JANA Gets What JANA Wants

Houston Exploration has rejected the $1.8 billion buyout offer from JANA Partners LLC. Management believes the company is worth more. Investors want to know: How much more?

For months, JANA Partners LLC has been banging its dinner plate on the prison bars, trying to "unlock shareholder value" at Houston Exploration (NYSE: THX  ) . The hedge fund owns 12.3% of Houston Exploration shares, is demanding a return on its investment, and has offered to buy the whole company to generate the return it desires. While it is very unusual for a hedge fund to purchase an entire exploration and production company, it appears that JANA will be getting what it wants. Houston Exploration announced today that it is seeking alternatives to the $62-per-share offer from JANA.

JANA attacks
Back in March, JANA began insisting that a $650 million share repurchase was the best method for Houston Exploration to increase shareholder value -- as opposed to company plans to repay debt and purchase additional properties. In May, when there was no response from the company, JANA went public with its demands, accusing Houston Exploration's Board of Directors of "playing possum." It continued with the following zinger:

We challenge you to either respond with your own analysis showing that your stated plans will create more value for shareholders, or commit to the substantial repurchase we have outlined. Failing to respond and proceeding blindly ahead as planned without having demonstrated any semblance of consideration for maximizing value will demonstrate a clear breach of your fiduciary duties, and we will not hesitate to hold each Board member individually liable for doing so if necessary.

When this did not generate the desired result, JANA stepped up and offered to buy the whole company with their $1.8 billion bid.

HoustonExploration responds
On the other side, Houston Exploration believes the current bid significantly undervalues the company. Therefore, Lehman Brothers (NYSE: LEH  ) has come in as a financial advisor to explore "other options." The other likely options are a share repurchase (what JANA originally asked for), a special dividend, or a sale or merger of the company.

Management is also quick to defend its business plan. Executives point to a $200 million share repurchase and a shift to onshore production, where the company has a more predictable track record of reserve and production growth. Management suggests it has not wasted money on acquiring properties, projecting a 9% production increase in 2006, followed by a 19% production increase in 2007. The company also believes that its portfolio of drilling prospects offers excellent opportunities for many years into the future.

What's Houston worth?
Putting a price on any exploration and production company is tough. One common method is to use $/BOE (barrel of oil equivalent). As demonstrated by recent acquisitions, valuations using this method range from $9/BOE for Vintage Petroleum to $42/BOE for Spinnaker Exploration. However, the market recently provided another data point that may prove relevant for Houston Exploration.

Last week, Anadarko Petroleum (NYSE: APC  ) announced the purchase of Kerr-McGee and Western Gas for roughly $20/BOE. If Houston Exploration's drilling prospects are as attractive as the company believes, this could be a fair price for its acquisition. Adjusting Houston Exploration's reserves and cash positions based on its recent $590 million sale of offshore properties, I estimate $75 per share as a possible buyout price.

That sly dog
I think this is what JANA wanted all along. I doubt it ever wanted to take the reigns of an exploration and production company. Last year, JANA was active with Carl Icahn in demanding a large share repurchase from Kerr McGee, and it profited handsomely. This is just another case where clamoring from activist shareholders with deep pockets is driving management to action. If Houston Exploration sells for a premium over current prices, this shareholder won't mind at all.

Are you an activist shareholder or a sit-back-and-relax investor? Whatever your style, the Fool has a newsletter for you.

Fool contributor Robert Aronen owns shares of Houston Exploration. Please feel free to share your comments with him.


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