Sunday, December 07, 2008

Tribune deal: Reckless from the very start

Less than a year after being taken private by Sam Zell, the Tribune Co. may be on the verge of filing for bankruptcy because it cannot service its massive $12 billion in debt, according to the Wall Street Journal.

As discussed when the buyout was announced in 2007 (the full post is reproduced immediately below), the plan seemed reckless from the very start, because the newspaper industry back then was well into a secular decline subsequently exacerbated by the worst recession in generations.

Zell, a previously successful radio and real estate investor who characterizes himself as a "grave dancer" drawn to troubled assets no one else wants to buy, acquired the diversified media company immediately before Christmas in 2007 in a complex structure featuring an employee stock ownership plan.

Although it is not clear how the Tribune ESOP would be affected by a potential bankruptcy filing, this backgrounder on ESOPs tells what happened to employee ownership plans at other failed companies. It is not particularly encouraging. However, owing to the newness of the plan, most Tribune employees would not have an enormous portion of their retirement savings invested in the ESOP.

To be sure, it remains possible that Tribune Co. can gain sufficient concessions from its creditors to stave off a bankruptcy filing. In that event, the lenders would relax the requirements that the company pay nearly $1 billion in interest by the end of this year and another $512 million in June, 2009.

While Tribune actually may have enough cash to make either or both of those payments, the deteriorating profitability of its business may cause it to be in violation of loan requirements that require its operating cash flow to reach a prescribed level in proportion to its debt, according to the New York Times.

Failure to comply with these so-called coverage ratios would put the company into a technical default. A technical default, just like one where the company has insufficient cash to make a payment, can force a company to go to court to seek bankruptcy protection from its creditors.

Another alternative, of course, is for the borrower and lender to renegotiate new terms for a loan. The threat of a bankruptcy filing sometmes is used by borrowers to urge creditors to modify a loan, because bankruptcy often results in the creditor recovering less than the full value of his loan.

Some of the facts and figures in the encore post below have changed slightly over time. The debt, for example has been reduced by some $1.4 billion through the sale of Newsday and other initiatives.

But the Tribune Co. remains as precariously financed today as it was when Zell first engineerined the buyout.

What also has not changed is that Zell never, ever had a plan to propely fulfill his stewardship of some of the greatest newspapers in America.

Here's the original post from April 2, 2007:

Tribune bets the Tower

The plan to take Tribune Co. private will push aggressively the envelope of how much a newspaper-heavy media company can borrow in a period of constricting audiences and sagging advertising revenues.

There’s nothing wrong with loading a company with lots of debt, if you have a plan to build sales, boost profits and generate enough cash to service an imposing schedule of escalating principal and interest payments. But tardy payments – or, worse, a default – would prove disastrous to the company; its new investor, Sam Zell, and possibly its new employee stock ownership plan.

To ensure Tribune can satisfy its demanding new debt covenants, the company appears to have no alternative but to reduce expenses sharply throughout the operation and take a hard look at selling more assets than the lovable but ill-starred Chicago Cubs. Raising sales would be nice, too. But there would be scant margin for error.

To fund the planned buyout, Tribune Co. will raise its debt load by 167% to a formidable $13.4 billion from the present $5 billion, according to analyst Alexia Quadrani of Bear Stearns.

The new debt, which will be 9.2 times the company’s operating earnings, will make Tribune the second most leveraged of the 20 largest public media companies, as illustrated in the graph below.

Leverage is determined by the ratio of debt to a company’s earnings before interest, taxes, depreciation and amortization (EBITDA). Lenders pay close attention to this ratio in evaluating a company’s likely ability to repay its loans. Most bankers these days draw the line at lending roughly 7.5x earnings for newspaper companies.

Highly leveraged companies, which the Tribune appears set to become, pay greater interest rates on their loans than less-levered companies to offset the risk of potential default, thus increasing operating expenses.

Immediately after learning of Tribune's planned financing, two independent bond-rating agencies plunged the company's issues to further into junk territory, instantly raising its borrowing costs. Higher borrowing costs mean the compnay will need to devote even more of its profits to debt service.

The leverage planned for Tribune is three times greater than the average debt-to-earnings ratio of 3.1x for the 20 largest publicly held media companies. By contrast, the debt of Gannett and McClatchy, respectively the largest and second-largest newspaper publishers, is 2.2x and 2.3x their EBITDA over the prior 12 months.

The only publicly held media company with a greater debt burden than planned for Tribune is Charter Communications, a cable-television operator with a 10x debt-to-earnings ratio. The most highly leveraged company after Tribune would be Cablevision Systems, another cable company, which has borrowed 6.9x its earnings over the last 12 months.

At the other end of the continuum, Google has zero debt and Yahoo has borrowed only 0.4x its earnings. These new-media powerhouses are generating so much cash from their expanding operations that they don’t need to borrow money to finance their growth.

As a newspaperman-turned-cable-guy, I can tell you that the economics of the cable industry are far more predictable than those of the modern newspaper industry.

If Tribune Co. goes through with the massive borrowing that appears to lie in its future, the new mega-millionaires running Tribune Tower in Chicago will be taking a big leap of faith in their ability to increase sales, cut expenses and raise earnings.

Here’s hoping they look carefully before they leap.


Blogger Tim Windsor said...

Mark Potts also weighed in some 352 days ago with his post, "Here Come the Death Eaters."

"And at this holiday time, say a prayer for the poor Tribune employees, who could be left holding the bag—through their retirement plan, which now owns the company through Zell's creative accounting—if things turn sour. Memo to Tribune employees: Get. The. Hell. Out."

6:17 PM  
Anonymous Anonymous said...

Are we witnessing the death knell of American newspapers? We will be down to three national papers and a bunch of local newspapers? Is this how it ends?

7:45 PM  
Anonymous Anonymous said...

...I understand a gambler doubling down on a losing proposition when the alternative is to lose right now. Time buys hope and miracles do happen. But why would anyone in his right mind loan him money to do it? I haven't read anyone who thinks that the economy, or especially the newspaper business, is going to improve before 2010. If conventional wisdom is correct, that means a year or two at minimum of declining subscriptions and ad income. Who's going to foot the cash to prevent default of the Tribune Co. ?

10:09 PM  
Anonymous Anonymous said...

Why is there something in the back of my mind telling me this billionaire investor is bluffing. Obviously, as you have previously forecast, Sam Zell is in deep trouble, but the stories only say he's hired bankruptcy advisers. That is clearly ominous, but perhaps just a signal to the big banks to come to the table and strike a new deal, or suffer restrictions that would be imposed by a bankruptcy court under Chapter 11. I also bet that before too long, we will hear similar noises from McClatchy, and Blethen.

5:41 AM  

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