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Hedge Fund Jana Offers to Buy Houston Exploration for $1.8B

Houston Exploration (THX) shares gained about 4% last week to $56.71 as of mid-day Friday following a $62/share buyout offer ($1.8 billion) by hedge fund JANA Partners LLC, which has been critical of THX management and recently demanded that the company open its books. THX advised shareholders to take no action on the offer until its board has had time to review it. Analysts had a negative reaction to the offer.

JANA, a hedge fund with more than $5 billion in assets, currently owns about 12.3% of the independent production company's outstanding shares. JANA requested that the parties begin immediate discussions on the purchase.

"We believe that there is still tremendous value in Houston Exploration, but that it will continue to be destroyed as long as the company remains in the hands of those who show far less interest in maximizing this value than they do in transferring it to the company's management," JANA Managing Partner Barry Rosenstein wrote in a letter last Monday.

Citing ill-advised plans to use the proceeds from a $590 million sale of its offshore Gulf of Mexico assets to pay down debt and buy onshore exploration and production assets rather than to repurchase shares, Rosenstein charged THX with corporate waste and breach of its fiduciary duty to shareholders. Several months ago, JANA called on the company to use proceeds from the recent sale to maximize shareholder value through a $650 million share repurchase and the exploration of strategic alternatives, including a potential sale of the company.

Rosenstein also said that Houston Exploration's reluctance to heed its sound investment advice is only the latest in a string of mismanagement incidents that include corporate waste, pursuing expensive acquisitions and inefficient debt repayment.

Rosenstein said the problems with the company run much deeper than this latest asset sale. He said, the board has overseen a "massive transfer of shareholder value to company executives," particularly CEO William Hargett, over the last several years. He cited "massive compensation increases" for Hargett -- more than a 500% between 2003 and 2005 -- 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."

The company responded to some of JANA's demands two weeks ago, agreeing to provide some of the documents requested but not all. While it agreed to provide minutes of board meetings in which executive compensation and employment agreements and bonuses were discussed, the company rejected requests for other documents on grounds that they were "irrelevant" or the demand was "overly broad, vague and unduly burdensome."

Rosenstein said last Monday that the company's response falls well short of what is required. "It appears that the board may have in the past rebuffed private inquiries regarding a potential acquisition of the company at a significant premium, in which case the board has not only failed to generate maximum value for shareholders, it has stood in the way of shareholders potentially realizing this value through a sale, thus further perpetuating the cycle of value destruction at Houston Exploration."

He said given the board's "recent confirmation that it intends to proceed blindly ahead with demonstrably wasteful acquisitions despite the shareholder outcry this has generated, we believe action must be taken now to protect the value of our investment in the company."

THX operates mainly in South Texas, the Arkoma Basin of Arkansas and Oklahoma, East Texas, the Uinta and DJ Basins in the Rocky Mountains, and the Gulf of Mexico. As of Dec. 31, 2005, it had net proved reserves of 861 Bcfe.

AG Edwards analyst Michael Scialla said in a research note on Tuesday that he believes JANA's offer is "insufficient." He noted the THX stock reached $70/share in the fourth quarter of last year prior to the Gulf asset sale, "which were sold roughly in line with our forecasts.

"We believe shareholders should resist this offer in favor of either the possibility of a better offer (at least in line with our year-end 2006...projection of $73/share) or allowing management to implement its acquisition strategy."

Standard & Poor's Rating Services placed its BB- corporate credit rating on THX on CreditWatch with negative implications following the hostile takeover bid. THX has about $425 million in total debt outstanding.

"The CreditWatch listing reflects the company's significantly increased business and financial risk associated with external pressures and existing shareholders that may cause management to pursue equity-focused initiatives that are neither supportive of credit quality nor within our expectations for the current ratings," said S&P credit analyst Brian Janiak. The agency said uncertainty about the strategic direction of the company and ultimate use of cash proceeds from its recent asset sales "further highlight concerns" about the company's credit quality.

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