Hess Breakup Maps Path to Shale Riches (Update 2)

Updated to reflect comments from Elliott Associates.

NEW YORK ( TheStreet) -- Hess ( HESS) plans to split off its oil and gas refining and marketing businesses, in a move that will help the New York-based oil conglomerate refocus on drilling its shale energy assets, while making a big payout to shareholders after years of underperformance.

Such action represents a 'win-win' for shareholders, even if Hess is yet to fully map out the financial impact of its divestiture plan, according to Bank of America Merrill Lynch analysts.

Still, Elliott Associates, a hedge fund pushing for change at Hess, called the company's plan "incomplete" and lacking in accountability in a late Monday letter.

The company said earlier it would fully divest its downstream businesses, including retail gas stations, energy marketing and trading, adding to a deconsolidation plan the company mapped out in January.

Hess also said in a press release that it would divest oil and gas assets in Indonesia and Thailand and exit midstream businesses in the North Dakota Bakken shale by 2015.

Bank of America energy analyst Doug Leggate forecasts Hess may eventually put its Bakken assets into a master limited partnership (MLP) that can be spun off to investors.

Hess's breakup plan follows similar moves made by Conoco Phillips ( COP) and Marathon Petroleum ( HESS) to split exploration businesses from refining and marketing and deliver value to investors.

With proceeds from asset sales and a reduction in overall expense, Hess appears to be ready for a more aggressive drilling program that could increase the company's oil and gas production growth rate in coming years.

The company now targets a five-year production growth rate of 5% to 8%, and forecasts 'mid-teens' production growth between 2012 and 2014.

Shareholders also will see an immediate payout as Hess executes the multi-year plan to focus exclusively on oil exploration and production.

Hess on Monday said that its annual dividend will increase to $1 a share beginning in the third quarter. The company also said it had authorized up to $4 billion in share buybacks tied to the timing of asset sales.

"Our Board and management team have been pursuing a multi-year strategy to transform Hess into a focused E&P company," John Hess, Chairman and CEO of Hess, said in a statement.

"By 2014, Hess will be a pure play E&P company with a tremendous portfolio comprised of higher growth, lower risk assets."

Hess's decision to exit retail, marketing and trading comes on the heels of a large stake taken by Elliott Associates, which in January said it would make a near $1 billion investment in the company in an effort to gain seats on the company's board.

While Elliott Associates doesn't appear to have impacted Hess's strategy or board configuration -- the company said on Monday that it has nominated six new independent board directors -- those betting on the company's refocus on oil and gas drilling may have won out.

In a New York Times interview, John Hess said a board comprising of directors without energy experience created poor optics. Hess's new directors appear to have significant operational or financial experience in the energy sector.

Following Elliott's stake, Hess hired Goldman Sachs ( GS) to sell its terminal network in the U.S. and close a terminal in Port Reading, N.J., which will release $1 billion in working capital. The network, concentrated on the East Coast, has a storage capacity of 28 million barrels of oil spread among 19 terminals.

The company also announced asset sales worth a total of $2.4 billion, in addition to divestitures ranging from oilfields in Russia to the Eagle Ford shale in Texas, in recent months.

In November, Jim Cramer said at The Deal's Deal Economy 2013 that Hess should split off its downstream businesses because its oil and gas assets would be worth more without the added expense of running its refining business.

" This type of corporate restructuring should enable Hess's upstreamoperations to become more predictable and generate more competitive returns given a greater exploitation emphasis, and corporately have less earnings volatility from energy trading and marketing," John Herrlin, an analyst with Societe Generale wrote, in a note upgrading the company from to 'buy.'

The prospective share buyback would allow Hess to reduce its share count by over 15%, Harrlin calculates.

In late Monday trading, Hess shares rose over 3% to $68.90, adding to 2013 gains in excess of 20%.

Other oil and gas giants, notably Transocean ( RIG), are also feeling the heat of activist investors in 2013.

The moves indicate that the energy sector is poised for another busy year of asset sales and board transitions after many of the nation's largest players, from ConocoPhillips ( COP) and Sunoco ( SUN) to Chesapeake Energy ( CHK), underwent dramatic change in 2012.

In January, Carl Icahn increased his stake in oil rig contractor Transocean to 5.6% and called for the company to pay out a dividend of $4.00 a share to investors.

While Transocean has heeded Icahn call for a dividend boost, the company's $2.24 a share dividend announced on Monday did not impress the legendary activist investor.

Icahn, who is now Transocean's largest shareholder, said on Monday he opposes the smaller than recommended dividend boost and will propose new members to the company's board at its annual shareholder meeting.

Speculation that Transocean could increase its capital return to shareholders began in 2012 after the company admitted to criminal charges for its role in a 2010 oil spill in the Gulf of Mexico and agreed to pay out $1.4 billion in fines to settle claims with the Department of Justice.

Icahn has had a busy 12 months in the oil and gas space, highlighted by an activist stake in embattled driller Chesapeake Energy ( CHK), which has netted billions in asset sales and a revamping of the company's board.

Sandridge Energy ( SD) -- another noteworthy energy sector activist play -- is currently battling hedge funds Mount Kellett Capital Management and TPG-Axon Capital Management over whether CEO Tom Ward should be fired.

Occidental Petroleum ( OXY) is another underperforming energy sector giant facing similar pressure amid leadership change.

All told, activist investments and management changes indicate a cloudy outlook for the oil and gas industry, even as refining profits rebound and gas prices remain high.

Many drillers have spent wildly to gain access to highly valued shale assets, but may be stretched financially as drilling programs kick into gear.

For Hess, an exit from midstream businesses may help the company finally drill its portfolio of shale energy reserves, helping to boost overall production in coming years.

-- Written by Antoine Gara in New York

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