reserves." InterOil also needs to construct a pipeline and gas-liquefaction facility in order to process the gas. The company readily acknowledges that this project requires substantial financing and will take "a number of years," to complete. Typically LNG plants take four to five years to build after ground is broken.
Though InterOil has no reserves according to the SEC definition, it possesses a contingent resource estimate for natural gas that the company believes will bring in 914.4 millions of barrels of oil equivalent. If that energy were readily available, it would be worth nearly $100 billion at current market prices. By comparison, Exxon Mobil (NYSE: XOM) claims reserves of 24.9 billion barrels equivalent.
Rumble in the jungle
Though Tilson mocks InterOil's exploratory activities, that company's not the only one digging for buried treasure on the tropical island. Exxon has invested $15.7 billion and is building a 450-mile pipeline to ship natural gas from the impoverished nation to the booming markets of Asia. The oil giant expects to begin exporting in 2014. Meanwhile, Royal Dutch Shell (NYSE: RDS-A) has recently taken steps to work with Petromin, Papua New Guinea's state oil company, to develop the country's energy resources. According to a British consulting firm, Papua New Guinea holds an estimated 22.6 trillion cubic feet of natural gas reserves.
InterOil is not without partners, either. In September, it asked Macquarie Capital, Morgan Stanley, and UBS to find a company experienced with large liquid natural gas production, and Korea Gas -- the world's largest importer of LNG by volume -- appears to have stepped up to the plate, joining Mitsui and Japan Petroleum Exploration to work on InterOil's gas project. InterOil shares shot up over 7% on the news.
And there's at least one stateside competitor looking to get in on the race to export LNG. Cheniere Energy (AMEX: LNG) has plans to build a natural gas export terminal in Louisiana by 2015. But its shareholders may want to keep an eye on the developments in Papua New Guinea. Natural gas prices in Asia are already high, and demand should continue to grow. Those companies with access to the nearby island's resources figure to have a geographic advantage.
Foolish final thoughts
While the InterOil bears may be roaring after Soros's latest move, they should remember that he still holds a healthy stake in the company. If he saw them going up in flames, surely he would have ditched his entire interest. Still, if he chooses to dump the rest of his investment anytime soon, that might be the sign for other shareholders to jump ship.
Tilson, on the other hand, makes a good argument against InterOil, but seems a little overzealous in his tirade against the Australian company. Tellingly, the T2-fund manager may be best known for his bear call on Netflix, going short as early as January 2010, when it was trading near $60. Unfortunately, Tilson got burned by the red-envelope mailer's rise soon after, and he closed out his position in February 2011, when shares traded over $200.
With negligible net income to speak of and years to wait on potential energy production, InterOil is a speculative play for sure. But right now, producing gas on Papua New Guinea and shipping it to thirsty Asian markets looks like easy money for whoever can get it.
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