Icahn, who owns a 9.9 percent stake in Dynegy, had opposed Blackstone's offer of $5 per share. He bid 10 percent higher at $665 million, and Dynegy said Icahn would support even sweeter deals from other players.
Calls to Blackstone and Seneca Capital, another prominent Dynegy shareholder, were not answered Wednesday morning.
Dynegy had been considering a takeover for several months as natural gas prices slumped and the company was forced to book millions of dollars in asset impairment charges. The company reported a net loss of $1.25 billion in 2009 and another $70 million loss in the first nine months of this year. Dynegy also holds $3.95 billion in debt.
With the economy on the mend, however, shareholders are looking for a rebound in energy prices and energy companies like Dynegy. They sided with Icahn, who thought Blackstone's offer was too low.
Blackstone's offer was thought to be "highly misrepresenting the future potential of power markets," said RBC Capital Markets analyst Lasan Johong.
The deal with Icahn Partners will go through if it at least 50 percent of the company's stock is tendered. The firm will start a tender offer for Dynegy stock by Dec. 22, and Dynegy said the deal should close in the first quarter of 2011 if regulators and shareholders approve.
Dynegy said it will continue evaluating its strategic options and look for superior offers until Jan. 24. Shareholders appeared to believe that was possible, as Dynegy stock rose 24 cents, or 4.4 percent, to $5.69 above the offered price in pre-market trading.
An affiliate of The Blackstone Group agreed to buy Dynegy in August for $4.50 per share. It later raised its bid to $5. Dynegy management supported the sale, but shareholders rejected it. Icahn offered Dynegy a $2 billion loan to ease the company's financial straits if the Blackstone deal fell through.