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InterOil: An Object Lesson For Shareholder Exits

By Mitchell Posner

For years, InterOil (NYSE: IOC) wasn’t taken seriously as an E&P company. The business press used words like “fluky.” It’s now a mainstream LNG producer, and has provided a considerable return for its shareholders.

Last week, the company announced that Oil Search will acquire InterOil, exchanging 8.05 shares for each share of InterOil, about $40.25 per share[1] in U.S. dollars. The offer is valued at approximately $2.2 billion, per the announcement.

But wait, there’s more: IOC shareholders will be paid an additional $6.05 USD per share—in cash—for each tcfe[2] of hydrocarbons over the 6.2 tcfe contained in the company’s interest in the Elk-Antelope fields.

Investors in E&P companies—experts and novices alike—should and do ask, “What’s the upside?” For many companies the answer has grown vague in the current low-price environment.

Old-school thinking on exit strategy is often inconsistent: sell when the asset attains a certain amount of PDP[3]’s. Sell when production reaches a set level, or something much cloudier, like a reserve estimate. “Flipping” acreage will always exist, but suitable assets for such a play are declining.

Treadstone Energy CEO and Founder Frank McCorkle describes three basic exit ramps[4]:

A complete sale. No explanation needed, but likely buyers would be large independents or majors, or companies with private equity backing seeking an eventual IPO.

Partial exits come in two flavors: one, a joint venture in which the original E&P company steps back and becomes a non-operating partner, and another, in which a joint venture partner provides the capital and the original E&P continues to explore and develop the assets.

A more complex extended exit allows the E&P to sell some of its PDP assets on scheduled and agreed terms. In some cases the company may be recapitalized, providing funds for further development in the hope of larger payout down the road, possibly through an IPO.

While E&P’s can’t control market conditions or the oil/gas price, in practice, key determinants include management capabilities and the corporate objectives. Some are better at simple acquisition and divestment; other companies may be better suited to delineating a target prior to exit. Several have the technical know-how, 3D seismic database and capital to optimize production on their own, which increases their leverage when negotiating a payout.

One such firm is Petro River Oil (OTBB:PTRC). Management includes Stephen Brunner, who formerly served as president and CEO of Constellation Energy Partners and EVP of Pogo Producing Company. Chief Geophysical Advisor James Rector, Ph.D. is Professor of Geophysics, UC Berkeley, Senior Consultant to Chevron BP and Baker Hughes and a leading authority on seismic. Technical team members each have more than 30 years of industry experience.

Petro River Oil is capitalizing on that knowledge base. PTRC has wisely confined to conventional projects and avoided the tight formation large acreage resource plays that have saddled many companies with uneconomic and debt-laden ventures. It’s been an astute acquirer of several eclectic projects from Oklahoma to California and a unique prospect in Northern Ireland. Most of its assets are in historic basins with break-even’s in the range of USD $10, such as its acreage in California’s San Joaquin Valley, home to four of the largest oil fields in the U.S. Its initial drilling program is funded and it has no debt.

PTRC is positioned to employ all available exit ramps. Management can reach out to the majors—key team members have been executives at Royal Dutch Shell, Texaco, Pogo and Burlington Resources. Many of PTRC’s assets are near producing fields operated by majors and large Indies. An IPO exit is baked-in through its capital structure: PTRC is already public and owns 20% of privately-held Horizon Energy Partners LLC, run by industry exploration and production veteran Jonathan Rudney. Horizon is a major stakeholder in the assets, so PTRC and Horizon can consolidate as part of an exit.

With a potential 105MM bbls (P50) Prospective Resources and an NAV potential of $2.6 Billion (P50), PTRC is an attractive target, but its Executive Chairman Scot Cohen, a former hedge fund and private equity executive, believes the company can tap the equity markets to self-fund to a later development and production phase.

PTRC is not alone. While there are some very savvy, small independent operators with similar strategies, you won’t find them on the stock market. But there are few publicly traded E&P’s containing only “pure” conventional resource plays (i.e., vertical drilling, conventional reservoirs, and no hydraulic fracking). Most are saddled with the legacy of shale plays that need hire oil prices to trigger divestiture. Should PTRC’s prove up its reserve base, it will have fewer challenges to exit than the today’s typical E&P.

  1. This is per share as traded on the ASX, not to be confused with the ADR that trades in the U.S.
  2. Trillion Cubic Feet Equivalents
  3. Proved developed producing reserves. The combination of proved developed producing and proved developed non-producing reserves.
  4. Archived Presentations – Independent Petroleum Association of America (2015): Living an Exit Strategy. IPAA Private Capital Conference, January 29, 2015. Houston, Texas

Disclosure: OG Market Report has been compensated in the past, and expects to be compensated in the future, by Petro River Oil Corp. for investor relations services. OG Market Report reserves the right to be compensated for investor relations services by companies mentioned in this article. OG Market Report is not liable for any investment decisions by its readers or subscribers. OG Market Report is  NOT a registered broker/dealer/analyst/adviser, holds no investment licenses and may NOT sell, offer to sell or offer to buy any security. 

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