By Emily Thornton
BusinessWeek
Real estate mogul Sam Zell built a complicated deal to take over Tribune Co., putting little of his own money at risk.
If there is one thing Sam Zell foresaw correctly, it is this: The day after Zell announced he was buying Tribune for more than $8 billion, the real estate tycoon told Chicago Tribune reporters the deal would not change his lifestyle no matter what happened. But, he said, "it's likely to change yours."
How right he was. Just one year after Zell bought the company (BusinessWeek, 7/30/08), Tribune announced on Dec. 8 that it is filing for bankruptcy. That means Zell could lose a small fraction of his estimated $5 billion fortune. The reason: The man who likes to call himself "the grave dancer" put very little of his own skin in the game. Instead, employees of the Tribune properties will bear the brunt of the pain, as they technically own the company and hold its $12.9 billion in debt. Tribune reported $7.6 billion in assets.
Tribune comprises eight newspapers, including the Chicago Tribune, Los Angeles Times, and Baltimore Sun; a 31% share of Food Network; two dozen TV stations, including outlets in the three biggest U.S. markets; and the Chicago Cubs baseball team. The Cubs franchise was not part of the bankruptcy filing.
ESOP Used to Borrow
Tribune's bankruptcy will be complicated. For starters, figuring out the value of Tribune in bankruptcy could be problematic. Every day brings a slew of steadily worsening statistics on ad revenue and circulation, pummeling newspaper valuations. On top of that, Zell used complex financing schemes predicated on tax advantages in structuring his deal. Those arrangements now raise thorny questions.
One of the trickiest issues will be how to handle a financing scheme Zell used to buy Tribune that relied on a tax-exempt employee stock ownership plan, known as an ESOP. Although employees had no say over how the ESOP was used, Tribune's board approved Zell's bid, which used the ESOP as a vehicle through which he borrowed hundreds of millions of dollars to tax-efficiently fund the transaction. The scheme allowed Zell to pony up just $315 million of his own cash to wrest control of the company and made employees technically Tribune's owners.
But ownership came at a price: Tribune cut back its 401(k) contributions and instead committed to use a portion of its payroll to pay down the hundreds of millions in debt that a trust set up for the ESOP used to buy Tribune shares, according to employee stock owner plan expert Corey Rosen. "It was like a mortgage that you use to buy a house with no money down," says Rosen, who wrote a report that goes into detail on Tribune's ESOP arrangements.
Tax Gains at Issue
Early on in the deal, Zell tried to motivate his troops by telling them the financing scheme would result in tax gains that would give Tribune a big advantage and could one day make employees rich. "This business lends itself to ESOPs because you have a lot of people, at least in theory, who are intelligent," he said in the Chicago Tribune interview in December 2007.
Now, the ESOP's equity stakes will likely be wiped out, and the handling of the tax gains will likely become an issue in the bankruptcy restructuring. "If a company goes bankrupt, the equity runs the risk of not being worth much," says Standard & Poor's analyst Emile Courtney. "They will probably lose everything" in the ESOP, predicts tax expert Robert Willens, who has closely studied the Tribune deal.
In a Dec. 8 note to Tribune employees, Zell still addressed them as "partners." He said their payroll, benefits, and 401(k)s would not be affected by the filing. As for the ESOP, Zell said, "it is part of the ownership structure, so its value and role long term will be determined in the restructuring. We believe the structure is a valuable asset to the company and that there are strong reasons to preserve it."
Silver Lining for Employees
But the ESOP could raise governance issues about who should be in charge of reorganizing the company. As part of his financing scheme, Zell also obtained a warrant to buy 43% of the company. So, there's a question if it is "the ESOP trustees who preserve value for the ESOP itself? Or if it is Zell negotiating to protect his note?" says one bankruptcy expert who asked not to be named.
The bright side may be that Tribune employees didn't have a lot of time to put much money toward ESOP contributions. "In a weird way, the employees are better off that the company crashed today instead of seven years from now," says a banker familiar with the deal, who asked not to be named.
With reporting by Michael Arndt. Thornton is a senior writer for BusinessWeek.
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Tribune Co. files for bankruptcy
The media conglomerate was smothered by a drop-off in advertising and a crushing $13 billion in debt from the company‘s takeover a year ago by Chicago real estate mogul Sam Zell.
"When you look at the near term, prospects for the company and the industry are certainly not very bright," said Dave Novosel, an analyst with the Gimme Credit research firm.
Tribune Co., which has 20,000 employees, owns baseball‘s Chicago Cubs as well as 10 daily newspapers, including The Hartford (Conn.) Courant and the Orlando (Fla.) Sentinel, cable channels and 23 TV stations. Its papers‘ total circulation of more than 2 million puts the Tribune Co. among the top three most-read newspaper groups nationwide.
"Tribune‘s debt was so outsized and so disproportional to its cash flow compared to these other companies that it can be the sore thumb sticking out rather than an example of the industry," said Ken Doctor, media analyst with Outsell Inc.
Although the Tribune Co.‘s next major debt payment is not due until June, the company was in danger of missing the financial targets set by its lenders. The bankruptcy filing could give the Chicago-based company some time to press its lenders to ease their targets.
"So, how did we get here? It has been, to say the least, the perfect storm," Zell, chairman and chief executive, wrote in a memo to employees. "A precipitous decline in revenue and a tough economy have coupled with a credit crisis, making it extremely difficult to support our debt. All of our major advertising categories have been dramatically impacted."
Longtime Chicago Tribune reporter Maurice Possley, who resigned after winning this year‘s Pulitzer Prize for investigative journalism, said many talented people have left the paper in recent months, and he worries about the ones who remain.
Brent Jones, a Sun reporter and union leader, said the bankruptcy filing unnerved the newsroom and prompted questions about whether the company might cut more jobs or sell the paper.
Philip Gregory, a lawyer for a Times auto critic and five former newsroom employees who sued Tribune in September over Zell‘s takeover, said the bankruptcy filing was predictable.
"We knew he was going to take this business under," Gregory said. "Of course he‘s blaming the market, but it‘s really the $13 billion in debt that he brought into the business."
In filing for bankruptcy, the company reported $13 billion in debt and $7.6 billion in assets.
John Penn, a bankruptcy lawyer at Haynes & Boone, said decisions about whether to sell papers or other assets would boil down to this: "If it makes cash, keep it. If it loses cash, get rid of it. And that‘s either by selling it, closing it or whatever it takes to stop the bleeding."
Stephen Lubben, a bankruptcy professional at Seton Hall Law School in Newark, N.J., said Tribune employees are particularly vulnerable because they participate in an Employee Stock Ownership Plan. Stockholders are last to be paid in bankruptcy, and often end up with nothing, with the stock getting wiped out.
Employees will not see all of their retirement savings wiped out, though. The company has continued making contributions into traditional retirement plans that are not affected, and many employees have separate 401(k) programs, said Corey Rosen, executive director for the nonprofit research group National Center for Employee Ownership.
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