Tribune goes private, Cubs on the auction block

by Michael Oneal

Chicago Tribune (MCT)

3 April 2007


The Tribune Tower in Chicago, Illinois.
(E. Jason Wambsgans/Chicago Tribune/MCT)

CHICAGO - After an epic corporate takeover drama, Chicago’s Tribune Co. will go private in an deal that puts the 159-year-old media conglomerate in the hands of the city’s most iconoclastic entrepreneur, setting up a high-stakes bet that a pillar of the nation’s old-media establishment can tug itself into the digital future without toppling over.

Late Sunday night, following a weekend of heated negotiations, Tribune’s board accepted a revised $34-dollar-a-share proposal from Chicago real estate magnate Sam Zell to buy out the company’s public shares in a complex, $8.2 billion transaction structured around an employee stock ownership plan.

To help finance the deal, Tribune said it would sell the beloved Chicago Cubs and its 25 percent stake in local cable channel Comcast SportsNet Chicago after the 2007 season. It will also take on $8.4 billion in new loans, leaving the company with more than $13 billion in debt and the most encumbered balance sheet in the newspaper industry.

The match between Tribune and Zell couldn’t be more improbable. The deal will place a motorcycle-riding, epithet-slinging multibillionaire atop of one of the most conservative, buttoned-down companies in America.

Just two months ago Zell was selling his nationwide real estate company for a $1.1 billion profit. With the exception of an investment in radio stations several years ago, he has little background in media and none in journalism. Yet he will control the fate of a venerable set of newspapers that includes the Chicago Tribune and Los Angeles Times, and big television stations such as WGN.

In normal times, that would be odd. But these aren’t normal times. The Tribune saga provides the most dramatic evidence yet that the newspaper industry is caught in a historic set of crosscurrents that are likely to change forever the way news and information are delivered.

Although the Internet has been chipping away at old-media revenues for years, the trend has accelerated over the past 12 months, eroding the prodigious earning power of newspaper and local television companies and weakening their stock prices.

That has created an unprecedented scramble to find a new way of capturing a younger generation of computer-savvy readers by marrying print and online journalism. Newspaper companies are running as fast as they can to improve their Internet offerings, but even leaders like the New York Times Co. and Washington Post Co. are finding that print revenue is falling off faster than it can be gained online.

“The rules of the game have changed in the past year,” said one rival newspaper executive. “We’re figuring we could go through three years of cash flow declines because print is declining faster than online is growing.”

Zell, however, has supreme self-confidence in his own ability to find value where others see only ruin. His self-imposed nickname, “The Grave Dancer,” reflects his belief that when it comes to making money the consensus view is often dead wrong.

By dialing up the financial pressure on Tribune, Zell believes, this transaction will force the company and its new employee owners to find answers to questions that have been bedeviling the newspaper and television industries ever since the Internet started stealing their customers more than a decade ago.

Indeed, the 65-year-old Highland Park, Ill., native seems to revel in attempting to prove the naysayers wrong.

“I don’t really believe in conventional wisdom,” he said. “In fact, going against the conventional wisdom usually produces a positive result.”

Zell’s proposal trumped a rival, 11th-hour bid from Los Angeles billionaires Ronald Burkle and Eli Broad.

Tribune had been leaning toward the Zell offer anyway - partly because the Burkle/Broad offer was less firm, but also, sources said, because Tribune’s board and management had a queasy feeling about handing Tribune to a pair of billionaires who wouldn’t say, as Zell did, that they had no plans to inject themselves into the editorial process.

Yet, the board wouldn’t accept Zell’s offer until he agreed to raise a previous bid of $33 a share to meet Broad and Burkle’s $34-a-share offer. On Sunday around 9:30 p.m., Zell put in his final offer and went off to bed, having rushed back to Chicago from Malibu, Calif., where he spent the weekend while his team negotiated. He thought he had a deal, but Tribune’s board would haggle over it for two more hours and a deal wasn’t announced until early Monday morning just before the markets opened.

The deal includes a provision for a relatively small $25 million breakup fee, which means it might not be prohibitively expensive for Broad and Burkle to come back with a more fully formed bid. But the hold-up on Monday had less to do with them and more to do with the vast complexity of Zell’s proposal.

The new company structure depends on the creation of what’s known as an S Corp ESOP, which is essentially a sole-proprietorship encased within an ESOP trust. The attractiveness of the structure, according to one of the people who put it together, is that it eliminates most of the corporate taxes Tribune would otherwise pay, which boosts the cash flow and allows the company to support a heavier debt load. If the structure had been in place in 2006, for instance, Tribune would have been able to avoid paying $348 million in taxes.

For the first 10 years of an S Corp. ESOP the trade off is that the company does have to pay capital gains taxes on asset sales. That helps explain why Zell has said he has no intention of breaking the company up, since most of the company’s long-held assets would generate big capital gains. After 10 years, however, the company can sell assets without paying capital gains. So at that point the glue holding the company together might not be so strong.

Zell will initially invest $315 million in the deal, which will close in several steps. In the first step the ESOP will buy $250 million worth of newly issued stock, which will represent the equity of the new company. Zell will invest $250 million and receive a note from the company. He will also pay $90 million for a warrant that can be converted into about 40 percent of the company if Zell pays $500 million.

Meanwhile, the company will stage a tender offer for approximately 126 million shares at $34 a share. It will borrow $7 billion at the same time, using $4.2 billion to pay for the tender and $2.8 billion to refinance existing debt. Then, in a final step that will take place if or when various government approvals can be secured, Tribune will merge with the ESOP and convert into an S corporation and will borrow another $4.2 billion to buy the rest of the shares at $34 a share.

When the deal is complete, the ESOP will hold all of Tribune’s then-outstanding stock with Zell holding a subordinated note for $250 million and the warrant entitling him to acquire 40 percent of the common stock for $500 million. In effect, the ownership split will be 60 percent employees, 40 percent Zell.

Zell will join the board upon completion of his initial investment and become chairman when the transaction closes. Tribune’s current Chairman and CEO Dennis FitzSimons will remain on the board, which will have a majority of five independent directors. Zell will be represented by himself and one director of his choosing. Employees won’t be represented on the board but an ESOP trustee will guard their interests.

Despite the company’s ailing stock price and sluggish performance, Zell said he endorses keeping Tribune’s top executives - at least as long as they perform. And management has signaled its long-term commitment to turning the company around by agreeing to put some of their compensation related to signing the deal into the new company. FitzSimons said a block of stock in the new company will be reserved for management compensation that can be earned based on specific performance criteria.

A source said that if all goes as planned, Zell’s projections show the company paying down a large share of the debt within 10 years. But getting there will depend on maintaining the company’s cash flow. According to Standard & Poors, the company’s new debt load will be 10.7 times its $1.4 billion in 2006 cash flow. That’s about twice the level of the next most leveraged company in the newspaper industry, which explains why the major bond rating agencies downgraded Tribune’s debt Monday. The cash flow generated by the tax-free ESOP structure will ease that burden somewhat. But Tribune will still be under the gun, Wall Street analysts said.

Tribune’s stock, which was trading near $32 a share before the deal was announced, has fallen 36.4 percent over the past three years. That’s what led California’s Chandler family, Tribune’s largest shareholder with a 20 percent stake, to put the company in play early last June. Along the way, Tribune management suffered the embarrassment of an insurrection at the Los Angeles Times when the paper’s publisher and editor rose up against cost-cutting ordered by their bosses in Chicago and ultimately left the paper. And all of this bad news came against a backdrop of falling advertising and circulation revenue.

Both the takeover battle and the display of righteous indignation in Los Angeles have turned Tribune into a symbol of the momentous change and turmoil roiling an industry. Zell insists he has no interest in meddling with the editorial mission of the newspapers. But he will be a forceful presence on the business side.

A source with knowledge of his thinking said Zell believes more aggressive leadership can uncover significantly more value than the market is giving Tribune credit for. He contends the newspapers have market power that is not being fully exploited and he’s certain there is a trove of hidden value in Tribune’s Internet strategy, which has already produced one winner in CareerBuilder.com, the nation’s leading online job recruitment site.

Executives at other companies Zell has invested in say he doesn’t tend to micromanage. But he takes an active and important role by asking questions and testing assumptions, trying to guide them toward more effective strategies.

Even so, said an analyst for one Tribune investor, “I think it’s pretty outrageous that Sam Zell is getting control of the company for $300 million. The timing is great for Zell and horrible for (existing shareholders) with the cyclical and secular pressures on the publishing industry.”

But Chicago money manager John Rogers, whose Ariel Capital Management is the company’s fourth-largest shareholder, said he’s seen Zell in action as an investor in Glenview, Ill.-based Anixter Inc. and firmly believes his expertise is worth a lot.

“What Sam brings is a certain new energy and fresh new ideas and he asks all the right questions,” Rogers said. “Having that makes the team better.”

The irony of a free-spirited entrepreneur like Zell taking control of Tribune Co., a charter member of the city’s establishment, would be hard to miss. First printed on a hand press in a one-room plant at Lake and LaSalle Streets, the Chicago Tribune helped elect Abraham Lincoln and was a staunch backer of the Union cause during the Civil War. Under the leadership of its longtime editor and publisher Col. Robert R. McCormick, the Tribune evolved into one of the leading conservative voices in America.

The company’s $8.3 billion acquisition of Times Mirror Co. in 2000 gave it the Los Angeles Times and Newsday, among other papers. But it also created a world of trouble. Tribune inherited a circulation scandal in New York and a $1 billion tax liability from which its stock has not recovered. Moreover, the logic behind the acquisition - to let Tribune benefit from owning both newspapers and television stations in the nation’s three largest markets - never bore fruit. And when newspapers began to fall from favor on Wall Street, the heavy concentration in print made Tribune especially vulnerable.

Other Chicago business people seemed relieved last week when it seemed likely that a local would end up controlling this long-time Chicago institution.

“He’s a local and recognizes the Tribune as a local icon with deep Chicago roots from Col. McCormick to McCormick Place,” said Jerry Cizek, president of the Chicago Automobile Trade Association, which represents 500 area auto dealers.

But Tribune will have to leave history behind if it wants to continue to grow and thrive in Chicago, observers say. The many iconic businesses that have left the city in one way or another - companies like Marshall Field’s, First Chicago Bank and Amoco - failed to adapt to new realities in their businesses. Companies that are thriving - McDonald’s, the Chicago Mercantile Exchange, Boeing - have confronted the future and remade themselves to fit.

Will Zell make the difference?

“We’ll find out,” said Tribune CEO FitzSimons, “He’s got a hell of a track record.”

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