Sunday, December 21, 2008

How debt did in America’s newspapers

The stock of Lee Enterprises was worth about $1.5 billion when the company borrowed almost an identical amount of money to buy the Pulitzer newspaper group in the summer of 2005. Today, Lee’s shares are worth only $13.5 million.

That’s right: $13.5 million. Thus, the stock in this once well regarded company has dropped by more than 99% in 3½ years, vaporizing more than $1.5 billion in value as investors fled in fear the company would default on its debt and render their shares worthless.

Lee is but one example of what happened to many publishers who borrowed too much money to fund ambitious acquisitions between 2005 and 2007, taking advantage of the then-juicy profitability of newspapers and the once-easy access to abundant, relatively cheap debt.

Had the newspaper industry continued to thrive in the last three years in the way it had for the decades since World War II, the executives who engineered these transactions would look like heroes today. But that’s not how things worked out.

Shareholders, lenders, readers, employees, former employees and soon-to-be-former employees are paying the price for acquisition strategies that loaded several publishing companies with debt they cannot handle today because industry sales have dropped by 25% since 2005 and profits have dried up despite desperate efforts to throttle expenses.

The first major newspaper bankruptcy already has occurred. Less than a year after it was taken private by Sam Zell, the Tribune Co. filed for protection from creditors owed a staggering $12 billion. Stock in the company, whose shares were worth $8.2 billion when Zell bought it 366 days ago, is worth nothing today.

Beyond Lee and Tribune, publishers struggling with too much debt include Journal Register Co., GateHouse Media, McClatchy, MediaNews Group, Minneapolis Star Tribune, Morris, New York Times Co. and Philadelphia Media Holdings. The details in each case may be different. But the story is the same.

Long one of the most rigorously managed companies in the industry, Lee today is struggling to avoid default on $1.4 billion in debt, the unpaid remainder of the money it borrowed to finance the acquisition of the St. Louis Post-Dispatch and 13 other papers in 2005.

The company also is in danger of becoming the fourth newspaper publisher this year to be booted off the New York Stock Exchange because the price of its shares has fallen below the required minimum.

Lee’s shares closed Friday at 30 cents apiece, far below the $1 minimum required for continued listing on the Big Board. The stock has been trading below the minimum for about half a month. If the price fails to reach $1 for 30 days in a row, the stock will be banished to the Pink Sheets, where it will join GateHouse, Journal Register and the Sun-Times Media Group, whose shares closed Friday respectively at 5 cents, 0.4 cents (that was not a typo) and 4.5 cents.

This is a vastly different outcome than anyone expected when Mary E. Junck, the chief executive of Lee, proudly announced that she had bought Pulitzer in January, 2005.

Noting that the acquisition would more than double the sales of her prospering company, she said “the acquisition of Pulitzer allows us to take an exciting and logical next step into another exceptionally attractive group of markets.”

Although this purchase took Lee’s debt higher than it ever had been, Mary said she was “confident that the combined cash flow of the business will enable us to return quickly to an investment- grade profile,” adding that this deal is “exactly the kind where we excel as an industry leader in building revenue and circulation.”

For a short while, the acquisition worked as planned. Newspaper advertising revenues hit an all-time industry high of $49.4 billion in 2005, but began a slow slide in April of the following year that since has turned to an absolute avalanche. Ad sales are on track this year to come in at $38 billion or less, representing a 25% decline from where they stood in 2005.

Twenty-five percent is a magic number for most newspapers, because it is pretty close to the industry’s traditional average operating profit. Newspapers and their lenders were counting on margins of that magnitude, or better, to repay their hefty borrowings.

As sales began decaying, papers tried to cut expenses fast enough to preserve their profits. But the accelerating sales decline – and uncontrollably accelerating expenses in areas like newsprint, fuel and employee benefits – has overwhelmed even the most draconian cost cutting, severely curtailing profits. Lower profits mean that newspapers are not generating the money they need to repay their loans.

Today, companies like Lee either are out of compliance with the terms of their loans – or close to defaulting on them.

In some cases, the papers literally do not have enough cash to pay the sums they owe. In other cases, the publishers are failing to comply with the myriad technical conditions in their loans that prescribe things like a minimum stock value or certain ratios of profitability to debt. A default on these so-called technical terms can trigger sanctions as severe as the failure to make a timely payment on a loan.

In Lee’s case, the falling value of its stock – occasioned by mounting investor concerns that it would default on its debt – forced the company earlier this year to declare as a loss about half of the $1.46 billion it spent to acquire Pulitzer.

Last week, the company said the same accounting rules that forced the first writeoff will require it to declare a loss on at least another $180 million of the value of the Pulitzer deal. In that event, Lee will have been forced to write off some $900 million, or 62%, of the money it spent on Pulitzer. The final figures are being calculated and likely will be announced by the end of the year.

Even though Lee generated $211 million in operating profits on sales of a bit more than $1 billion in the last 12 months, the company said the plunge in the value of its stock is likely to put it out of compliance in the spring with the requirement in a $306 million note that the company maintain a mininmum net worth higher than it is today.

Lee is hoping to persuade creditors to relax the net-worth provision of the note. If the company fails to do so, a default of that note automatically would trigger breaches of some of the company's other debt, too.

The severity of the situation is underscored by a warning from Lee’s auditors that they may have to add a statement to the company’s annual report questioning its “ability to continue as a going concern.”

In plain langauge, that means auditors are worried that the Lee's debt load threatens its ability to remain a healthy and sustainable business.

And remember, Lee is not alone. It is but one of several publishers who are, more or less, in the same wobbly boat.


Anonymous Anonymous said...

We are not far off from seeing the same type of story on the other side of the communications business: the large multinational publicly owned conglomerates of advertising/pr/interactive/etc. agencies. Even in good times, they have way too many layers of overhead and, in many cases, debt. They have an out-dated business model based on selling the commodity of time when clients do not care how busy the agencies are, just how much value they provide. The other side of the revenue formula is commissions on media purchases and markups on production charges -- both are against the interests of their clients. Furthermore, they exist in (and promulgate) silos ("practice groups") when the revolution in communications makes truly integrated campaigns and collegiality across areas of expertise much more important, effective and efficient. Finally, this model now exists in a world where communications budgets are being slashed. We are just beginning to see the news of layoffs in the communications business -- it will really become apparent in the first quarter of 2009.

Fair Disclosure: I am biased. Since 2000, i have been co-founder of a communications company that does everything 180 degrees from what I described above -- a new model -- no debt, no time sheets, no silos, full integration -- and now, no layoffs and a strong pipeline of new business, and a margin that is significantly higher than our big competitors (some rankings list us #6 or higher among nationa's largest independently owned firms). That's not to say we won't get hurt by the economic downturn -- it is to say however that we think while we get hurt, we will see others killed. In a period of creative destruction, you're likely to see the "creative industry" itself destroyed and replaced by new models.

Doug Poretz

4:19 AM  
Anonymous Anonymous said...

i have been following LEE for some time. I wrote an article about them in November, 2008 here:

no one was focusing on the pulitzer debt or how much cash the new bank pricing will siphon out of the company.

most troubling is that Junck has never blamed the internet as one of the reason for their problems. She says it's all due to the poor economy. About six months ago when I first started following them, they had a chance to turn things around. Their biggest mistake was not to voluntarily cease paying their dividend. It was obvious, at least to me, taht they should do that. When they were forced to do so by their banks, the game was effectively over.


6:35 AM  
Anonymous Anonymous said...

If a newspaper company does not have a debt problem, what is the outlook for it?

I work for a mid-sized, fairly healthy community paper owned by a subsidiary of News Corp.

Do you have the sense that some papers can emerge from the latest downturn in OK position? With cost-cutting, smaller papers, a few layoffs and such? Or do smaller papers remain at risk of a corporate parent's stock problems regardless of their own success?

11:41 AM  
Anonymous Anonymous said...

...Debt is certainly the weapon, but the murder suspect isn't debt, it's the changes in communications that diverted customers. Advertising follows the customers eyes, which are NOT on the inkstained newsprint any more. Even a debtless newspaper isn't going to survive the loss of advertisers and subscribers.

7:19 AM  
Anonymous Anonymous said...

But hasn't this blog made the point that, absent debt, newspapers still remain more profitable than several other classes of business, and that something like 60 percent of revenue still comes from print advertising?

And let me ask a naive question. (I'm recently retired, the last of three generations of newspaper editors and writers -- not owners.)

Hasn't it been necessary for publicly traded firms like Lee to take on huge amounts of debt not only to fuel grandiose levels of growth but to inoculate themselves against takeovers?

Isn't there a crazy Wall Street law of the jungle driving all this that requires both constant growth (for the quarterly report) and also dangerous levels of debt (to ward off predators?

And, if true, isn't it a reckless course for such a critical democratic and community institution to pursue? With Wall Street and the banks discredited, is there an opportunity now for the newspapers that survive to crawl out of the meat grinder?

12:59 PM  
Blogger Ron McCrea said...

I'm a recently retired editor who is the last of a three-generation run of midwestern newspapermen -- workers, not owners. I'm not a financial expert.

But isn't it true that there is a powerful Wall Street law of the jungle at work in publicly-traded companies like Lee? On the one hand, it appears to require constant, aggressive growth to meet the expectations of the short-term bottom line. On the other hand, it also appears to require profitable companies like Lee to take on huge levels of debt to avoid being cash-rich -- to inoculate themselves against takeover.

Isn't this a reckless course for an industry with a precious public trust to pursue?

You've pointed out in that past that, absent large debt, newspapers still are more profitable than several other classes of industry. And you've noted that, despite the inroads of the Internet, some 60 percent of newspaper profit is still from print advertising.

With Wall Street and the banking industry discredited, is there a chance for the media companies that survive the current crisis to crawl out of the financial meat grinder, settle for moderate prosperity and a stable balance sheet, and go back to doing their real jobs?

1:20 PM  
Anonymous Anonymous said...

"Isn't this a reckless course for an industry with a precious public trust to pursue?"

That statement is exactly why newspapers are failing. They are filled with people who really don't understand how to make a profit. You folks have this "mission" that blinds you to the reality of the world.

Frankly, bankruptcy will be a blessing. Only once these monopolies are dead will something better be able to rise from the ashes.

Take your "precious public trust" and shove it.

3:43 PM  
Blogger JorgXMcKie said...

It would also help if that "precious public trust" were exercised in a much less ideologically biased. And don't start in on why I see bias. If I see it and quit subscribing because of it, it's not my job to prove to you why I see it if you want my business.

11:19 AM  
Anonymous Anonymous said...

Having been part of Lee for more than 10 years, I can tell you that it is one of the most poorly managed companies filled with some of the least business-savvy people I've ever encountered. After 10 years of fighting with them on nearly everything, they still always believed they could expense-manage their way to profitability with a cult-like approach to having a few people in Davenport, Iowa (of all places) think of a few ideas that are then rolled out to all of their properties across the country, with no regard for city, geography, size, demographics or any other factor that makes one community different from another.

More surprising to me is that it is still be run by the same fools that drove it all into the ground in the first place - still hiding under the "it's the economy's fault" excuse.

11:46 AM  
Anonymous Anonymous said...

Poorly managed indeed. It's the amateur hour in Philly. The investors paid way too much for the two papers, and they continue to slash the staff to make their payment. They fill the space with wire stories and photos that you can see anywhere on the web. The readers know a con when they see one. Killing the staff doesn't work.

6:48 AM  
Blogger Unknown said...

Sorry to disappoint. Looks like Lee has paid off a third of its debt and has managed to refinance the rest over the next three years at least. The terms are ramped up, and the Pulitzer-purchase debt continues to weigh heavily.

But no default. No imminent bankruptcy. Wanna try again?

3:06 AM  

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