Can Tribune Financially Survive Privatization?

Philip Stone July 26, 2007

It’s all well and good for Tribune to say it has all the financing in place for the Sam Zell privatization, but with the company’s dismal results thus far this year the main question is whether the group will be able to earn enough money to pay off the debt, and there is a growing feeling among the money people that right now it’s about 50-50.

Even though Tribune reported a 58% plunge in Q2 earnings over a year earlier the shares actually closed Wednesday up 3.8% because Chairman and CEO Denis FitzSimons told Wall Street what it wanted to hear. “Our going private transaction is on track and the financing for it is fully committed. We anticipate closing the transaction in the fourth quarter.”

FitzSimons statement that the debt money is all arranged is not the first time he has said that, so the initial reaction in the market was a little surprising with the shares jumping some 6%. But by the close they had fallen back from that euphoria to end up 3.79% at $28.20 -- still $5.80 a share less than Tribune has agreed to pay shareholders. How come still that difference? The only real answer is that, still, people are not absolutely, positively, without a doubt sure that the deal will go ahead given the company’s awful results thus far this year.

But even if, for the sake of argument, the deal is concluded that would seem to be just the beginning of Tribune’s future problems. In borrowing $7 billion to finance the first part of the deal, and then an additional $4.2 billion to complete everything once all the necessary approvals are in the house Tribune will be faced with a huge debt bill with terms more onerous than it had first thought.

For instance, Tribune had wanted seven years to pay back $8 billion; instead the bond holders increased the interest rate on the loan by half a percentage point, said that applied to $6.5 billion of the loan that can be paid in seven years but the other $1.5 billion, at a slightly lower interest rate, had to be paid back within two years.

In order to absorb a debt load like that – and under the ESOP (Employee Stock Ownership Plan) used for this privatization it means the employees, and their pensions, will be left holding the bag if it all goes wrong – the company has to assure sufficient cash flow, and be prepared for more asset sales if the cash flow isn’t there.

So the announcement Wednesday that profit sank 58% in Q2 is not exactly great news – and remember its largest newspaper, The Los Angeles Times, said its Q2 overall revenue dropped 10% with cash flow plunging 27% -- and since Tribune blamed a huge decline in real estate advertising in particular for the poor performance, and no one is expecting real estate to improve any time soon -- it will probably be more of the same for the rest of the year.

So, can Tribune make the debt payments? Probably, but it may have to sell more assets than originally envisaged, although there actually is some bright news out on the horizon that could really benefit the company.  

The first bit of good news is that the interest in buying the Chicago Cubs baseball team is pretty hot and it is very likely the company will see more out of that than first thought. Figures around $1 billion plus are being mentioned with at least 15 serious parties thought to be considering bids, and that’s not bad considering Forbes Magazine valued the business at some $600 million just in April. If it does collect $400 million - $500 million more than first thought for the franchise that will certainly be very welcome in helping help pay down the debt.

There’s also talk that a sale of its one-third interest in the cable Food Network could produce more than first thought, and, separately, there could be a $350 million tax windfall in the works, too.

And don’t forget that next year is a double-whammy good year for television station owners – Tribune has 23. It’s not just an election year, but it’s a Presidential  election year , and based on the extraordinary political spending that occurred in 2006, especially close to election day, television stations  are  going to clean-up big-time on the political advertising.  Based on TV political advertising revenues reported this year by major TV groups compared to the same period last year, TV stations could experience at least a seven-fold increase in political advertising next year, and it could well be much higher than that.

And next year is a summer Olympics year and television, and newspapers to an extent, has always benefitted from additional advertising somehow pegged to the Games. Take the elections and the Olympics and Tribune’s TV stations should really be contributing well to that needed cash flow.

Don’t expect any great numbers from newspapers – it will be interesting to see if meaningful new revenue is created from the new front page ads and whether there really is any more fat on the bone to cut -- and Internet revenues will continue growing, but add it all up and it next year will probably be okay for the debt payment schedule, but the year after without further asset sales?

And there is one other bit of the privatization puzzle that won’t get resolved until Q4, and perhaps that still has people worried. The company needs waivers from the Federal Communications Commission that will allow it to keep TV stations in markets such as Los Angeles and Chicago that violate cross-ownership rules (owning a newspaper and TV station in the same city).  

The FCC has said it will make the decision in Q4 but hasn’t given any indication which way that ruling might go, but frankly it would be very surprising if it did not allow the privatized company to continue the current waivers, especially since Tribune’s flagship newspaper in Chicago is a bastion of Republican thinking and it is, after all, a Republican controlled FCC that makes the decision.

So, at the end of the day, if the deal does go forward the current shareholders will get their $34 a share and then it’s an employee owned (but not managed) company.

Sam Zell will hold about 40% of the company and be named chairman for his $315 million investment (and you wonder how billionaires become billionaires – by investing as little of their own money as they can for possibly very big rewards). The employees will own 60% but they don’t even have a promise of getting a seat on the board of directors!

The risks for the employees are great. The ESOP plan offers several tax advantages but involves employee pensions to do it. Instead of Tribune contributing to the 401k type of pension plan at most US companies that allows employees a free choice of how that money is invested for their retirement, an ESOP requires the employer to put that retirement money into it, and the ESOP in turn invests in the shares of the now privately held company, with stock dispersed at retirement age to the employees.

The ESOP contributions are treated as paying off principal, so both principal and interest can be deducted from Tribune’s taxes, rather than just interest. Very clever, but if Tribune drowns under all of that debt then where are the employee pensions? Answer: They’re not! If Tribune does really well under private ownership then the value of those shares will increase and it will truly be one big happy family.

How would you feel gambling with your retirement future given the company’s financial performance thus far this year?