By Michael Oneal
Chicago Tribune
Debt-for-equity plan under discussion in bankruptcy reorganization could give biggest stake to creditors, spur Sam Zell's exit
Chicago-based Tribune Co. and its creditors are in the early stages of negotiating a plan of reorganization in U.S. Bankruptcy Court that sources said likely would transfer control of the troubled media conglomerate from Chicago billionaire Sam Zell to a group of large banks and investors that holds $8.6 billion in senior debt. The plan is still taking shape, the sources said, and much could change as negotiations continue.
But the general contours of a new capital structure are coming into focus, and the plan centers on a debt-for-equity swap that probably would give the senior lenders a large majority ownership stake in the reorganized company. A source with knowledge of the situation said the plan would wipe out a $90 million warrant Zell negotiated as part of his $8.2 billion deal to take the company private in 2007. The warrant gives the Tribune Co. chairman the right to buy about 40 percent of the company for $500 million and is the basis of his control over Tribune Co., which owns the Chicago Tribune.
Zell also holds a $250 million note representing a loan he made to the company as part of the going-private transaction. That note, however, is near the bottom of the hierarchy of claims in Tribune Co.'s Chapter 11 bankruptcy case, and the source said it is unlikely it would retain any value as the capital reorganization proceeds.
Bankruptcy experts said the plan's outline raises questions about whether the senior lender group would want to retain Zell and his management team or seek new leadership for the company. It also poses the question of whether Zell would want to stay without a large ongoing stake in the company. Sources close to both the creditors and the company said it is too early to make such decisions and Tribune management continues to control the process because it currently has the exclusive right to propose whatever reorganization plan it wishes. But Zell's team has indicated that it wants to work toward a consensual plan with the company's creditors, which means issues such as who manages the company and whether those managers are given equity as part of an incentive package will be negotiated over time, experts said.
"It completely depends on whether the new owners see value in keeping Zell," said Douglas Baird, a corporate reorganization specialist at the University of Chicago Law School. "They have to decide: Is the person at the helm when the company went into the storm the most able person to steer it out?"
Zell was not available for comment, but in a statement Tribune Co. said he and his top managers "remain actively engaged and committed to this company. The restructuring is still in progress, and it is premature to speculate about the final ownership structure." Howard Seife, a partner with Chadbourne & Parke in New York, which represents the committee of unsecured creditors in the Tribune Co. case, said negotiations so far have been "fairly general and not particularly advanced."
The central logic behind the debt-for-equity swap is that Tribune Co. can no longer afford the nearly $13 billion in debt that grew out of Zell's $8.2 billion deal to take the company private in 2007. With advertising revenue in decline and the company's cash flow deflated, the company must shrink its obligations to a more sustainable level while giving creditors enough potential value in return that they agree to the cuts without a fight.
The senior creditors -- a group that includes large banks such as JPMorgan Chase and Citigroup, as well as institutional investors and funds such as Oaktree Capital Management and Angelo, Gordon & Co. -- have claims worth $8.6 billion. But the senior debt is trading on the open market for about 30 cents on the dollar, suggesting the company may be worth somewhat less than $3 billion.
Consequently, sources said, it is generally assumed that the claims of these creditors overwhelm all others, and that it would take a large chunk of equity to satisfy them in a swap, arguably most of it. But since other groups are likely to press their claims anyway, the senior group may agree that creditors lower on the hierarchy should get some consideration in the restructuring plan so that the process doesn't bog down in court.
Although talks so far have been friendly and productive, sources said, management's plan of reorganization may still be months away. It helps that apart from plans to sell the Chicago Cubs, the company will likely stay intact, partly because values for newspapers and broadcast outlets are so depressed.
But there are other complications, including the question of what to do with Tribune Co.'s employee stock ownership plan.
Tribune Co. employees own 100 percent of the company's equity through an arcane, tax-advantaged corporate structure known as an S-Corp ESOP. But a tangle of S-Corp rules would make it difficult to give the senior lenders equity and maintain the S-Corp structure.
Among other things, an S-Corp can have only 100 shareholders, and they must be individuals, not corporations. A retirement plan like an ESOP, which can have thousands of members, is permissible. But a lender like JPMorgan would be prohibited, and Tribune Co.'s senior lender group has more than 100 members anyway.
Zell's team has argued to creditors that keeping the S-Corp structure adds value to the company. It shelters Tribune Co. from paying income taxes and facilitates the company's ability to spin off assets without paying capital gains taxes. Last year, for instance, the structure helped Zell's team construct a tax-advantaged deal to unload its Newsday metropolitan daily in New York for $650 million. It also is figuring prominently in plans to shelter Tribune Co. from a big tax bill stemming from its pending sale of the Cubs.
Jack Levin, a senior partner at Chicago's Kirkland & Ellis, said it would be possible to work out a plan that preserves the S-Corp ESOP and gives lenders an acceptable stake. But any solution would be highly complex.
One idea would be to put Tribune Co.'s assets into a partnership or limited liability corporation owned to a large degree by the lenders, with a small amount given to the S-Corp ESOP. The lenders would have to pay their share of income taxes, but the structure would retain a tax-advantaged vehicle to preserve the benefits of the Newsday and Cubs deals.
Another idea would be to give the lenders warrants convertible to equity at the end of the S-Corp's 10-year useful life span. That preserves the tax breaks but forces a large number of lenders and investors to hold onto securities that may not be marketable for seven to eight more years, something they may be reluctant to do.
Any revised structure also would be open to interpretation by the Internal Revenue Service, which increases risk for creditors, said tax consultant Robert Willens.Sources on both sides of the table said the calculation for lenders likely will come down to weighing the cost of this complexity versus the value of the tax advantages. The new owners will also have to consider how much it would cost to replace Tribune Co.'s ESOP with a retirement plan attractive enough to retain employees -- a 401(k) plan with a company match, for instance.
"It's too early to say, but the bias among folks is that simplicity has its virtues," one source said. "A lot of people would rather have something that's simple and easily monetizeable."
mdoneal@tribune.com
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