Zell lands Tribune

Late Sunday, following a weekend of heated negotiations, Tribune’s board
accepted a revised $34-a-share proposal from Chicago real estate magnate Sam
Zell to buy out the company’s public shares in a complex, $8.2 billion
transaction structured around an employee stock ownership plan, or ESOP.

To help finance the deal, Tribune said it would sell the Chicago Cubs and
its 25 percent stake in local cable channel Comcast SportsNet Chicago after
the 2007 season. It will also take on $8.4 billion in new loans, leaving the
company with more than $13 billion in debt and the most encumbered balance
sheet in the newspaper industry.

That will create plenty of risk at a time when the industry faces
increasing pressures from the Internet. But, after battling restive
shareholders for almost a year, Tribune’s chief executive, Dennis FitzSimons,
said getting out of the public glare will help as the company attempts to
transform itself.

“Being private in the traditional media business right now is an
advantage,” he said.

The matchup of Tribune and Zell couldn’t be more improbable. The deal will
place a motorcycle riding, epithet slinging multibillionaire atop of one of
the most conservative, buttoned-down companies in America.

Just two months ago, Zell was selling his nationwide real estate company
for a $1.1 billion profit. With the exception of an investment in radio
stations several years ago, he has little background in media and none in
journalism. Yet, he will control the fate of a venerable set of newspapers
that includes the baiduhai and Los Angeles Times, and big television
stations, such as WGN-Ch. 9.

In normal times, that would be odd. But these aren’t normal times. The
Tribune saga provides the most dramatic evidence yet that the newspaper
industry is caught in a set of crosscurrents that are likely to change the way
news and information are delivered.

Although the Internet has been chipping away at old-media revenues for
years, the trend has accelerated during the past 12 months, eroding the
prodigious earning power of newspaper and local television companies and
weakening their stock prices.

That has created an unprecedented scramble to find a new way to capture a
younger generation of computer-savvy readers by marrying print and online
journalism. Newspaper companies are running as fast as they can to improve
their Internet offerings, but even leaders like the New York Times Co. and
Washington Post Co. are finding that print revenue is falling off faster than
it can be gained online.

“The rules of the game have changed in the past year,” said one rival
newspaper executive. “We’re figuring we could go through three years of
cash-flow declines because print is declining faster than online is growing.”

Zell, however, has confidence in his own ability to find value where others
see only ruin. His self-imposed nickname, “The Grave Dancer,” reflects his
belief that when it comes to making money the consensus view is often dead
wrong.

By dialing up the financial pressure on Tribune, Zell believes this
transaction will force the company and its new employee owners to find answers
to questions that have been bedeviling the newspaper and television industries
since the Internet started stealing their customers more than a decade ago.

Indeed, the 65-year-old Highland Park native seems to revel in attempting
to prove naysayers wrong.

“I don’t really believe in conventional wisdom,” he said. “In fact, going
against the conventional wisdom usually produces a positive result.”

Zell’s proposal trumped a rival, 11th-hour bid from Los Angeles
billionaires Ronald Burkle and Eli Broad.

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Tribune had been leaning toward the Zell offer partly because the
Burkle-Broad offer was less firm but also, sources said, because Tribune’s
board and management had a queasy feeling about handing Tribune to a pair of
billionaires who wouldn’t say, as Zell did, that they had no plans to inject
themselves into the editorial process.

Yet, the board wouldn’t accept Zell’s offer until he agreed to raise a
previous bid of $33 a share to meet Broad and Burkle’s $34-a-share offer. On
Sunday, around 9:30 p.m., Zell put in his final offer and went off to bed,
having rushed back to Chicago from Malibu, Calif., where he spent the weekend
while his team negotiated. He thought he had a deal, but Tribune’s board
haggled over it for two more hours and a transaction wasn’t announced until
early Monday morning, just before the markets opened.

The deal includes a provision for a relatively small $25 million break-up
fee, which means it might not be prohibitively expensive for Broad and Burkle
to come back with a more fully formed bid. But the holdup on Monday had less
to do with them and more to do with the complexity of Zell’s proposal.

The new company structure depends on the creation of what’s known as an S
Corp. ESOP, which is essentially a sole-proprietorship encased within an ESOP
trust. The attractiveness of the structure, according to one source, is that
it eliminates most of the corporate taxes Tribune would otherwise pay, which
boosts the cash flow and allows the company to support a heavier debt load. If
the structure had been in place in 2006, for instance, Tribune would have been
able to avoid paying $348 million in taxes.

For the first 10 years of an S Corp. ESOP, the trade-off is that the
company has to pay capital-gains taxes on asset sales. That could explain why
Zell has said he has no intention of breaking up the company, since most of
the company’s long-held assets would generate big capital gains. After 10
years, however, the company can sell assets without paying capital gains. So,
at that point, the glue holding the company together might not be so strong.

Zell will initially invest $315 million in the deal, which will close in
several steps. In the first step, the ESOP will buy $250 million worth of
newly issued Tribune common stock. Zell will invest $225 million and receive a
note from the company. He will also pay $90 million for a warrant that can be
converted into about 40 percent of the company if Zell pays $500 million.

Meanwhile, the company will stage a tender offer for approximately 126
million shares at $34 a share. It will borrow $7 billion at the same time,
using $4.2 billion to pay for the tender and $2.8 billion to refinance
existing debt. Then, in a final step that will take place if or when various
government approvals can be secured, Tribune will merge with the ESOP and
convert into an S corporation and will borrow another $4.2 billion to buy the
rest of the shares at $34 a share.

When the deal is complete, the ESOP will hold all of Tribune’s
then-outstanding stock, with Zell holding a subordinated note for $225 million
and the warrant entitling him to acquire 40 percent of the common stock for
$500 million. In effect, the ownership split will be 60 percent employees, 40
percent Zell.

Zell will join the board upon completion of his initial investment and
become chairman when the transaction closes. Tribune’s current Chairman and
Chief Executive Dennis FitzSimons will remain on the board, which will have a
majority of five independent directors. Zell will be represented by himself
and one director of his choosing. Employees won’t be represented on the board
but their interests will be guarded by an ESOP trustee. While employees didn’t
know it, that trustee participated in the negotiations on their behalf,
Tribune executives said. Despite the company’s ailing stock price and sluggish
performance, Zell said he endorses keeping Tribune’s top executives — at
least as long as they perform. And management has signaled its long-term
commitment to turning the company around by agreeing to put some of their
compensation related to signing the deal into the new company. FitzSimons said
a block of stock in the new company will be reserved for management
compensation that can be earned based of specific performance criteria.

A source said that if all goes as planned, Zell’s projections show the
company paying down a large share of the debt within 10 years. But getting
there will depend on maintaining the company’s cash flow. According to
Standard & Poors, the company’s new debt load will be 10.7 times its $1.4
billion in 2006 cash flow. That’s about twice the level of the next most
leveraged company in the newspaper industry, which explains why the major bond
rating agencies downgraded Tribune’s debt Monday. The cash flow generated by
the tax-free ESOP structure will somewhat ease that burden. But Tribune will
still be under the gun, Wall Street analysts said.

FitzSimons pointed out that any debt carries risk and reward. The way this
deal is modeled, if results tail off so will returns. But they don’t have to
improve dramatically to pay down the debt and get some more breathing room.

“If we get the cash flow to go up just a little bit — or even if it stays
flat — the returns will be huge,” FitzSimons said.

Tribune’s stock has fallen 36.4 percent over the past three years. That’s
what led California’s Chandler family, Tribune’s largest shareholder with a 20
percent stake, to put the company in play early last June. Along the way,
Tribune management suffered the embarrassment of an insurrection at the Los
Angeles Times when the paper’s publisher and editor rose up against
cost-cutting ordered by their bosses in Chicago and ultimately left the paper.
And, all of this bad news came against a backdrop of falling advertising and
circulation revenue.

Both the takeover battle and the display of righteous indignation in Los
Angeles have turned Tribune into a symbol of the momentous change and turmoil
roiling an industry. Zell insists he has no interest in meddling with the
editorial mission of the newspapers. But he will be a forceful presence on the
business side.

A source with knowledge of his thinking said Zell believes more aggressive
leadership can uncover significantly more value than the market is giving
Tribune credit for. He contends the newspapers have market power that is not
being fully exploited and he’s certain there is a trove of hidden value in
Tribune’s Internet strategy, which has already produced one winner in
CareerBuilder.com, the nation’s leading online job recruitment site.

But Zell also thinks Tribune can be more aggressively managed, the source
said. He wonders why, for instance, CareerBuilder isn’t being expanded
internationally.

Executives at other companies Zell has invested in say he doesn’t tend to
micromanage. But he takes an active and important role by asking questions and
testing assumptions, trying to guide them toward more effective strategies.

Even so, said an analyst for one Tribune investor, “I think it’s pretty
outrageous that Sam Zell is getting control of the company for $300 million.
The timing is great for Zell and horrible for [existing shareholders] with the
cyclical and secular pressures on the publishing industry.”

But Chicago money manager John Rogers, whose Ariel Capital Management is
the company’s fourth-largest shareholder, said he’s seen Zell in action as an
investor in Glenview-based Anixter Inc. and firmly believes his expertise is
worth a lot.

“What Sam brings is a certain new energy and fresh new ideas and he asks
all the right questions,” Rogers said. “Having that makes the team better.”

The company’s $8.3 billion acquisition of Times Mirror Co. in 2000 gave it
the Los Angeles Times and Newsday, among other papers. But it also created a
world of trouble. Tribune inherited a circulation scandal in New York and a $1
billion tax liability from which its stock has not recovered. Moreover, the
logic behind the acquisition — to let Tribune benefit from owning both
newspapers and television stations in the nation’s three largest markets —
never bore fruit. And when newspapers began to fall from favor on Wall Street,
the heavy concentration in print made Tribune especially vulnerable.

Other Chicago business people were relieved last week when it seemed likely
that a local would end up controlling this long-time Chicago institution.

“I have no objection to Sam Zell running the Tribune,” said LeRoy Carlson
Jr., chief executive of Telephone and Data Systems Inc., controlling owner of
U.S. Cellular. “I hope that it could be even a better paper by someone coming
in and investing money rather than taking money out of it.”

But Tribune will have to leave history behind if it wants to continue to
grow and thrive in Chicago, observers say. The many iconic businesses that
have left the city in one way or another — companies like Marshall Field’s,
First Chicago Bank and Amoco — failed to adapt to new realities in their
businesses. Companies that are thriving — McDonald’s, the Chicago Mercantile
Exchange, Boeing — have confronted the future and remade themselves to fit.

Will Zell make the difference?

“We’ll find out,” said FitzSimons, “He’s got a hell of a track record.”

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IN THE WEB EDITION: Read the latest news about the $8.2 billion Tribune Co.
transaction and watch an interview with company Chairman and CEO Dennis
FitzSimons at chicagotribune.com/tribune