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April 09, 2007

Reservations for Zell's Purchase of Tribune

Sam Zell's ESOP driven takeover of Tribune (TRB) is being met with a lot skepticism by the mainstream business press and newspaper industry observers. The gist of the skepticism is that employees are being asked to take on a huge risk by using their retirement savings to finance a very highly leveraged buyout of a company with declining revenue trends. Goldman Sachs analyst Peter Appert pointed out how little margin for error exists given his expectation for $13 billion in debt, $1.3 billion in EBITDA, and $1 billion in interest expense.

To put that $300 million in perspective, consider that based on 2007 analyst estimates TRB is expected to reports its fourth consecutive year of declining operating income. In fact, operating income in 2007 will be about $280 million less than in 2003. Furthermore, over the past six years, TRB capital expenditures have averaged $215 million annually....

The ESOP structure was adopted to eliminate taxes, the other major drain on cash, but even so Zell and the ESOP don’t have a lot of levers to pull to increase their breathing room. Expenses could be cut to increase operating income or assets sold to reduce debt and interest expense. Revenue growth could resume at level above expense growth but given recent trends and secular challenges I wouldn't be counting on that if I were one of TRB's new owners.

I don’t think there is a lot of room to cut expenses unless the entire model of news collection is blown up. Every conference call for the last two years has had extensive discussion of cost savings initiatives and analysts don’t seem to think there much left to cut without hitting bone.

As for asset sales, so far Zell has ruled out selling anything but the Cubs. The Cubs are valuable and some estimates think the sale price could be as high as $1 billion. At that price, interest expense savings would be $75 million. Net of reported profits for the Cubs of $10-20 million, the sale will provide a meaningful amount of additional breathing room.

The bottom line is that this analysis is bad news for the rest of newspaper industry. TRB didn't sell at much of a premium to current industry public market values and few other companies have an asset as valuable as the Cubs that produces so little cash flow.

I guess the only upside to the TRB buyout is that I have one less boring, maybe hopeless, investment to track.

Posted by Steve Birenberg at April 9, 2007 07:32 AM in TRB