‘Til Debt Do Us Part

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By: Mark Fitzgerald And Jennifer Saba

For newspapers, it’s the morning after their big binge ? a multi-billion dollar borrowing spree. They maxed out their credit cards for all kinds of neat things that seemed to break down as soon as they got them home. Now they’re trying to hock their purchases, but so is almost everyone else they know. They’re making their minimum payments, and the sheriff isn’t at the door yet ? but the really big bills are about to hit the mailbox.

And for a few, probably quite surprised major publishers, those TV ads about bankruptcy protection are suddenly speaking right to them.

Debt. Of all the reasons newspaper companies are suffering through this industry recession ? the cyclical slump in housing and jobs pulling down classified; the defection of advertisers and readers to the Internet; digital revenue growth outpaced by print revenue decline; the jump in materials costs; and stock prices that have cratered as margins eroded ? debt may be the most powerful force upending the business, from the newsroom to the loading dock and everywhere in between.

Certainly, it’s the most intractable.

“In the cold light of dawn, creditors expect to be paid in full, and on time,” says Tom Corbett, equity analyst for Morningstar Inc. in Chicago.

It’s dawn now, and cold indeed, for the many newspaper companies that not too long ago bought newspapers by the dozen to Wall Street applause, only to watch revenue from those brand-new properties sputter and fall while their market values sank.

When some newspapers report their quarterly results these days, the only thing growing is the interest on their long-term loans. “Actually, the capital crisis is getting much worse,” says media economist Robert Picard, who sounded alarms about news- paper debt more than two years ago. “We’re seeing more and more companies whose debt has grown to such proportions that they just cannot service it, and they’re clearly going to have to do something in the short term. Many of them have huge, huge debts coming due.”

And these are not obscure newspaper chains that are in trouble. The list of companies whose debt Moody’s now rates as junk bonds, or just one notch above junk, reads like an industry Who’s Who: Tribune Co.; The McClatchy Co.; Freedom Communications; Morris Communications; Journal Register Co.; Block Communications; and MediaNews Group Inc. Newspapers across the nation are racing to drive down costs so they can service debt with declining or flat revenue streams.

It’s increasingly obvious that debt is what’s really behind layoffs in newsrooms, consolidation of printing plants, and outsourcing of everything from ad design to copy editing, says Edward Atorino, managing director of Benchmark Capital. “Without a doubt; read the conference call transcripts,” adds Atorino, who often shows up on them as a close questioner of CEOs reporting financial results.

Debt is forcing Tribune to sell one of its best-performing newspapers, Newsday in Melville, N.Y. Morris sold 14 dailies last November to make an $85 million debt payment, and at the end of the year, it still owed about $428 million. Debt is marching increasing numbers of newspapers to the auction block, further depressing sales prices.

The repo man cometh
And now debt looks ready to draw its first blood. Bankruptcy, triggered by defaults on loans, looms as a real possibility for a few newspaper companies.

Some analysts think Tribune Co., saddled with $13 billion in debt, could have trouble staying within its loan covenants in the next few years (see sidebar, p. 26).

Avista Capital Partners ? the New York City private-equity firm that in 2006 bought the Star Tribune in Minneapolis from McClatchy for what was then a fire-sale price of $530 million ? has had to deny a report that it is on the brink of bankruptcy. But Publisher Chris Harte, who says the paper has sufficient liquidity and is current on its debt-payment obligations, concedes Avista has brought in Blackstone Group to look at “restructuring” its balance sheet.

Avista borrowed about $450 million to swing the Star Tribune purchase, and has watched revenue fall $75 million since then.

In a conference call with analysts after reporting 1Q results, McClatchy CFO Pat Talamantes emphasized the company’s efforts to confront debt. He noted McClatchy paid down $76 million in the first quarter alone, and said it would use a $185 million cash tax refund from the sale of the Star Tribune to further reduce its debt. “We continue to expect our debt balance at the end of 2008 to be approximately $2 billion,” Talamantes added.

The situation is much more parlous for Journal Register, which says it is likely to default on the loan covenants on $625 million in debt when its debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio is calculated on July 23. Theoretically, its creditors could then demand repayment of the entire amount.

That’s not likely, but radical changes at Journal Register are certain. One possibility: a second brush with bankruptcy. In the late 1980s, Journal Register was nearly run out of business by debt, a consequence of former owner Ralph Ingersoll II financing a newspaper-buying binge with junk bonds.

If a company defaults, “most banks will provide a waiver, but it costs a bunch of money to do that ? and gets harder every time you ask,” says Hale Holden, a research analyst at Barclays Capital. Terms then become stricter, too.

Loan covenants set debt using a ratio to some variant of EBITDA. Morningstar equity analyst Corbett calculates that the publicly traded newspaper companies his firm tracks have debt-to-EBITDA of 4.4 times, with The New York Times Co. (1.6 times) and Gannett (2.3 times) on the light debt end of the scale, and companies such as McClatchy (about 6 times) and GateHouse (6.3 times) on the upper end.

Journal Register’s covenants, which were renegotiated as recently as May, limit its debt ratio to 6.5 times for the remainder of this year, and sets 7 times as the 2009 limit. It’s not clear if that might be too high to justify a waiver. “Alarm bells go off at 7 times,” says Morningstar’s Corbett.

These days, the lenders are feeling pain, too, says Barclays Capital’s Holden: “It’s not good to be a newspaper creditor right now. The value of your debt has gone down, and the value of your assets backing the debt has gone down.”

Chairman and CEO James W. Hall noted, however, in a conference call earlier this year, that Journal Register did pay down some $150 million in debt in 2007.

A good idea at the time
Historically, newspapers have rarely had to worry about debt. By their very nature, newspapers throw off copious streams of free cash they can use to buy printing presses or other papers, to bulk up the newsroom, or to pay shareholders through dividends or stock buybacks. When big deals did come along that needed financing, newspapers could be counted on to pay down debt quickly.

It seemed that would continue to be the case when publishers took on big but seemingly manageable debt for this century’s blockbuster deals: Lee Enterprises Inc.’s buying Pulitzer Inc., McClatchy swallowing Knight Ridder Inc., and Tribune taking itself private, to name three. Getting bigger would, in theory, finance the loans with more free cash flow and increased revenues.

But newspapers didn’t realize they were living in a historical aberration, says Alan D. Mutter, the San Francisco-based newspaper and new media consultant. News- paper profit margins were at historical highs, and credit was readily available.

“There was this impetus during the credit bubble to load up on debt, and amass more assets to somehow get better,” he explains. “It’s happening in other industries, too. Delta is a bad airline, and Northwestern is a bad airline, so lets put them together and somehow we’ll get a good airline.” The high debt wasn’t seen as a problem, Mutter adds, because it “was premised on an extraordinarily high level of profitability that is not sustainable.”

Now that the credit market has tightened for all U.S. businesses, newspapers are at an even greater disadvantage. Their downgraded ? and even “junk” territory ? credit ratings mean that new financing will be more expensive. Newspaper stocks are so out of favor with Wall Street that raising capital that way is all but impossible.

For now, the only solution for many of these highly leveraged companies is to sell off assets. But who’s buying newspapers?

“There are people who buy football teams, which is not exactly a great investment,” says economist Picard. “But they buy football teams because they like to hang out with interesting people, and they like the game.” The problem for newspapers, Picard adds, is that those kinds of buyers, people who made their money in other industries, haven’t been the best for journalism over the years.

Another short-term strategy for newspaper companies is to sell and lease back their many real estate holdings, freeing up substantial amounts of cash.

No gain, much pain

Of debt’s many perils, perhaps the most insidious for newspapers is that it can block a newspaper company’s only way out of its financial fix: growing top-line revenue.

These days, just about everyone from Wall Street analysts to publishers agrees that newspapers are reaching the point where chopping away at costs and employees become self-inflicted wounds that only accelerate decline. “Newspapers should be reinvesting and improving their products, not cutting,” says industry analyst John Morton. “Essentially, knock off all this cost cutting. It’s diminishing newspapers’ stature and standing in their markets, and that is exactly what they need to succeed … if they are hoping for a successful future combining Internet and print.”

But high debt prevents reinvestment by forcing companies to devote more free cash flow to interest and principal payments. “The interest on debt is a fixed charge that typically doesn’t change with the prospects of the business,” notes bond analyst Mike Simonton of Fitch Ratings. “So it’s there, whatever the financial results.”

Debt service then becomes another fixed cost in a industry that already has plenty of high unavoidable costs for gathering news, printing and packaging newspapers, and physically delivering them to the marketplace. “The cost of every element of doing business is going through the roof,” adds San Francisco consultant Mutter. “Even if you fire all the reporters, the numbers still don’t work.”

No vision? That’ll cost ya
Analysts say there’s a reason for the industry’s capital crisis that goes beyond even the self-inflicted wound of high indebtedness: Newspaper companies, especially the biggest ones, are not providing investors with any vision of how they will flourish in the future.

They’re not even handling the present very well, argues Fitch’s Simonton. “There’s been no evidence yet of these companies being able to turn the corner,” he says. “There’s been a lack of compelling strategic vision and subsequent execution that would make creditors comfortable that lending to a newspaper company over the long horizon is a proposition they could be compensated appropriately for.”

For instance, all newspaper companies insist they have a digital strategy, but are unable to articulate it clearly. Simonton says, “the margins available in the digital space will not replicate what’s going on in the print space, with its high fixed costs. So how are they going to get there?”

Newspapers need to start looking down the road more, agrees economist Picard.

“Debt is a huge problem, it is a problem they are going to have to come to grips with, and it is a problem that cannot be resolved with just cutting, because doing so just strips the resources they need for new initiatives,” he says. “The public companies are so wrapped up with their debt there’s not much more they can do at the moment ? but if they don’t start resolving the problem soon, there won’t be any meat left.”

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