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.

Tribune: Earnings Stabilizing But No Growth

Tribune (TRB) reported slightly better than expected 4Q06 earnings with adjusted EPS coming in at 65 cents against a consensus estimate of 61 cents. Revenues also come in ahead of expectations at $1.47 billion vs. a consensus estimate of $1.43. 4Q06 contained an extra week compared to 4Q05 so it is possible some of the upside came from analysts not quite getting the extra week fully into their models.

Adjusting for the extra week, the quarter is nothing to get excited about. At the corporate level, revenues and EBITDA would have fallen by 1% without the extra week. Within Publishing operations, ad revenues fell 3% without the extra week while circulation revenues fell by 6%. TV results were better as there was some improvement in New York, Los Angeles, and Chicago. Adjusted for the extra week, TV revenues grew by 4%.

Digital revenues, which for TRB are primarily related to classified advertising, rose by over 30%, reaching 6% of total revenues. Adding back TRB's share of joint ventures, digital revenues represented 10% of total revenues. This is clearly a bright spot but online classifieds are usually priced a big discount to newspaper classifieds so it is not a clear win as overall yield is falling in the transition to online. If digital revenues continue to grow at 30%, there will be a boost of about 3% to overall corporate growth. Again, nothing to complain about but not large enough yet to drive TRB's overall top line....

TRB indicated that its December results in newspapers were down about 2.5% on the advertising line with January staying at this level or a little worse. This sounds pretty much inline with what other major newspaper chains have reported.

The best that can be said for TRB's recent results is that trends appear to be stabilizing. There is still no growth on the top line but results are not getting worse. Cost controls are tight and TRB will exceed its cost savings targets by $200 million over the 2007/08 time frame including savings in newsprint as prices and volumes are falling. TRB could return to very low single digit top line growth next year which coupled with cost cutting and the 22% drop in shares outstanding can drive EPS higher.

I still don’t think that is enough to get anyone interested in bidding the shares much above current prices so although the worst may be over for TRB, I can’t construct a bullish scenario.

Comments on the call related to the company's consideration of strategic alternatives were limited to a statement that the process would be wrapped up this quarter.

Tribune Auction Fails

My colleague at StreetInsight.com, Chris Atayan, made a really good point that the failed Tribune (TRB) auction shows that private equity isn't a cure for everything. I think another conclusion that can be drawn from the TRB auction is that private market value does not always noticeably exceed public market value. TRB shows that the public valuation of a business lacking growth potential and facing long-term secular challenges might just be an accurate valuation. No one will pay a premium if the supply (a poorly positioned company) is greater than the demand (the potential buyers of the company). Simple economics at work. In this case, there are not enough financial or strategic buyers to generated excess demand and the resulting price premium....

I think this a cautionary tale for the broader market and media stocks. Media stocks typically perform well when merger-and-acquisition activity is high. Many media businesses produce significant cash flow and they are sexy businesses that attract the big egos of CEOs, wealthy entrepreneurs, and private equity firms. In 2005 and much of 2006, media multiples compressed to significant discounts to historical public and private valuations. Over the past six months, investor psychology toward media has improved and multiples have risen (with the notable exceptions of newspapers, radio, and TV). While multiples today are below prior peak valuations, they are with a band of normality. Private multiples for assets like cable networks, cable systems, and movie and TV production are still above current public valuations, in some cases significantly. However, I think the TRB auction should make investors cautious of analyst valuation models that rely on private multiples.

Don't take that as too bearish. After all, the Cablevision (CVC) situation where the board correctly rejected a low ball bid by the Dolan family shows that well-positioned media assets will still find plenty of buyers and set up the requirement for a significant premium if public shareholders are to be bought out.

Private Equity Shows Interest In Tribune

Newspaper stocks rose strongly yesterday after the Wall Street Journal reported that private equity groups were showing an active interest in Tribune (TRB). On its earnings call last week, TRB reiterated that it hoped to have the strategic review complete by the end of 2006. The Journal is reporting that TRB prefers to sell itself whole. If correct, this suggests to me that the Board has lost confidence in the current management team. Given operational and strategic missteps that have caused TRB to have far worse financial performance than events struggling newspaper peers, throwing in the towel on the current management team is not surprising. Also, earlier this year when the dispute between the Chandler family and Tribune was at its peak, the company looked at restructuring alternatives such as selling the TV stations and concluded that a massive share buyback via dutch auction was a better approach. At the time, I felt that breakingup the company would not produce much excess value as the pieces wouldn’t sell or trade at significant premiums to TRB’s current valuation....

I still believe that is the case today. The Board probably agrees and realizes that selling the whole to a private equity group which specializes in squeezing value out of assets is the best change to get a significant premium. Besides their expertise in selling assets, private equity would be less restricted by complaints about cost cutting measures like layoffs or selling sacred cows like the Chicago Cubs.

Unfortunately for TRB longs, the Journal says that the Chandler family, which owns 15% of TRB, will accept a price in the mid-$30s. The Chandler’s have three Board seats so their opinion matters. I’ve felt all along that amid to upper $30s price was the best TRB would get and I see no reason to change my opinion as fundamentals have only gotten worse at both the newspapers and TV stations.

Other newspaper stocks rallied hard yesterday as well. Presumably, investors were better that if private equity were interested in TRB, they would also come to the rescue of Gannett (GCI) or Dow Jones (DJ caught an upgrade which might have contributed to the pop). Anything is possible but GCI has higher margins and fewer extraneous assets than TRB and DJ has family control that seems willing to support management as it aggressively reorients the company toward electronic publishing.

The bottom line is that beyond selling non-core assets at a premium, the only way to make a lot of money on a newspaper stock, either as a public or private investor, is if sustainable revenue growth returns to the industry. With the secular shift of key advertising categories like automotive, movies, help wanted, and retailing to the internet and national TV, the odds of a renewed growth in newspaper advertising are low.

Tribune: As Bad The Cubs

Tribune (TRB) reported an unimportant quarter form the perspective of the near-term stock price. It is not just that the near-term will be dominated by the outcome of the strategic review due by year end. The quarter was just more of the same, which means bad, and won’t move the needle at all. In fact, my key takeaway from the call si that analyst question ran out after just 40 minutes of total length. It is sad to the once great newspaper slowly die but that appears to be what is happening. TRB and others are really just very long-term liquidation plays where you have to judge how much you are willing to pay for a secular loser of market share.....

TRB reported 43 cents on revenues of $1.35 billion. Consensus was 45 cents and $1.38 billion, so the numbers were slightly light. The September ad report was weak with newspaper tracking the industry decline of low single digit declines and TV, radio, and entertainment performing worse than expected. Real estate is still rising strongly, up over 20%. This will be a headwind in 2007 when other categories benefit from easy comps. Newspaper circulation revenue was down 6% but based solely on individually paid subscriptions the decline was 1-2%. As the self imposed bulk subscription pullback laps year over year the circ declines will improve. Interactive revenues were up 28% to $61 million and now represent 6-7% of total publishing revenue.

Cost control was good and along with higher than expected interest income and equity income supported EPS. Food Network provided the bulk of the upside and losses at CareerBuilder and the WB lessened.

The bottom line on fundamentals is that operating profits fell 17% for the corporation with publishing also down 17%. The outlook for 4Q is not much better except for the benefit of political advertising at the TV stations (which the street doesn’t pay for). October started softly for the newspapers but management expects November and December to improve. TV is picking up due to political. Cash expenses will again be tightly controlled. All this adds up to another weak quarter ahead.

I don’t see much upside from the strategic review as multiples are under severe pressure across all of TRB’s businesses. Long-term fundamentals are also weak, especially relative to other economic sectors. Beyond a cyclical pickup in advertising and easing comps, I see no reason to be interested in TRB.

Despite Possible Sale Upside in Tribune is Limited

Yesterday, Tribune (TRB) gave up about 25% of its gains since announcing a settlement with the Chandler Family and creation of a committee of independent directors to look at shareholder enhancement opportunities. Supposedly everything is on the table, including the spilt up or outright sale of the company.

Investors expecting a big payday due to published estimates that the company might be worth $40 or more have to be disappointed so far. I think that my StreetInsight.com colleague Chris Atayan basically has it right when he says that the company already looked at all the alternatives the independent directors will consider and decided to complete a dutch auction and buy back additional shares from the McCormick Foundation. Chris is likely correct in his analysis that management and the Board already know that the dutch auction created as much value as any other alternative. In other words, management knows what I and some others have been saying for awhile: TRB shares are not significantly undervalued when they are trading in the low $30s.

In fact, if you put public market multiples on the separate TV and newspaper parts, at best, you get to a mid $30s target....

Historically, private market values might have been as much 20% above public values but due to lousy near-term fundamentals, severe secular challenges, strict cost cutting, and the addition of substantial leverage in the dutch auction, I suspect that public market values are about right in this case.

The only thing that worries about my analysis is that it has quickly become conventional wisdom that TRB isn’t worth much more than the current stock price. After all the company is for sale in what is essentially an auction process. I know there aren’t many buyers for the whole company due to regulatory and other issues. But just like at an antique auction (yes, I am calling TRB an antique!), all it takes is one buyer willing to pay more than anyone else. I don’t expect that buyer to show up at TRB’s auction, so I plan to sit this one out.

Should TRB shares fail to advance much further, there are implications for newspaper and TV valuations as this would be the second major asset sale (Knight Ridder was the other) that would confirm that public market values are accurate and fairly reflecting the challenging near-term and long-term fundamentals faced by these industries.

Tribune Dutch Auction Results Provide Near-Term Support

Tribune (TRB) shares had a big pop last Tuesday after the company announced results of its dutch auction. There was no follow-through since then and the shares are trading just below the $32.50 price at which the tender was complete.

TRB is buying 45 million shares at $32.50, the top end of auction range. The company was willing to purchase 53 million shares, so the auction was not fully subscribed. The next step in the company's recapitalization is the purchase of 10 million shares from the McCormick Foundation. After that, beginning in mid-July the company will purchase an additional 20 million shares in open market purchases. Open market purchases were originally expected to total 12 million. The larger amount serves to make up for the shortfall from the auction. In total, 75 million shares of 25% of the share base will be repurchased.

The best response I found to the results of the auction appeared in the business section of Wednesday's Chicago Tribune where Bear Stearns analyst Alexia Quadrani states, "Now it is back to business as usual, and business as usual in the newspaper business is not that good." The quote captures my own view of current fundamentals but given the high profile dissent of TRB's new largest shareholder, the Chandler family, it is not clear that weak fundamentals mean that TRB shares will be a poor investment....

Determining what might happen with the Chandler family is impossible. We do know that the family has talked to private equity firms about potential strategies for further enhancing shareholder value at TRB. We also know that the Chandler family and TRB are locked into a tax and valuation dispute over difficult to unwind partnership worth billions. Additionally, we know that so far the independent directors of TRB have shown unanimous support for management and no support for the Chandler's. Finally, we know that TRB doesn't have an annual meeting that would enable a proxy fight for until 2007.

Big Shareholders Boycott

What we don't know is what large shareholders besides the Chandler's are thinking. We can infer from the unfilled demand in the Dutch auction that many large shareholders did not participate, implying that they think the stock is worth a lot more than $32.50. What we also don't know is if private equity firms are willing to step to the plate in a deal that could reach $8 billion or more in market cap plus several billion more in assumed debt.

Not Bullish on TRB

I am not really sure what to make of TRB shares. If I had to guess, I'd say that the stock is likely to drift lower over the next couple of months as weak June revenues, a poor 2Q earnings report, and weak guidance for the balance of 2006 trump takeover or restructuring speculation. But I don't think the shares are likely to fall much below $30 as asset value in excess of $35 definitely exists at TRB, a significant shareholder is publicly agitated, and private equity still seems to have great interest in media assets based on the outcomes at Knight-Ridder (KRI) and Univision (UVN).

A Defensive Stock

The bottom line is that in an uncertain stock market environment over the balance of 2006, TRB shares remain a good place to hide. Upside exists and catalysts are realistic while downside is protected.

Is There Excess Value At Tribune?

One of the theories behind breaking up Tribune (TRB) is that the broadcast television assets are worth a significant premium to the current valuation of TRB shares. Recent TV station sales support this idea but an article last week in the Wall Street Journal there outlined the pressure that local TV stations are feeling. It makes me wonder if a breakup of TRB might not yield as much upside as some expect.

On the other hand, the New York Times has reported that several of the major private equity shops that specialize in media have already approached the Chandler family about either buying out their stake or partnering with the family on a buyout of TRB.

The Jounral articles notes that for now reasoningthe TV business is still basically OK which is what attracts private equity money. The question, though, is whether the 8 times EBITDA multiple for CBS (CBS) or the 12-14 times multiple of recent station sales are the correct valuations. It makes a big difference to your opinion of TRB.

I suppose TRB is a good place to hide given the heightened speculation about a breakup of the company. I still have this nagging concern that any restructuring short of a sale of the entire company will produce a stock price that falls far short of bullish estimates north of $40. The depressed valuation of CBS and the fact that pure play newspaper companies are trading at the same multiple as TRB are the source of my concern.

The Journal Stays on the Tribune Case

The Wall Street Journal had another front page article on Thursday about Tribune (TRB), followed by a Heard on the Street column on Friday. Both articles suggest a potential restructuring or sale of Tribune (TRB) might be more likely than I had assumed.

My key takeaway from the latest articles is that TRB's future could move beyond control of current management and the Board. However, I think Chris that both the Chandler family and TRB are conservative entities that aren't likely to move quickly on a sale or split of the company unless forced by outside parties.
I think a sale would probably occur near $40, so there is upside in the event if it occurs. A split of the company into separate broadcasting and newspaper stocks would produce similar value. The excess value vs. the current stock price would come from placing private market values of 10 times newspaper EBITDA and 12-14 times broadcasting EBITDA. Presently, TRB trades at 9 times EBITDA.

The articles continue to push TRB shares higher. I stand by my analysis that barring an outright sale, the upside in TRB shares will be dictated by improving fundamentals as measured by renewed revenue growth. I don't see that on the horizon. Additionally, the breakup of Viacom shows that separation doesn't necessarily result in the higher multiples that are assumed. Consequently, I am wary of chasing TRB shares and would remain on the sidelines.

Interesting Developments at Tribune

The Wall Street Journal reported on Wednesday about some interesting developments at Tribune (TRB). The three Board members nominated by the Chandler family voted against the company's plan to buy back 25% of the shares outstanding. The Chandler family controls 12% of TRB shares that were acquired via their sale of Times Mirror. It is not clear what further action, if any, the Chandler family might take but public opposition to a significant corporate initiative which is supported by senior management suggests that turmoil exists in the TRB Boardroom.

Back on May 30th, TRB announced that it would repurchase 75 million shares, or 25% of its outstanding shares. 53 million shares will be purchased in a Dutch auction at a price of $28-$32.50. An additional 10 million will be purchased from the McCormick Foundation, currently TRB's largest shareholder, with the final 12 million coming in open market purchases.

At $30, the repurchase will cost $2.2 billion to be financed with debt and asset sales totaling $500 million pre-tax (an Atlanta TV station has already been sold to Gannett (GCI) for $180 million). TRB also announced that incremental cost savings of $200 million annually were being targeted. Pro forma for the buyback, debt to EBITDA will be about 4.7 times and shares outstanding will be about 235 million....

The Journal noted that some investors view the company's share buyback as a first step in a larger plan to create shareholder value. The article quotes a TRB spokesman saying "the Board considered a broad range of strategic alternatives" before settling on the leveraged buyback. This comment certainly allows lots of room for rumors. Some analysts have suggested that the company should consider splitting its broadcast television assets, which account for approximately one-third of EBITDA, from its newspaper assets. Other speculation has centered on much larger asset sales possibly including the Chicago Cubs.

With the Chandler family's opposition to the buyback possibly indicating a lack of confidence in management and frustration with the lack of appreciation in the shares since the Times Mirror sales in 2000, one has to wonder if this could be the beginning of the end for TRB as we have known it. If so, the question is whether there is significant incremental value that could be unlocked in TRB shares.

Analysts have TRB trading at 8-9 times 2006 estimated EBITDA. With pure play newspaper companies trading at similar multiples, it doesn’t seem like public market values offer much upside from the newspaper assets. On a private market value basis, Knight Ridder (KRI) is being sold for around 10 times EBITDA. TRB owns major market newspapers including leading papers in the top three markets, so even though the KRI bidding was subdued, TRB might attract more attention. A takeout of TRB would cost around $12 billion, an amount that private equity could seemingly raise easily.

Where value might exist at TRB is in its broadcasting assets. A number of TV stations have been sold recently at 12-14 times EBITDA. Placing that 5 multiple point premium on TRB's $400 million of TV EBITDA theoretically creates $2 billion in value or close to $7 per TRB share on the current share base.

So would I buy TRB here? I would not. I think the leveraged recap creates potential value by transferring it from bondholders to shareholders and adding asset value per share. However, I continue to think that multiples in traditional media will contract until top line growth picks up to at least the mid-single digits. I don’t see that happening at TRB anytime soon, so I'll sit on the sidelines with the expectation that I can buy the stock around the current price months from now. As for the Chandler family actions leading to a raid on TRB, it is a risk I'll take. I don’t think it will happen.

Tribune: Addressing Unique Issues But Industry Challenges Remain

Tribune (TRB) are up over 2% since reporting 3Q05 earnings and conducting a conference call on Thursday morning before the open. The key takeaway from the report and call is that TRB is putting its unique issues in the past and the company's fortunes will begin to closely track the newspaper industry. Given poor trends in the industry, the lack of any signs of improving advertising or circulation growth, and multiples that still remain at historic averages, things really aren’t looking great for TRB. However, the worst appears over relative to the group which should allow TRB shares to regain some of its multiple relative to its peer group and thus outperform other newspaper stocks in the near-term....

....Entering the earnings report, TRB shares had been the second worst performer among newspaper stocks, falling by more than 20%, trailing only New York Times (NYT). This has led TRB shares to trade at an EBITDA multiple that is below its long-term average. Among newspaper stocks, besides TRB, only Gannett (GCI) also trades at a discount to its historical multiple. In fact, TRB trades at the second lowest multiple in the group, about 7.5 times 2006 projected EBITDA.

TRB's status as a poor performing and relatively cheap stock is deserved. The company's estimates have fallen steadily all year as in addition to industry woes, the company has had a series of self-inflicted wounds including: a major circulations restatement and advertising rebate at Newsday, a circulation restatement at Hoy, and the loss of tax litigation that resulted in a $1 billion tax penalty. TRB also has suffered disproportionately from poor trends in retail and national advertising due to its concentration in New York, Chicago, and Los Angeles. Los Angeles has its own set of issues as the Los Angeles Times faces tough competition and well above industry average circulation declines.

The bright light is that trends in the third quarter indicate that the self-inflicted wounds are largely winding down relative to year-over-year growth. The tax issue is well understood and analyst estimates for 2006 incorporate the higher debt and stable rather than increasing share repurchases that the higher debt mandates. This places TRB shares in the position to outperform the group if management takes shareholder friendly actions or if industry trends improve, especially for big city dailies.

As far the quarter and 4Q05 guidance goes, the company reported as expected. EPS of 50 cents actually exceeded street estimates by 2 cents. Year-over-year EPS growth was -2%. Revenue that matched street estimates. Publishing revenue was flat against a 1% increase in expenses, while Broadcasting revenue fell 2% against operating expense growth of -15%. Trends in TV were worse with revenue down 6% against a 4% increase in operating expenses. New York, Los Angeles, and Boston stations have "ratings issues" and the WB Network is off to an awful start this season. Guidance appears about as expected although the company noted that retail advertising in publishing weakened a bit more in October and television pacings are down low double digits.

Key data points to get more bullish on TRB would be confirmation of improved circulation trends and a return to growth in advertising categories and mediums that have incremental exposure to big cities. I am not yet ready to make the call but TRB has moved toward the top of my list if I ever get bullish on newspaper stocks.