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Hedge Fund Demands That Houston Exploration Open Its Books

Charging Houston Exploration with corporate waste and breach of its fiduciary duty to shareholders, hedge fund JANA Partners LLC, which owns 10% of the independent producer's common stock, stepped up the pressure on the company, demanding that it open three years of books and accounting records. The company said on Thursday in a letter to JANA that it would provide some of the documents requested but not all.

JANA Managing Partner Barry Rosenstein sent a letter to the Houston Exploration board in April to follow up on the fund's request that the E&P company use proceeds from a $590 million sale of its offshore Gulf of Mexico assets to repurchase shares rather than to pay down debt and buy onshore exploration and production assets. The board, however, chose to stick with its plans (see NGI, April 10; Nov. 14, 2005).

"We have made every effort to work constructively with the company's board of directors in our efforts to focus them on delivering maximum value for shareholders," Rosenstein said this month. "For our efforts we have been rewarded with complete apathy from a board whose members appear more intent on protecting their personal fiefdom than satisfying their fiduciary duties to maximize value for shareholders."

Rosenstein said this latest step will determine if members of the board breached their fiduciary duties to shareholders and could lead to further action, including steps to hold individual board members personally liable, or seeking an injunction to prevent the board from entering into transactions that "destroy shareholder value."

Rosenstein cited several instances of corporate waste, including pursuing expensive acquisitions, inefficient debt repayment, and "ignoring repeated attempts on our part to engage in a productive dialogue about the best use of the proceeds of the recent Gulf of Mexico asset sales. The analysis we have provided to the board clearly demonstrates the substantially higher returns which would result from using these proceeds to repurchase approximately $650 million in stock."

JANA said analysts, including Russell Sherrill, managing partner with AIG Financial Products in Houston, and Jeffrey W. Robertson of Lehman Brothers, shared its views, but the company's board "has not had the courtesy or curiosity to legitimately respond to our analysis or to offer their own..."

And if those concerns weren't enough, Rosenstein also claimed that the problems with the company run much deeper than this latest asset sale. In fact, he said, the board has overseen a "massive transfer of shareholder value to company executives, particularly Chairman, CEO and President William Hargett," over the last several years. He cited "massive compensation increases" for Hargett and other executives "in exchange for the paltry returns they have generated during a time of massive growth in the oil and gas exploration industry."

Rosenstein also accused Hargett of wasting corporate funds by keeping an unneeded office in Alabama near his home, having the company pay for travel between that office and the company's Houston headquarters and "failing to disclose such compensation as required by law."

He also said the board may have "rebuffed inquiries from parties interested in pursuing an acquisition at a significant premium. We find it astounding that a board that has done so little to maximize value would compound their failures by refusing to explore offers which very likely represent the highest possible return for shareholders given the company's history of underperformance.

"In sum, this board appears to have a perverse desire to destroy shareholder value," he said, "and we believe it is time that these matters are brought into the full light of day."

As a result, the Cayman Islands-exempted hedge fund demanded that, in accordance with Delaware law, it be allowed to inspect the books and records of Houston Exploration, including every document, email, or analysis reviewed over the past three years. The fund also demanded a complete list of the stockholders of the company and related information.

If Houston Exploration does not respond within five business days, JANA warned that it intends to file with the Delaware Court of Chancery for an order to compel inspection.

Houston Exploration's board initially issued a response to the demands, stating that, contrary to JANA's claims, it is "focused on enhancing shareholder value and we will continue to take the actions that we believe will enable us to achieve this objective. It is unfortunate that rather than work with us in this effort, JANA has decided to pursue this public relations campaign." The company also noted that it already has authorized a $200 million share repurchase. It said that its plan to build onshore E&P assets would lead to more stable production and reserve growth.

On Thursday, the company sent a letter to Jana agreeing to provide some of the requested information, including minutes of Compensation Committee and board meetings dealing with executive employment agreements and bonuses for Hargett and others that were tied to asset transactions; letters and reports from consulting firms related to executive compensation or bonuses paid in connection with an asset exchange transaction; and a list of the stockholders in the company.

Houston Exploration told JANA that Hargett pays for the office on Alabama and nonbusiness related travel and that all compensation paid to executives is reviewed by the compensation committee and disclosed in public filings.

The company rejected the request for all other documents on grounds that they were "irrelevant to the stated purpose of the demand" or the demand was "overly broad, vague and unduly burdensome." The company also said some of the requested information already is publicly available or is "protected by attorney-client privilege, business strategies privilege or other applicable privileges."

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