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Sunday, May 21, 2006

Interra @ 46 cts ( Oil / Indonesia ) 2 comments

Final Poll Results: 20:12

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Main issues

1.Little organic growth potential from Myanmar fields

2.Sale of ONWJ/SES stake not likely to be at high valuation

3.Inorganic growth via acquisitions may be at high valuations

Interra is the reincarnation of Van de Horst, otherwise known as Wonder Horse in its heyday in the early 1990s (it hit ~$10/share) when it secured plum Indonesian power and infrastructure contracts by virtue of strong contacts (chairman Kotjo linked to Salim Group, while a son of Suharto was a substantial shareholder). The new company, under Edwin Soeryadjaya (from the former owners of Indonesia's Astra Group), is still primarily an Indonesia play and is still a popular traders' (rather than investors') stock. The difference is that now, the theme is oil.

Interra operates or owns stakes in oil and gas production fields in two countries: Myanmar and Indonesia. The total annual shareable production of the group in 2005, measured in boe (barrels of oil equivalent), was ~1.1M, of which 10% was produced by its 60%-owned Myanmar fields, 15% by its 70%-owned Tanjuung Miring (TMT) South Sumatra field, and the balance of 75% by the ONWJ(north Java)/SES(south Sumatra) concessions in which only Interra only effectively holds a 2.5% stake.

It will be fair to say that the production growth in the majority-owned stakes in the Myanmar fields and TMT field are non-existent. This can be seen in the 1Q06 production profile where gross production is virtually unchanged from 1Q05. Revenue growth has been driven by a 30% rise in oil price (weighted average). On the costs side, direct production expenses have risen 50% suggesting increased expenditure to extract the same amount of oil. There are also problems of trade receivables on the Myanmar fields; S$0.6M was written off in 4Q05 and another S$1.1M written off in 1Q06. That signifies a worsening of credit conditions on the Myanmar side. It will be fair to observe that if oil prices had not appreciated substantially, Interra's core operations (from Myanmar and TMT) would be operating at a substantial loss, both in FY05 and 1Q06. Another way of phrasing it is that buying the core operations of Interra is a (rather poor) proxy method of betting on oil prices continuing to rise substantially in 2006 (hence again providing the boost to revenue, given that unit barrels remain similar).

Also note the huge drag in profits created by the debt burden amounting to ~S$0.6M per quarter (referring to 1Q06 statement). This is mainly due to the convertible bonds issued to finance the mid-2005 purchase of the jewel in the crown -- the 2.5% stake in the ONWJ(north Java)/SES(south Sumatra) concessions, and it is this set of assets that we now turn to. Being a minority stake, the revenue from these concessions are not consolidated but clearly their profit contribution is probably the most substantial, contributing S$2.9M of after-tax profit in two quarters in FY05 (following their purchase) and another S$1.1M in 1Q06. As also observed above, the total shareable production from these oil fields is substantial, comprising 75% of Interra's total production despite the group's small stake. Beyond this, it is difficult to obtain more information on the operational aspects of this set of assets, given that it is equity-accounted in Interra's statements.

Without this asset Interra would probably be worth half its price currently traded on the Singapore market, and would have been languishing in the 20s (as it was before its recent price surge to the 40-50s). There has recently been an unsolicited offer (probably by CNOOC or BP, the main operators) for Interra's stake in the ONWJ/SES concessions, as yet preliminary. It could prove the wild card but my views are as follows: (1)the sudden mid-April price (nearly tripled in 1-2 weeks) looks likely to have anticipated this corporate development (announced in mid-May); (2)offer price won't be ridiculously huge given Interra's small minority stake and it being a non-operator of the fields. The stake was only purchased in mid-2005 and I wouldn't expect any offer to be more than double the carrying book value of S$20M .... and that is if it does transpire. (In comparison, the 4X NTA paid to takeover Pearl Energy, a similar Singapore-listed company, reflects its much larger operational scale, its controlling interests in fields spread across ASEAN (Thailand, Indonesia, Philippines), and the premium for its entire corporate setup, such as exploration and development expertise).

A 2X NTA purchase of the ONWJ/SES stake would bring a $0.10/share gain, bringing group NTA to $0.28. But to what avail? The irony of high oil prices is that it is going to make it costly to acquire new stakes in oil concessions, so this is going to limit any intended growth by acquisitions. As pointed out above, the Myanmar and TMT concessions are hardly going to drive organic growth, and indeed profits from these are erratic. A wildcard would be any ability of the Soeryadjaya family connections to secure new contracts at good prices, but under the new pro-FDI Bambang regime things might be more difficult.

One final thing to note: the bonds mentioned above could convert to a hugely dilutory 54M new shares (~28% of existing share capital); these warrants are now in-the-money because the recent share price surge has brought it way above the exercise price of $0.28. Any such conversion would wipe out debt but this beneficial aspect on profit (and hence earnings per share) would be offset by the huge dilutory effect of new shares. Neutral effect overall, in my view, given that interest expense forms a significant proportion of Interra's total costs and hence a wiping out of this debt by converting it to equity may not be such a bad thing; its financial risk is reduced.

All in all, little organic growth from its core concessions, and difficulty of further acquistions at good prices should its ONWJ/SES stake be sold, make the stock hardly worth a punt, especially when its price has run up substantially.




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