Wall Street Journal, April 4, 2007
By Sarah Ellison

Tribune Co. and Sam Zell just took out a risky loan on the future of the newspaper industry. Now, they have to start paying it back.

The big question hanging over Tribune's $8.2 billion buyout deal unveiled Monday is this: How do they plan to do that, given that the newspaper industry faces uncertain prospects? Financed almost entirely by debt, the buyout will leave the newspaper and TV concern staggering under more than $12 billion in debt, when existing borrowings are included. That is about 10 times Tribune's annual cash flow, a ratio several times higher than typically carried by most media businesses.

"We think it is possible that Tribune is leveraged higher than the total assets of the company after taxes," wrote Hale Holden, an analyst at Barclays Capital.

In an interview yesterday, Mr. Zell defended the borrowing. "The actual debt burden is less than any of the other alternatives Tribune had," including the self-help option the company was exploring, he said. "Our structure allows us to rapidly pay down debt because of the [employee stock ownership plan]."

To structure the buyout, Tribune and Mr. Zell are engaging in some fancy financial footwork, adopting special tax-efficient structures such as the ESOP. Tribune also plans to sell the Chicago Cubs baseball team, which could fetch about $600 million. Even so, "the transaction leaves little room for error," says Peter Appert, a newspaper analyst with Goldman Sachs.

"We feel that given the cash flow that our company generates and the tax advantages of the structure, that the debt levels, while high, are manageable," Tribune Chief Executive Dennis FitzSimons said in an interview Monday.

Mr. Zell will become Tribune chairman upon completion of the deal, and said that his longtime associate, William Pate, would also serve on the board. "Obviously, all you have to do is look at all the other companies I've run, and I think it is safe to say I've been an aggressive owner in driving value in everything I've been involved in," Mr. Zell added.

Tribune's properties include the Los Angeles Times, Chicago Tribune and Newsday of Long Island, as well as a string of television stations, many carrying programming for the nascent CW network. Mr. Zell believes the company can be more aggressive in its strategy — particularly on the Internet — to boost revenue, according to a person familiar with his thinking. But as newspaper investors have learned, predicting the future course of the business is difficult.

A year ago, private-equity firms such as Chicago's Madison Dearborn indicated they could be willing to pay $38 a share for Tribune, according to people familiar with the matter. Today, that kind of money has long been scared away from the newspaper industry, where a decline in ad revenue worsened suddenly last summer. Mr. Zell's deal with Tribune involves a buyout offer of $34 a share.

The ESOP structure brings clear tax benefits. The employee share plan, combined with tax breaks available to companies that adopt so-called S-corporation status, will let Tribune avoid paying corporate taxes that last year cost the company more than $300 million, according to a person familiar with the deal.

But saving taxes won't be much help unless Tribune can pay its interest bills. And that is where things could get tricky, analysts say. Last year, Tribune paid $274 million in interest on its borrowings, which it could easily afford, given its $1.3 billion in earnings before interest, taxes, depreciation and amortization. With the new debt load, the interest expense could rise to roughly $1 billion annually, based on an average interest rate of 8.5% estimated by one bond analyst yesterday. Tribune is likely to pay a higher rate on new debt than in the past, as its credit rating has been downgraded to junk status in the wake of the deal.

While Tribune's revenue has remained flat overall for the past several years, its earnings have declined slightly. And the company is off to a difficult start for this year, with revenue down 4.3% through March 4 from a year earlier. Mr. FitzSimons, Tribune's CEO, told employees Monday that there would be "limited staff reductions" to compensate for the declines in revenue, though he added that he hoped to accomplish those mainly through attrition. The staff of the Los Angeles Times, Tribune's single biggest division, has been bracing for layoffs for weeks.
[Tribune]

Yesterday, Mr. Zell met with Tribune's general managers and publishers, who had come to the company's historic Chicago headquarters to be briefed on the deal.

If ad revenue keeps falling, as many analysts expect, Tribune will have to cut costs. Another option would be asset sales, though Tribune says it isn't planning such action. Selling cash-generating assets isn't likely to solve a financial crisis, unless the sale price is extraordinarily high. What's more, despite the tax breaks the new company will have, it would still be liable for capital-gains taxes on profits from asset sales, at least in the next few years (S corporations can sell assets tax-free after 10 years).

Some people estimate that the tax rate on selling the Los Angeles Times, one highly sought-after asset, could be around 35%, which would make it prohibitively expensive to unload directly, despite interest from local Los Angeles moguls such as David Geffen. It is always possible, of course, that Mr. Geffen or another potential buyer could try to structure some complex tax-efficient structure. Mr. Geffen says, "I'm still interested in making a deal for the L.A. Times." Mr. Zell's offer beat out a proposal from two other Los Angeles businessmen, Ron Burkle and Eli Broad, who could still come back with a new offer for Tribune.

A person familiar with Mr. Burkle and Mr. Broad's thinking said they are "meeting with their advisers and continuing to study the Tribune opportunity."

Mr. FitzSimons said Tribune wasn't planning any big asset sales, though "there may be some real-estate assets we choose to sell off." The person familiar with the deal said any real-estate sales would likely be in the "tens of millions of dollars," a tiny portion of Tribune's property portfolio, which is estimated to be valued at around $700 million.

So the company's ESOP will likely pay off its loans the old-fashioned way, which could take time. Mr. Zell, who is contributing $315 million in equity to the deal, expects the ESOP could pay off between a third and a half of the debt within 10 years, according to the person familiar with the deal.

If things go well, Mr. Zell stands to profit handsomely. Upon completion of the deal, Mr. Zell will receive a 15-year warrant to purchase 40% of Tribune's common stock for $500 million.

Corporate debt levels have soared in recent months, reflecting the increased appetite for leverage among private-equity firms and other investors. Still, newspapers, with higher fixed costs and declining revenue, are under particular pressure, and such a leveraged deal in the newspaper world is untested. Last year, when a group of local investors bought the Philadelphia Inquirer, they were forced to make severe cutbacks in order to compensate for the paper's declining earnings.

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