Plains Exploration & Production Co. (PXP) has run into a setback in its plan to purchase Pogo Producing Co. after one of PXP's major shareholders said it will vote against the deal because of the "negative natural gas price environment."

In a letter to PXP Chairman Jim Flores, investment management company Fir Tree Inc. said large-scale share buybacks would be a better use of money in light of the turmoil in the capital markets. Fir Tree owns about 9.1% of PXP's stock.

Houston-based PXP announced its plans to bail out its troubled cross-town peer in July in a stock and cash transaction (see NGI, July 23). The acquisition would give PXP estimated proved reserves of 635 million boe and a total estimated reserve potential of 1.4 billion boe of proved, probable and possible reserves.

"Since the announcement, the macro environment and industry fundamentals have changed materially," Fir Tree wrote. "Most importantly, Plains Exploration has lost about $1 billion in shareholder value as a result of the announcement."

If PXP cancels the transaction, Fir Tree said PXP could use proceeds from the sale of noncore assets to repurchase 20-25 million shares, representing 30% of outstanding stock. And the buyback plan could lead to a 70% increase in PXP's share price.

However, if the "companies were to reverse the deal with Pogo buying Plains at a premium," Fir Tree said there may be shareholder support.

PXP had no comment on Fir Tree's letter. At midday Friday both companies' stocks had shown gains over the week: PXP was trading at about $42.77/share; Pogo was at $51.77/share.

At year-end 2006 pro forma for asset sales, Pogo reported 219 million boe of proven reserves. Pogo owns about 1.9 million gross leasehold acres in oil and gas provinces in the United States, 6.4 million acres in New Zealand and 1.5 million acres in Vietnam.

Pogo management has been under increasing pressure to build value in the company after activist hedge fund Third Point LLC purchased a 7.2% stake in the independent last year, which made it the largest shareholder (see NGI, Dec. 4, 2006). Third Point over the course of several months demanded that Pogo refocus its operations, and it called on CEO Paul G. Van Wagenen to resign. Pogo early this year said it would try to sell the company outright or find a merger partner.

The Motley Fool's Toby Shute said when he looked at the proposed buyout in July, he looked at it from the perspective of Pogo shareholders. Now, he said, he is looking at it from PXP shareholders' perspective.

"Fir Tree initially supported the deal," Shute noted, "but now that natural gas prices have tumbled, Pogo's gas-heavy assets are suddenly looking less attractive. Fir Tree isn't alone in this assessment -- since the day of the merger announcement, Plains' share price has fallen harder than that of any other exploration-and-production outfit that I follow," said Shute.

Fir Tree "didn't just take this opportunity to gripe publicly. It also laid out an alternative strategic vision for the company in its filing," the analyst said.

According to Fir Tree's filing, PXP's forward multiple to proven reserves, after adjusting for future noncore asset disposals, is less than half that of several members of its peer group, including Cimarex Energy, Petrohawk Energy and Newfield Exploration.

"The bottom line? Plains can either buy Pogo for what appears to be a fair price, or it can buy its own shares at a deep discount. I'm inclined to believe that ditching Pogo might just help Plains regain its mojo," Shute wrote.

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