Hedge fund JANA Partners LLC may have gotten just what it wanted from Houston Exploration Co. (THX). The THX board last week unanimously voted down JANA’s $1.8 billion unsolicited acquisition proposal. But following the announcement, a JANA spokesman called the decision “a positive development.”

JANA, which owns about 12% of THX, has pursued the Houston-based producer for weeks, offering $62/share in cash for the company in mid-June (see NGI, June 26). Following days of silence, THX CEO William Hargett sent a letter to JANA Managing Partner Barry Rosenstein last Monday. Hargett said the company would not accept JANA’s offer but instead would consider other alternatives for the company, such as a share repurchase, special dividend, operating partnerships, strategic alliances and another sale or merger.

“Since announcing our restructuring plan in the fall of 2005, decisive actions have been taken to improve the company’s financial and operating performance,” Hargett said. “We have completed the sale of our offshore assets and are now focused onshore where the company has a proven track record of more stable and predictable production and reserve growth — in fact, we currently estimate onshore production to grow by approximately 9% this year and 19% in 2007. With the company’s portfolio successfully realigned, the board believes that now is an appropriate time to explore additional strategic alternatives that may be available to further enhance shareholder value.”

Hargett noted that “well before” JANA disclosed its 12%-plus holdings to THX, the company had begun a major restructuring plan to improve its financial and operating performance. Since the plan’s inception last November, THX has completed the sale of its offshore assets and begun a share repurchase program. THX now is focused on domestic natural gas exploration.

“We believe that with our current asset portfolio we can deliver substantial increases to production in 2006 and 2007,” Hargett wrote. “Our current net production rate is over 200 MMcfe/d, and as previously announced, we plan to exit 2006 at a rate of 225 MMcfe/d with our existing drilling program of more than 400 wells. In 2007, we expect to step-up our drilling activity to over 550 wells, which we believe will result in an average production rate of 245 MMcfe/d, based on a capital expenditure program of approximately $490 million.”

Hargett added that “while we have confidence in the company’s plan, the Houston Exploration board is, and has always been, committed to pursuing the path that provides the greatest value to Houston Exploration shareholders.” He said, “in sum, our board and senior leadership team continue to be focused on fully realizing the value of Houston Exploration. Thank you for your interest in the company.” Lehman is serving as financial adviser to THX; Akin Gump Strauss Hauer & Feld LLP and Morris, Nichols, Arsht & Tunnell LLP are legal advisers.

After receiving the news, JANA spokesman Charlie Penner called the announcement a “positive development.”

“It’s a public commitment to maximize shareholder value which is what we’ve wanted all along,” said JANA spokesman Charlie Penner.

Financial analysts thought the offer to buy THX was actually a strategic move by JANA.

“I think this is what JANA wanted all along,” said Motley Fool analyst Robert Aronen, who owns shares in THX. “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.”

Raymond James analyst John Freeman said JANA could raise its takeover bid, but it more likely would continue to use its ownership stake as leverage to influence the strategic view.

Scott Hanold, an RBC Capital Markets analyst, said in a note to clients that he doesn’t think a sale or merger is likely for THX, given its “limited upside potential” that he projects over the next few years. However, Hanold said THX could appeal to some potential buyers, “as it appears cheaper than the two companies Anadarko plans to buy [Kerr-McGee Corp. and Western Resources Gas] and the industry median, based on proved reserves.” More likely, he said, THX will offer a special dividend, an increase to its share buy-back program or make some acquisitions. Hanold maintains a “sector perform” rating on THX with a $63/share target price.

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