Morgan Stanley Pinpoints Knight Ridder's 'Underperforming Papers'

By: E&P Staff Three private equity firms are considering purchasing Knight Ridder. The Blackstone Group, Providence Equity Partners, and Kohlberg Kravis Roberts have banded together in a possible bid for the newspaper company, The Wall Street Journal reported today.

The potential deal, if it pans out at all, is still in the early stages; the trio might balk at the price tag -- Knight Ridder's market capitalization is $4 billion.

However, the paper reported that some financial buyers say that Knight Ridder could be attractive under new management. Other private equity firms are sniffing around as well. The first rounds of bids are due Dec. 9, according to the Journal.

Meanwhile, Morgan Stanley research analyst Douglas Arthur issued a report on Tuesday that considered the implications of a possible sale of the company. Morgan Stanley, which was hired by Knight Ridder as a second advisor to Goldman Sachs, examines several different scenarios that involve potential buyers. (The research division of Morgan Stanley is separate from the investment bank, which was hired by Knight Ridder.)

The key point in the report notes that central in all of this is the notion that "Knight Ridder's costs can be cut further and perhaps significantly" -- by as much as $350 million.

The cost-cutting measures would hit labor the hardest. Using Gannett as the benchmark, Morgan Stanley estimates that Gannett's work force is far less expensive and pulls in more money.

Labor costs at Knight Ridder account for 41% of revenues versus 31% at Gannett. "Viewed differently," the report said, "the average FTE [full time employee] at Gannett produces almost $115,000 in revenues less direct labor costs compared to approximately $103,000 at Knight Ridder, an approximate 12% advantage."

Morgan Stanley presents two different cases, one in which Knight Ridder saves $150 million by slashing 5% of its workforce, or 887 employees, and another that would trim the workforce by 1,064 people (6%), shut down the Philadelphia Daily News, and reduce some costs at Knight Ridder Digital by $80 million. The latter measure would save Knight Ridder roughly $350 million.

The report also pinpoints Knight Ridder's "underperforming papers," including the Philadelphia Inquirer and Daily News, the San Jose (Calif.) Mercury News, and the St. Paul (Minn.) Pioneer Press.

"A small number of major properties overly weigh down Knight Ridder's results," said the report. "A fresh set of eyes could conceivably be more dispassionate/less historically burdened in addressing the problem properties."

Morgan Stanley estimates that Knight Ridder earns less than $50 million in Philadelphia on almost $520 million in revenues. San Jose earns less than $22 million on $235 million in revenues. And the Pioneer Press operates in a competitive market with McClatchy's Star Tribune in Minneapolis. Morgan Stanley reported that the Pioneer Press has approximately a 10% profit margin.

As for buyers, the research firm thinks Gannett could afford the chain and might benefit if there is a recovery on the way, especially in metro markets.

While Morgan Stanley acknowledges Tribune as a potential buyer, it quickly says that the Chicago-based company has too much on its plate already.

McClatchy could gain from the deal, especially because the transaction "would leap frog McClatchy into the large cap newspaper space and give a well regarded management team a much more prodigious platform from which to operate."

Or, the sale of Knight Ridder could fall through based on some of these premises:

* Knight Ridder's board rejects Private Capital Management's "aggressive approach," forcing PCM to dump its 19% of the company's shares.

* The industry slump continues and investors lose confidence.

* A potential buyer could run into regulatory issues.

* There are a limited number of interested parties to place bids.

* Knight Ridder could buy PCM's shares.

* Knight Ridder unions could fight any attempt to merge it with another company.