Tribune Sale at Issue as Newspaper Woes Mount

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Billionaire real estate investor Sam Zell was viewed as a savior in some quarters last spring when he swooped in to orchestrate an $8.2 billion buyout offer for Tribune Co. amid tepid interest for the ailing newspaper publisher.

Now the industry’s accelerating decline has some Wall Street experts wondering whether the deal for the parent company of the Chicago Tribune, Los Angeles Times and Chicago Cubs could fall apart. And even if it goes through, the employee stock ownership plan that will own most of the company could face a debt burden even more onerous than the one envisioned in April.

Zell so far has put up only $50 million in cash, and his ability to walk away appears restricted to certain scenarios which, according to those following the deal closely, don’t yet exist. But double-digit drops in revenue and cash flow at the Los Angeles Times as well as deteriorating results at other newspapers have heightened speculation about the potential for the transaction to collapse before the planned closing late this year.

Tribune, which reports second-quarter results on Wednesday, already has borrowed $7 billion to finance the first step of the transaction and buy back shares but had to commit to repaying $1.5 billion of it in two years in order to secure the loan. Once the deal wins approval from shareholders and federal regulators ? far from guaranteed ? it must borrow an additional $4.2 billion to buy all remaining shares not owned by the ESOP.

Zell declined to comment on questions about his intentions and Tribune says its financing commitments are secure, despite speculation to the contrary that has sent its stock down some 15 percent below the transaction price of $34 per share.

?The financing for the transaction is fully committed by four of the largest banks in the world,? Tribune spokesman Gary Weitman said. ?We feel comfortable with the terms of the current financing arrangements.?

But employees of the struggling dailies, in particular, have cause for more worry after enduring a turbulent period of cutbacks and change as advertising revenue slumped and readers migrate to the Internet.

?Everyone is concerned,? said Michael Hill, a reporter for the Tribune-owned Baltimore Sun and unit chair of the Washington-Baltimore Newspaper Guild. ?We’re very worried that the debt payment this new deal requires means that they’re going to keep cutting to try to make those numbers.?

With the capital markets increasingly skeptical about the newspaper industry’s ability to generate cash from operations, higher interest rates for the next round of borrowing appear inevitable and would push up Tribune’s payments significantly.

?If cash flows decline while interest goes up, they (Tribune) may not be able to access the markets in the ways they initially intended,? said Mike Simonton, an analyst for the bond rating firm Fitch Ratings. ?Lower cash flows and higher interest costs could impair the company’s capacity to service its obligations.?

That could put the company in a cash crunch even after the Chicago Cubs are sold at the end of this year’s season ? raising the possibility that at least some of its 11 daily newspapers and 23 TV stations also may need to be divested to reduce debt.

Los Angeles Times Publisher David Hiller informed employees in a July 13 memo of drops of 10 percent in revenue and 27 percent in cash flow in the second quarter, making it ?one of the worst quarters ever experienced.? Tribune’s newspaper results, he said, were worse than the industry as a whole.

Like most analysts, Jake Newman of research firm CreditSights doesn’t think current conditions are bad enough for the deal to be scrapped or fall through. But he says newspaper publishers generally can’t support the kind of leverage that Tribune is taking on.

Tribune’s total debt after the transaction is complete will be about $13 billion, or more than 10 times earnings before interest, taxes, depreciation and amortization. The average among newspaper publishers is two to three times, he said.

?Zell has a special structure in which he’ll get tax benefits, and having it (ownership) in the ESOP gives him the ability to get rid of 401(k) matching contributions. Those are some things that can help him support more leverage than normally would be supportable,? Newman said. ?But I still think that the amount of leverage that they’re putting on this company is extraordinary.?

Assuming the deal is completed, Zell will own warrants to buy about 40 percent of the company, with the ESOP and Tribune management controlling the remainder. The real estate magnate, whose office is about a mile down the Chicago River from Tribune Tower, would have to pay about $500 million to exercise warrants, gaining control of the company and the chairman’s role for it.

But what if he decides the media company, with its operating results worsening, no longer is worthy of the investment? His financial penalties under the deal would be relatively modest, primarily a $25 million breakup fee plus the $50 million he has already kicked in.

Barclays Capital credit analyst Hale Holden thinks Tribune’s performance isn’t bad enough for it to default on financial covenants, triggering ?outs? for Zell.

?In our view, Zell has very few options under the merger agreement to cancel the contract, and we think the transaction is likely to close as advertised in December,? Holden said in a research note last week.

The deal could still be scotched if the Federal Communications Commission denies Tribune’s request for waivers from rules banning same-market ownership of television and newspapers.

That would give Zell the right to cancel the deal. But the company could theoretically come up with enough cash to make its payments by selling off several assets.

?I don’t know that the lack of a waiver would necessarily torpedo the closing,? said Barrington Research analyst James Goss. ?Even in tough times such as those that currently exist, there’s still a fairly liquid market for specific properties. There’s almost always some ability to find a buyer.?

No competing buyer has yet to surface for Tribune as a whole, however, in the three months that the deal has been pending. With the newspaper industry in a tailspin, none is likely to.

All the turmoil over the transaction has prompted a commonly asked question to Tribune management from employees: What happens if the merger is not completed?

?Tribune would remain a public company, with the ESOP and Sam Zell continuing as shareholders of the company,? the company said in a written Q&A recently. ?Tribune still will have returned a substantial amount of capital to shareholders. We would expect our board to consist of the same directors we have today, including Zell.?

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