Nineteen years after it became part of U.S. Steel Corp. to ward off Mobil Oil's unsolicited takeover attempt, Marathon Oil Co. is about to break free of the Pittsburgh steel manufacturer and fully stand on its own as a major oil company. Investors are rewarding the plan. Shares of Houston-based USX Marathon Group (NYSE: MRO) rose 10% to $31.94, from the closing price several days prior to the announcement. Speculation arose April 20 that the USX board would make a decision concerning Marathon at an upcoming meeting. USX U.S. Steel Group (NYSE: X) shares jumped 19% to $18.90, on the day of the announcement. And, Wall Street oil analysts are applauding. "This is a very bold, very positive step, and should be beneficial for both sets of shareholders," says Frederick P. Leuffer Jr., who follows Marathon for Bear Stearns & Co. in New York. The two subsidiaries of USX Corp. have traded as tracking stocks since May 1991. Marathon's valuation has lagged those of its peers because of its association with a stock affected by steel-industry economics. For instance, Marathon Group's first-quarter operating income was $923 million, while U.S. Steel Group reported a $101-million operating loss. The separation will come at a price, however: the deal calls for Marathon to assume all USX corporate debt-which was incurred on its own behalf as well as for U.S. Steel-totaling about $900 million. How preferred shares-6.5% cumulative convertible and 6.75% convertible quarterly income-will be treated is still being examined. Standard & Poor's Corp. assigned a BBB+ to Marathon's corporate credit, with a stable outlook. Moody's Investors Service anticipates Marathon's senior unsecured debt would be rated at least Baa1, which is one step from A. Both services cited Marathon's position as an integrated oil, the size and diversity of its exploration and production operations and reserves, and the size and relatively stable cash flow it receives from Marathon Ashland Petroleum LLC , in which Marathon has a 62% equity interest. The Findlay, Ohio-based concern is a leading Midwest domestic refining joint venture with Ashland Inc. Marathon has 1.23 billion barrels of oil equivalent of proved reserves. 2001 production is expected to average approximately 425,000 BOE per day. First-quarter 2001 revenues for the whole company were $8.7 billion. Net income was about $500 million. Christopher Stavros, UBS Warburg LLC integrated-oil analyst in New York, says the assumption of debt will not hurt Marathon's balance sheet. He estimates its debt-to-capital ratio may actually decline slightly from 31% at year-end 2000. George J. Gaspar of Robert W. Baird & Co. Inc. in Milwaukee says, "We all should have sung a round of Handel's 'Hallelujah Chorus.' It's overdue. I'm glad USX finally saw the light." The timing is particularly good for Marathon because it has considerable built-in cash flow that should allow it to absorb the steel company's debt with relative ease, he adds. The separation does not make Marathon an acquisition target, according to Stavros. "While the plan would allow Marathon to pursue its own course free from the handcuffs of the tracking-stock structure, we do not view the company as a target for further consolidation within the sector, at least in the medium term." The new major's president, Clarence P. Cazalot Jr., who came to Marathon a year ago from Texaco Inc., has made many improvements, but "much more work needs to be done," Stavros says. He initially maintained his Buy on MRO and put his $32-per-share target price under review. At press time, he had lowered the rating to Hold, as the stock had reached the $32 target and because of a change in refining-market dynamics that may squeeze the refiner's margins. Gaspar raised his rating to Strong Buy and bumped his valuation 28%, to $46 per share. Michael Mayer, who follows Marathon for Prudential Securities in Menlo Park, California, maintained a Strong Buy. He raised his target 6%, to $35. The stock's tracking status was only one reason for its selling at a steep discount to its peers, Mayer says. Others were an above-average exposure to the lower-multiple U.S. refining sector, a poor E&P record and a debt-to-equity ratio that is higher than average. "This reorganization should eliminate the significant valuation drag due to the letter-stock structure and support an improvement in its normalized cash flow multiple, which is currently by far the lowest in its group at only 5.3," Mayer says. Why split? USX Corp. board members began a review of splitting the energy and steel operations in November 2000, and retained Credit Suisse First Boston and Salomon Smith Barney as financial advisors in the evaluation. "Our goal was to make Marathon and U.S. Steel more competitive in their industries and to enhance shareholder value for holders of both classes of our common stock," says USX Corp. chairman Thomas J. Usher. The separation will be a tax-free spin-off of the two businesses, each into free-standing, publicly traded companies that will be known as United States Steel Corp. and Marathon Oil Co. Holders of U.S. Steel shares will become holders of the new steel company's stock, and vice versa for holders of the Marathon Group stock. Usher says the separation will allow each company to focus on its core businesses, and make acquisitions "based solely on its own considerations instead of issues related to a combined company." Usher expects Marathon will have an investment-grade rating. A Moody's analysis suggests Marathon would receive an investment-grade rating (A) and United States Steel a speculative-grade rating (C) as stand-alone entities, if not for Marathon's assumption of the USX debt. The debt transfer "is designed to enhance the credit quality of the steel business, but will also somewhat diminish the prospective credit quality of Marathon," a report says. The Baa1 rating, just shy of A, that Marathon will receive when spun off is the rating presently of USX Corp. Shareholders are to vote on the proposal in October. The deal may be done in the first quarter of 2002. Usher is to remain chairman of Marathon, United States Steel and Marathon Ashland Petroleum, and chief executive officer of United States Steel. Cazalot, Marathon president, will receive the additional title of CEO. Marathon's goals are to replace 120% of reserves and grow production 3% annually, via exploration or acquisition. "This structural change will facility Marathon's ability to do this," Usher says. Cazalot has tried to reinvigorate Marathon's exploration program since joining the company last year, says Gaspar. "Marathon needs to deliver upstream. It had a fair hot streak going a few years back and developed many of those assets. Now, from a pure exploration standpoint, the Gulf of Mexico should offer Marathon more opportunities than it has had in some time." Gaspar considers Marathon's downstream performance exceptional since it formed Marathon Ashland Petroleum. "It's not the biggest, with 950 million barrels per day of total refining capacity. But it has a great retailing corridor, with sometimes astonishing market shares, and can move a lot of gasoline." Concerning the separation the board is recommending, "it is unclear as to how the U.S. Steel shareholders will view this," Stavros says. "It is possible that some steel shareholders may view this as a first offer by Marathon and try to hold out for slightly more." At press time, MRO was about $31 a share, and X had improved further, to $19.55. The latter has more opportunity to appreciate in value than Marathon, Gaspar says. "Here's a company with 88 million shares, being absolved of $900 million in debt."