Hedge-fund manager Carl Icahn and fellow money manager Barry Rosenstein plan to nominate themselves to the Kerr-McGee Corp. (NYSE: KMG) board at the integrated-energy company's annual meeting May 10. They report they have accumulated 11.6 million, or 7.6%, of outstanding Kerr-McGee shares. Icahn manages three of the stock buyers-Icahn Partners LP, Icahn Partners Master Fund LP and High River LP-and Rosenstein is the founder and managing partner of Jana Partners LLC. Icahn and Rosenstein have suggested to Luke Corbett, Kerr-McGee chairman and chief executive, in their nomination letter that selling Kerr-McGee's chemicals business isn't enough. The company needs to pre-sell its production for the next five years and use the proceeds to repurchase stock. In a worksheet as part of a filing with the SEC, Icahn and Rosenstein suggest a $1.7-billion sale of the chemicals business; an $8.75-billion volumetric production payment (VPP) on 250 million barrels of oil equivalent; and the repurchase of 115 million shares. Using rough figures, Icahn and Rosenstein estimate each remaining KMG share would be worth $111. The news of Icahn's interest in Kerr-McGee has already pushed the stock price up. Shares have jumped from around $60 each in early February to as much as $83. Kerr-McGee has responded with a lawsuit that asks a judge to prevent Icahn and Rosenstein from taking a post on the board, and Corbett argues that a VPP would mortgage Kerr-McGee's future-its proved reserves-just to make some quick cash for Icahn and Rosenstein's fund investors. "Nominating directors is a stockholder's prerogative," Corbett says. "Kerr-McGee has an independent, strong and highly experienced board that is focused on building value for all stockholders, and we are confident in our strategy to do just that." David M. Khani, an analyst with Friedman Billings Ramsey, reiterated his Outperform rating on KMG shares and raised his price target to $90 from $85 based on a higher estimated value for Kerr-McGee's chemicals business and a new stock buyback program. "We believe that KMG's discount to its peers will continue to narrow through exploration success; deleveraging; commerciality of prospects in Alaska, Brazil and China; and the realization of its improving chemical business," Khani says. Standard & Poor's credit-rating analysts have lowered Kerr-McGee's BBB corporate rating to BBB- and left the company on CreditWatch with negative implications. Kerr-McGee has about $3.1 billion in debt. "The CreditWatch listing is based on the company's weak operating performance and metrics in 2004, uncertainty with respect to the strategic direction of the company, and increasing business and financial risk associated with external pressures that may cause management to pursue actions that are not supportive of credit quality," says S&P analyst Kimberly Stokes. She adds that "the company's focus on deepwater exploration and development has led to a somewhat uneven operating track record and relatively high cost structure." Another news agency reports that Icahn has also suggested Kerr-McGee scrap its deepwater exploration activity. Lehman Brothers and JP Morgan are advising Kerr-McGee. The Kerr-McGee board is considering a sale of the company's chemicals business and has approved a $1-billion stock buyback program. As for the VPP, Corbett says the deal Icahn suggests represents a third of the revenue potential from Kerr-McGee's proved developed producing reserves, yet will leave it with 100% of the associated production costs. "This would not leave the company with sufficient capital to develop the more than 425 million barrels of oil equivalent of reserves currently booked as proved but undeveloped. As a result, we believe the value of our remaining proved reserves would be greatly reduced," he said. Icahn's plan calls for using all proceeds from the chemicals-business sale and the VPP toward buying back stock. Icahn does not mention debt reduction. Corbett says that "would have very serious negative implications to our capital structure and likely cause our credit rating to drop to junk status." Corbett concludes, "We believe Mr. Icahn's analysis is flawed, and we will make our case directly with our stockholders." In 2004, Kerr-McGee's cash flow from operations was $1.9 billion and free cash flow was $331 million. Analysts have had mixed reactions to the recent events. Merrill Lynch has downgraded the stock to Neutral, as has A.G. Edwards, but Hibernia Southcoast Capital maintains its Buy rating and raised its target price to $92 from $87. Khani at Friedman Billings Ramsey says, "...Icahn could become an active investor and invoke changes within the company." Yet, he adds, "Kerr-McGee has significant blocking power. Kerr-McGee has a shareholder-rights plan in place that protects from potential buyers of 15% or more of common stock. The company also has a staggered board that will try to slow down a proxy fight." Meanwhile, Icahn has made a foray into other energy stocks-a $652-million investment in troubled E&P companies National Energy Group Inc. (NEG), TransTexas Gas Corp. and Panaco Inc. The three companies will be consolidated as AREP Oil & Gas LLC, a business of Icahn's American Real Estate Holdings LP. The companies have combined proved reserves of 357.8 billion cubic feet equivalent.

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