Prophet Motives

By: Mark Fitzgerald Newspaper ownership used to be a pretty simple thing. You set up shop with a press, churned out papers, charged what the market would bear for ads and circulation, paid the bills and banked the rest. In time you turned the business over to your kids, who ran it until it was time to turn it over to their kids.

Even when family ownership gave way to publicly traded corporations of dozens of properties, with shareholders and Wall Street analysts peering over their shoulders, newspapers still followed that straightforward business model. If anything, owning a newspaper got even simpler as the vast majority became the only paper in their market. About the only thing that changed was that profit margins grew much bigger.

But now the newspaper ownership model seems to be weakening ? if it's not already broken, as a growing chorus of voices claims. Margins have eroded, and the cash flows that once greased ever-larger growth in properties and profits are sputtering. Shrinking advertising dollars are steering away from print and paying little for newspapers' digital offerings.

Wall Street's romance with newspapers has become an operatic tale of a spurned lover bent on revenge, with The Street sending the lucky stocks down by 70% or more ? and exiling the truly unloved ones to penny-stock markets. Many chains are writing down the value of their "mastheads" ? the very newspapers that were once the engine of those fabulous margins ? by a billion dollars at a clip.

The publishers of the Chicago Tribune and Minneapolis Star Tribune went bankrupt, as did Journal Register Co. and Philadelphia Newspapers LLC. An industry once confident in its direction is suddenly at sea ? and not at all sure if this economic downturn, the worst publishers have ever personally experienced, is just an unusually bad business cycle or the beginning of the end.

Into this turmoil has come a cacophony of advice from industry in- and outsiders, each like an Old Testament prophet preaching the destruction of the traditional ownership model ? and urging a transformation to something new.

Consider all the alternative ownership ideas that have emerged just in the past few months:

-- Federal or state government should bail out newspapers with direct or indirect subsidies.
-- Newspapers should become nonprofits, like a charity, or nonprofits with endowments, like universities. Or, foundations should adopt newspapers.
-- Newspapers should forget about being papers, dump their printing presses and go completely online ? like MinnPost or Voice of San Diego.
-- Newspapers should be exempt from antitrust rules, like Major League Baseball.

Writing on Slate's Web site, Stephen Bates even suggests newspapers declare themselves a religion. The tax advantages are wonderful, and the priest-penitent privilege is a stronger legal protection than the reporter-source privilege, he notes. Bates, who teaches at the University of Nevada Las Vegas School of Journalism, is kidding ? isn't he?

If no idea seems out of bounds, it's because newspapers are changing business practices in ways once unimaginable: cutting out home delivery most days of the week, for instance, as the Detroit dailies began this month. Or not publishing at all on one or even two days a week, as dozens of "dailies" are now doing.

It's all a bit much for some publishers.

"It never ceases to amaze me, some of the wild thoughts and assertions that come from those who work with us and those in our industry," says MediaNews Group CEO William Dean Singleton. "Somehow, those who write and edit the news are just so ..." he pauses, searching for the right word, "so ... divorced from the reality of the business."

It's as if the recession has unhinged some industry thinkers, agrees Mike Reed, CEO of GateHouse Media Inc. "Everybody right now is operating in a panic state because of how severe the economic downturn is ? and that's causing a lot of what I think is irrational discussion to take place," he says. "None of us have lived through a time like this before, and so people are thinking the world is crumbling. And they're making decisions that may not be in their long-term interests when the economy does come back."

The L3C alternative
GateHouse is both a perfect example of why some industry observers are clamoring for new ownership models ? and Ground Zero for one particular alternative.

In the view of many ? though not, to be sure, Reed and other GateHouse executives ? the chain took on too much debt to grow too quickly, at just the wrong point in the economic cycle. Despite a portfolio of smaller, dominant community papers that are the industry's most reliable money-makers, GateHouse stock has been severely devalued and some of its newspapers are among those no longer publishing on Mondays or Tuesdays.

GateHouse is also the owner (since 2007) of the Journal Star in Peoria, Ill. The paper had been operated as an ESOP (employee stock option plan) until 1996, and the Peoria Newspaper Guild and its community supporters were never particularly enthusiastic about being owned by an out-of-state chain. From the moment GateHouse's fortunes began to falter, the Guild has been openly casting about to find another owner.

GateHouse CEO Reed says flatly the Journal Star is not for sale. But that hasn't stopped the Peoria Guild from working on a plan to buy the paper and operate it with an ownership model that may have the most buzz of any of the alternatives being bandied about these days.

It's called Low-Profit Limited Liability Company, or L3C, a corporation that qualifies as a charity under IRS rules but runs as a for-profit business.

"An L3C is a for-profit business that can take investments from foundations and charities instead of just grants because it's recognized as having a 'social benefit,'" says Jennifer Towery, the Peoria Newspaper Guild's president and the Journal Star's Neighbors editor. The social benefit: "To serve readers and fulfill its role in democracy."

The idea has taken off among the Guild, which is lobbying for federal legislation ? expected to be introduced later this spring ? that would explicitly include newspapers among businesses that have a "social benefit." At the moment, the IRS does not recognize newspapers as qualifying for that status.

Since last April, the L3C corporate structure has been approved in Vermont, Michigan and Montana, and several businesses are operating under that structure. L3C legislation is expected to become law in Illinois, Wyoming, North Carolina, Georgia, Oregon and Montana in the next few months.

"It's an interesting mix of for-profit and nonprofit," says Bernie Lunzer, the Guild's national president. "This is not a bailout. This is a tool, but you'd still have to have financing and succeed on your own merits."

With the market hammering away at the multiples newspapers once fetched ? and with many companies motivated to shed properties to pay down crushing debt loads ? the Guild anticipates cheap papers will be coming on the market, looking for a new and sustainable ownership structure. Around the country, several Guild locals have been contacting possible investors for their community's paper.

They may find help from management. E&P was told recently that at one chain, several publishers are quietly lining up locals in the event their papers are sold, or the company gets broken up.

It represents a turnaround from the union's strategy of finding a rich savior. "Look, no one wants to be Philadelphia or Minneapolis, and urge local buyers to get involved, take on too much debt, and [so far] fail," says Peoria's Towery, referring to the bankrupt Philadelphia Inquirer and Star Tribune. "That wouldn't be an improvement. There has to be something that is sustainable and long-term."

One hand helps the other
L3C proponents say the structure resolves that issue by spreading risk over many nonprofit organizations, businesses and community groups, each with different expectations of a return.

Robert Lang, a cosmetics business CEO who is credited with developing the L3C concept, says foundations are a good place to start in finding newspaper investors because they are required to pay out at least 5% of their wealth annually in so-called program-related investments (PRI). They can invest in for-profit businesses if they have a social benefit ? and it's OK if the investment makes the foundation money. They just have to give it away or make another PRI within a year.

Foundations could make the biggest investment in the newspaper, Lang says, but it wouldn't stop there. Every market is full of businesses that depend on a viable local newspaper for advertising and publicity who could be persuaded to invest in slices, or tranches, of the structured finance with varying degrees of risk, he says.

"You've got auto dealers, movie theaters, local restaurants ? all these people should buy a small bit of the mezzanine tranche in this venture," Lang says, referring to loan slices that pay higher returns but are protected from initial losses, if any.

Lee Egerstrom, who retired from the St. Paul Pioneer Press after 30 years of covering the agriculture business, says the spate of possible investors is even wider ? and could include industry vendors of products unique to newspapers such as printing presses, circulation software, inserting machines, newsprint and newspaper inks: "If a newspaper goes down, it's not like another company takes over buying from them ? they've lost a customer. Taking an equity position to keep a newspaper alive could be important for these vendors."

Egerstrom says newspapers must begin to think like farmers, who have always spread risk and investment among themselves: "Look at grain elevators ? do you think those things would have any other use? That's why they're rarely owned by any one person. It's set up as a cooperative to spread the risk and the reward up and down the food chain."

Endow, or endorse?
If the various ownership alternatives being bandied about have one thing in common, it's that they all suggest moving away from the media concentration of the last 40 or so years.

"The model of the past was to consolidate everything into larger media companies to achieve scales of economy and scope. And obviously over the years it has serviced media companies and their shareholders very well," Egerstrom says. "But it's not serving them very well now."

In a New York Times Op-Ed piece that added more fuel to the fiery debate over ownership, two investment specialists who manage Yale University's endowment argued that newspapers should adopt the university model.

"There is an option that might not only save newspapers but also make them stronger: Turn them into nonprofit, endowed institutions ? like colleges and universities," David Swensen and Michael Schmidt wrote. "Endowments would enhance newspapers' autonomy while shielding them from the economic forces that are now tearing them down."

Newspapers can't escape the financial pressures squeezing their business and their journalism as long as they remain for-profit enterprises, they argue. And that will become even truer as digital publishing replaces print.

Swensen and Schmidt are urging newspapers to organize themselves as "educational literary organizations devoted to the 'promotion of social welfare,'" which they say would exempt them from income taxes and allow tax deductions for contributors to the paper. Endowments would free them from the pressures of Wall Street and advertisers in a single stroke, they say.

This wouldn't be cheap. Swensen and Schmidt figure that to endow the Times ? with its biggest-in-the-industry newsroom budget of about $200 million ? would require raising an endowment of $5 billion.

And one big traditional aspect of newspapers would have to change if they were endowed institutions, Swensen and Schmidt concede ? they could no longer endorse political candidates or "influence legislation." No biggie, they argue: "While endowed newspapers would need to refrain from endorsing candidates for public office, they would still be free to participate forcefully in the debate over issues of public importance. The loss of endorsements seems minor in the context of the opinion-heavy Web."

But Slate Editor-at-Large Jack Shafer maintains that's just the beginning of the problems with an endowed newspaper.

"Even if someone did establish a foundation-funded, nonprofit newsroom as large as the Times' or the Post's, I'd still have misgivings about it," he writes. "Who would appoint the directors of the foundation? To whom would the foundation be accountable? To whom would the editors and reporters ultimately report ?the foundation directors, or the readers?"

Foundations, he adds, are notorious for "meddling with journalism."

Shafer and others also argue that the biggest danger of cosseting newspapers from the reality of the marketplace is that they will no longer know if they're truly serving readers.

"The discipline of the market is a healthy thing," says Jonathan Weber from the Missoula, Mont., offices of New West, a media company covering life and business in the Rocky Mountain West. "It keeps you honest in terms of creating products people really want. If people don't want them ? you won't stay in business. And journalism has been very unresponsive to the market, in a way."

When he was starting up New West in 2005, Weber very briefly considered going the nonprofit route. But the idea of spending so much time cultivating, and then pleasing, a big donor quickly dissuaded him.

"People say, well, if you're dependent on advertising for revenue, you're subject to what advertisers want," Weber says. "But a healthy media business will have dozens, if not hundreds, of different advertisers, and no one advertiser is in a position to dictate content.

"In certain kinds of nonprofits," he adds, "that's not the case."

MediaNews' Singleton doesn't disguise his scorn for the idea of nonprofit newspapers. "We spend $25 million a year just at The Denver Post to gather news," he says. "Now tell me, what nonprofit is going to fund $25 million a year to find the news?" Add to that the cost of printing, packaging and distributing the two dailies in Denver's joint operating agreement (JOA), and the price tag runs to roughly $300 million. He adds, "Tell me what nonprofit is going to fund $300 million a year?" (MediaNews' JOA partner, E.W. Scripps Co., folded the Rocky Mountain News on Feb. 27.)

Can't play, without pay
The traditional newspaper ownership model is suffering the death of a thousand cuts from cyclical and secular forces. But perhaps the deepest wound was self-inflicted: The industry-wide decision to give away its Web content. Newspapers now are desperately assessing tactical and strategic ways ? from imposing subscription-based pay walls to devising a seamless system for micropayments ? to begin charging for online content.

One school of thought thinks it has the answer: Tear down antitrust restrictions on newspapers.

Los Angeles Times media columnist Tim Rutten argues this would square the circle of letting government aid newspapers while avoiding a bailout. "The last thing we need is a government-funded National Public Newspaper," he writes.

Instead, the antitrust authorities should let newspapers, in effect, fix prices. They could negotiate among themselves an agreement on how to scale prices for online content ? and then impose them simultaneously.

It's not asking for anything more than the antitrust exemption that Major League Baseball has enjoyed since 1922, Rutten argues.

Lazard Managing Director John Chachas, who co-heads the financial advisory firm's media practice, says an antitrust exemption of just 36 months would be enough to right newspapers as they deployed an "industry-wide system to track and charge for re-use of their content."

Other antitrust restrictions are ludicrously out of date in this era of media overload and should simply be eliminated, he argues, including the restrictions on newspaper ownership of TV and radio stations, and prohibitions on newspapers merging with each other in the same market.

"Chrysler and GM are in merger discussions, but somehow the Minneapolis Star Tribune and the St. Paul Pioneer Press must sign a consent decree agreeing to not combine," he wrote in a Dallas Morning News Op-Ed. "Is it really plausible that local car dealers and merchants will suffer anti-competitive pricing if two marginally profitable papers merge? Should we fear pricing leverage created by a merger of newspapers, or the more profound impact of having no newspaper?"

Change has got to come
New West's Weber says a fundamental problem he has with the ownership alternatives under discussion is that "it takes as its starting point that newspapers per se need to be saved, and if we don't have a New York Times newsroom with 1,200 journalists ? that means journalism as we know it is over." The market may be saying that, after all these years, newspapers are no longer the "first answer to journalism," he says.

But Newspaper Guild President Lunzer says his union, for one, is not trying to go back to the good old days with its L3C proposal. "None of this can be an effort to save the current newspaper as it is. We understand that," he says. The Guild, at bottom, is "agnostic about business models," Lunzer adds, but wants to ensure that whatever model papers adopt, it secures their future as a news and information entity.

GateHouse Media CEO Reed, too, sees the business changing ? but remaining very much a business. "Everybody can argue all day long about what the profit margin should be ? and I think it's going to be lower, that's just the reality ? but you still have to run it as a business," he says. "Otherwise your investors, whether they're in a foundation or not, are going to run out of money or patience ? or both."

Fans of endowments need only look at the St. Petersburg Times, where ownership by the nonprofit Poynter Institute has not protected it from the ravages of Florida's economy, says Jeremy Halbreich, the former Dallas Morning News president and general manager: "Just because you've got an endowment, it doesn't mean you're bulletproof."

Halbreich just agreed to become chairman and interim CEO of one of the poster boys of the distressed newspaper industry, Sun-Times Media Group. But he says he would be "very troubled" if newspapers such as the flagship Chicago Sun-Times got government assistance. He'll take his chances on the marketplace, he tells E&P. That likely means far lower margins for the foreseeable future, but newspapers should not be daunted by that, Halbreich contends.

"People forget that up until about, what, 25 or 30 years ago, this was not a particularly profitable business," he says. "Publishers had very prestigious positions in the community and made a nice living. But then we had that run of 20 or 25 years when newspapers were very profitable, and we got fat, dumb and lazy, and let ourselves believe as business institutions that it would always be like that."

The newspaper business model is already changing and needs to change more ? but not turn into a nonprofit operation, says MediaNews' Singleton.

"There's a lot of wasted energy thinking of alternative models for ownership," Singleton says. "The future ? if we have one, and I believe we do ? is to develop a business model to monetize our products, become more efficient to deal with the smaller revenue base, and to still have a profit motive."