Star Scientific smokin' on patent ruling; Grey Wolf sells to Precision; Quest Resource dives on CEO exit

By Paul Deckelman

New York, Aug, 25 - Star Scientific Inc.'s shares were on fire Monday after a federal appellate court reinstated its patent infringement lawsuit against tobacco giant R.J. Reynolds.

On the merger-and-acquisition front, Grey Wolf Inc. agreed to be acquired by another energy contract driller, Precision Drilling Trust, which has pursued Grey Wolf for some months. However, the $2 billion cash-and-stock deal met with an underwhelming response from the investors of both companies.

Another M&A deal looked like it was starting to fall apart, as the would-be purchasers of Gilat Satellite Networks Ltd. said they would not go through with their previously agreed-upon $11.40 per share buyout, with Gilat in turn warning them that they must complete the deal on the existing terms within 72 hours, or face legal action.

Quest Resource Corp.'s shares nosedived, as did those of affiliate Quest Energy Partners LP, after the Oklahoma-based energy exploration and production company announced the abrupt resignation of its president and chief executive officer in the wake of disclosure of a probe by state regulators into some allegedly questionable money transfers.

Stocks were meantime broadly lower, dragged down by the financials sector. The Dow Jones Industrial Average fell 241.81 points, or 2.08%, to 11,386.25. Broader stock indicators also fell, with the Standard & Poor's 500 index down 25.36 points, or 1.96%, to 1,266.84. The Nasdaq composite index fell 49.12 points, or 2.03%, to 2,365.59.

Star shines on court ruling

Star Scientific was easily the day's biggest gainer on a percentage basis, zooming as much as 78% in intraday dealings on the news that a federal appellate court had reversed a lower court ruling that had quashed the Petersburg, Va.-based tobacco technology company's patent-infringement lawsuit against R.J. Reynolds Tobacco Co., a unit of Reynolds American Inc.

Its shares got all lit up on news that the U.S. Court of Appeals for the Federal Circuit had overturned a ruling by the federal court for the district of Maryland, which last year had thrown out a lawsuit filed by Star Scientific - which develops technologies for reducing carcinogenic toxins in tobacco and licenses them to tobacco producers - against Winston-Salem, N.C.-based Reynolds, the second-largest U.S. tobacco company and the manufacturer of such widely smoked cigarette brands as Camel, Salem and Kool.

Star Scientific had argued that Reynolds had infringed on its patents related to a curing process that reduces the level of cancer-causing nitrosamines in tobacco. That suit, filed in 2001, came before the district court in 2005, but before it could be tried, Reynolds attacked the validity and legality of the patents themselves, seeking a summary judgment by federal judge Marvin Gerbis quashing Star's suit. In a pair of rulings last year, Gerbis held for Reynolds, declaring that the patents were unenforceable because Star had not disclosed sufficient information to the U.S. Patent Office when it applied for the patents and tossing out the suit.

However, in Monday's ruling, the three-judge federal appeals panel ruled that those rulings by Garbis were "based on factual findings that we deem clearly erroneous" and sent the ruling back to the district court level for further review and a likely trial on the merits of the case. Star Scientific - which has demanded hundreds of millions of dollars in damages from Reynolds - praised the appellate ruling and expressed confidence that it would eventually prevail. Reynolds reiterated its claim of innocence and said it would defend itself should the case go to trial.

Star Scientific (Nasdaq: STSI) jumped $1.09, or 65.27%, to end at $2.76, on volume of 7.2 million shares - 20 times the usual turnover. Reynolds American (NYSE: RAI) fell 81 cents, or 1.48%, to $54.10.

Grey Wolf grabs Precision offer

Houston-based contract energy driller Grey Wolf and long-time would-be purchaser Precision Drilling Trust announced that Grey Wolf will finally accept a cash-and-stock acquisition offer from the Canadian-based driller - but its shareholders were not exactly howling with delight, as the shares of both companies fell on the news of the $2 billion deal.

In June, Grey Wolf had rejected three successive unsolicited cash-and-stock buyout bids from Precision within the month, for $9 per share, $9.30 per share and $10 per share, preferring instead to stick with a plan to combine Grey Wolf with Midland, Tex.-based Basic Energy Services Inc. in a merger of equals that was to have given Grey Wolf shareholders 54% of the $2.9 billion company that would have been created. But that deal never came to pass, with Grey Wolf shareholders voting against it on July 15, causing the merger agreement to be terminated.

With the Basic deal dead, Calgary, Alta.-based Precision resumed its dogged pursuit of Grey Wolf, finally capturing the U.S. firm with an offer of $5 per share in cash plus 0.1883 Precision trust unit per share, a 4.8% premium over Grey Wolf's closing price last Friday. Holders can alternatively elect to receive all-cash or all-stock, subject to pro ration. In the aggregate, the deal is worth around $2 billion.

Analyst David Rewcastle of Argus Research said that [Precision] "sweetened the deal, by offering more cash to [Grey Wolf] shareholders," since the previous offers capped the cash component at $5 per share. On top of that, Grey Wolf shareholders would get a 25% stake in the combined company, which would be one of the biggest drilling operators in North America, extending the Canadian company's reach into all of the major on-shore drilling fields in the United States.

Despite the sweetened bid, Grey Wolf's shares traded down.

"I guess the market thought that there would be a little bit higher offer there," the analyst said. However, he noted that Grey Wolf "has kept this takeover premium in its share price, while competitors' [shares] have dropped by 40% in the last month, when the oil and gas prices cracked. "So around $9ish per share is pretty much what shareholders were expecting."

That having been said, however, he predicted that "they could take it - or walk away." Even so, he pointed out that "management has accepted the deal. I don't think the shareholders are going to walk away from this one at the next meeting."

On the other hand, some in the financial community slammed the offer.

Jefferies & Co. analyst Jud Bailey called Precision's offer "clearly inferior" and said that the premium offered over Grey Wolf's recent stock price was "underwhelming." Precision could afford to come in with such an offer - which by some estimates is less in total value than its last offer which Grey Wolf had rejected - because once the Basic Energy deal went down in flames, "there were no other takers" for Grey Wolf.

Argus' Rewcastle said Grey Wolf "is a pricy stock now - it's got that [takeover] premium in it. You take a look at other drillers and they are [lower] - and these are some companies with very strong cash flow and expansion of production operations." So in all probability, he said, no other buyers will likely emerge for Grey Wolf. "There are far cheaper acquisition targets out there."

As to whether Grey Wolf blundered by pushing off Precision Drilling for all those months while it pursued the ultimately unsuccessful Basic Energy, he said that wasn't the case at all.

"I liked that Basic takeover. It was a good plan because it would have changed the company's mix from 90% gas [drilling] and 10% oil [drilling] to 75% gas and 25% oil and would have expanded their service line from having simply been a driller." He added that "I don't think that they screwed themselves" by holding off Precision Drilling while pursuing the Basic Energy deal, since they were "trying to diversify out pure gas. They might have benefited from having a cushion of more oil [drilling operations] and less gas."

But despite the sweetened deal, Grey Wolf shares traded below the offer price, perhaps on investor chagrin that the cash component - about 56% of the deal's total worth - wasn't bigger. Grey Wolf (AMEX: GW) lost 11 cents, or 1.28%, to end at $8.48. Volume of about 47 million shares was around seven times the norm. Precision Drilling (NYSE: PDS) fell by $1.17, or 5.48%, to $20.18. Volume of 5.7 million shares was almost seven times the usual level.

Gilat gets gored by Gores-led group

Also among the merger-related names, Gilat Satellite Networks, a Petach Tikva, Israel-based provider of satellite-based communications services whose shares trade on Nasdaq, lost altitude Monday after announcing that a private-investor group that had agreed months ago to buy the company out at $11.40 per share, or about $475 million total, is now looking to back out of that arrangement, even though the company said that it had met all of the conditions of the deal.

Besides refusing to close at the agreed-upon price, the company said in its announcement, "the purchasers made a number of new verbal proposals, which were substantially different from the definitive agreement."

Gilat rejected those new proposals, declaring that they were not in the best interest of the shareholders. It challenged the members of the buyers' group - Los Angeles-based private-equity firm Gores Group LLC, Israel-based Mivtach Shamir Holdings Ltd., companies affiliated with investors Roy Ben-Yami, Ami Lustig and Eytan Stibbe, and DGB Investments, Inc., a company affiliated with investor Doug Bergeron - to complete the deal as originally negotiated within 72 hours, or face the prospect of legal action.

Gilat also reminded the balky buyers that in the event that the deal does not go through, they will owe the company some $47.3 million as a breakup fee.

Gilat (Nasdaq: GILT) fell 63 cents, or 7.29%, to $8.01, on volume of 2.8 million shares, about 10 times the usual turnover.

Quest Resources retreats as CEO quits

Perhaps the day's biggest equity debacle was the plunge that Quest Resource Corp. took, along with its Quest Energy Partners LP unit, after the Oklahoma City-based independent oil and gas exploration and production company announced that Jerry Cash, the chairman and CEO of both of those companies, as well as their Quest Midstream Partners LP, had resigned all of his positions, effective immediately. Additionally, the company's chief financial officer, David Grose, was put on a paid administrative leave of absence.

Those sudden actions come in the wake of the discovery of questionable transfers of $10 million in company funds to an entity controlled by Cash. Quest began looking into the transfers as the result of an inquiry by the Oklahoma Department of Securities.

In response, the three companies named David Lawler, serving up till now as Quest Resource's chief operating officer, to the presidency of each of the three. He will also serve as a director of Quest Resource, replacing Cash on the company's board. And the boards of the three entities have formed a joint special committee to investigate the matter and consider the effects on the companies' financial statements. Grose will remain on his leave of absence pending completion of the investigation.

"That's the kind of thing you fear," a market source familiar with the energy sector said. "That's the kind of thing you don't want to come to work and have to hear about in the newspaper."

Quest Resource (Nasdaq QRCP) plummeted $2.05, or 29.58%, to close at $4.88. Volume of 3.9 million shares was nine times the usual activity level. Quest Energy Partners (Nasdaq: QELP) dropped $2.68, or 18.91%, to $11.49. Volume of 964,000 shares was 14 times the average daily handle.

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