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Despite slashed debt, is the Star Tribune still overleveraged?

At first blush, it seems wrong to suggest the Star Tribune’s $100 million debt is too much.

After all, creditors just accepted a huge write-down from $480 million, rung up by outgoing owners Avista Capital Partners. Debt payments fall from $35 million a year to around $10 million. And, because the creditors are about to own 95 percent of the company, they essentially pay themselves.

Friday's Part 1 looked at how likely the business will spin off enough cash to service the debt. For employment to hold, revenue must rise after years of decline.

Too much debt means too little wiggle room if plans the company’s financial projections don’t pan out. As noted in Part 1, if the Strib's ad staff doesn't come through with flying colors, then lots of journalists and blue-collar workers are toast.

Another approach, commonly used to judge deals, divides the debt by operating earnings, also known as EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization).

By the end of 2010, the Strib’s debt will have grown to $104 million. (More on that in a bit.) EBITDA is projected at $20.8 million. Divide 104 by 20.8, and the debt is said to be a "5X" multiple.

University of Minnesota Finance Professor Andrew Winton, a bankruptcy expert, says these days, "that’s a lot."

Media entrepreneur, analyst and former newspaper editor Alan Mutter, who has written extensively about industry multiples, says, "I agree with the finance prof that the 5x multiple is too high ... Especially for a company with scant visibility into its future sales prospects."

Secured, but not secure
Amid huge economic uncertainty, smaller multiples — meaning less debt or higher earnings — are better for stability and survival.

But why would owners load up their balance sheet with debt?  They own the $100 million obligation — and 95 percent of the Strib's shares (also known as equity). So for now, they're paying themselves. Why not take profits instead, and make the business that much more stable?

Winton says institutional investors — a category including the new owners and those who may buy the debt  — prefer loans to shares. 

One reason: debt is secured when things go bad; equity evaporates.

Consider that in the Strib bankruptcy, the equity owners (Avista Capital Partners and publisher Chris Harte) saw their stakes wiped out. Even though the debt-holders took a massive write-down, they got something: the business and its assets.

Debt is a superior obligation, paid first. Bondholders expect that $9 million to $10 million a year regardless of business conditions, and will be the last ones willing to take the haircut if expenses get cut.

So if the Strib’s revenues don't meet the projections, the bondholders have a perfect excuse to force more concessions, lay off people and strip out more costs. It’s a big reason the new owners will find a market to re-sell the debt, long before they find a buyer for the business.

Debt also has other advantages. The Strib’s interest payments can be deducted as a business expense, while profits are taxed as business income — and then taxed again when the recipients pay their taxes.

And interest payments also reduce profits unions might eye at contract time. Indeed, some of the newly concessionary labor deals — which included double-digit pay cuts and dozens of layoffs — include a profit-sharing sweetener for surviving workers.

Employees didn’t really expect to see anything, given the industry’s state. However, the capital structure makes a payout even more fantastical.

Interesting rates
The Strib’s loan is broken into two tranches: a $60 million component, and one for $40 million. Both carry a variable interest rate: 3 percent plus the LIBOR rate (a global benchmark).

LIBOR is currently 1.25 percent, but the debt agreement imposes a 5 percent floor. That means that for its $100 million, the Strib will pay no less than 8 percent (the floor plus 3 percent).

However, the $40 million tranche includes an upper limit: an 11 percent fixed rate that is “paid in kind,” or PIK.

Essentially, PIK means you don’t pay the principal or the interest — which accumulates at 11 percent for the privilege. "The PIK [rate], that’s high," Winton says.

Thanks to PIK, the Strib’s indebtedness actually rises over time. According to projections, it will climb from $100 million now, to $104 million in 2010 to $115 million in 2012.

Cash is king
The upside of PIK is that while indebtedness rises, so does cash on hand.

The Strib estimates it will have $26.8 million in cash or cash equivalents by the end of this year. By 2012, that cushion is projected to soar to $49 million, with a fair chunk of that rolled-over PIK interest.

In a troubled business, cash is critical for getting through crises — though it’s better if it came from operations unburdened by debt, rather than deferred debt payments.

Increased debt also can be acceptable if earnings rise faster. The exact opposite has been happening in the media world, but the Strib forecast depends on an enormous reversal. In their scenario, revenue rises faster than expenses or the PIK-fueled debt, dropping the 5X multiple to 4.6X in 2012.

That’s still a big number. But to be fair, the projections assume PIK because 11 percent is the maximum rate the paper would pay on the $40 million tranche.

In other words, building PIK into the projections is a prudent, worst-case assumption, even if you find the debt imprudent.

Should interest rates stay low, the Strib’s interest payments could fall, and the 5X multiple might decline faster. Then again, variable rates could rise, forcing up payments on the $60 million tranche.

Jawboning down debt
Brian Tierney, the Philadelphia publisher who’s at war with some Strib creditors in his own bankruptcy proceedings, is pursuing a zero-debt solution that leaves his bankers with cash and real estate.

Says Tierney of the Strib: “This seems like a restructuring in the best interest of the lenders, not balancing the needs of the readers, the community at large. It’s not good for the enterprise, but the judge signs off because nobody tells him any different.”

(As noted in Part 1, creditors would not comment for this piece, and neither would the Strib beyond a general media release.)

Tierney says if the Strib’s new financier/owners were asked instead to finance someone else’s $100 million Strib bid, "They'd say, 'You're crazy!'"

That remains hypothetical. In reality, the Strib's judge had no alternative, and was extremely unlikely to impose a lower debt figure. If creditors didn’t get what they wanted, they would’ve objected to the reorganization, potentially forcing the state’s biggest news source into liquidation and out of business.

Tierney contends that particular game of chicken isn’t necessarily as scary as it seems. He claims his legal efforts have forced his Philly rivals to cut their plan's proposed debt from $100 million to $85 million.

"Even if we lose, we’ll have benefited the operation, and the community," he states.

Of course, no one raised similar hell here.

Bradley Pattelli, the spokesmen for the creditor-owners, told Strib reporter Jennifer Bjorhus recently that his group could own the newspaper for five to seven years. If the Strib somehow produces five years of $20 million-plus EBITDA, or actually lowers debt, that consistency could reap a $100-million-plus sale price.

The debt matures in 2014, and looking at the 2012 balance, it won’t be paid off. No one really expects that; the maturity date just says the terms must be renegotiated five years hence. In a way, journalists, readers and the community may consider themselves fortunate if the obligation survives that long, though what the Strib will be like then is anyone’s guess.

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Comments (11)

David, there's one comment in your analysis that doesn't ring true: Alan Mutter's statement that "the 5x multiple is too high ... Especially for a company with scant visibility into its future sales prospects."

Mutter is way off base here: the Star Tribune advertising sales force has extremely deep knowledge of its current and potential customers, and of the Minnesota ad market. Assuming that the Great Recession ends, businesses that have discovered the limitations of everyone-ignores-them banner ads and invasive pop-ups will direct a considerable portion of their revived advertising budgets toward the only remaining medium capable of reaching a mass audience: the daily newspaper.

Will newspapers ever get back to gigantic (and amazingly lucrative) Sunday classified sections? Not on your life -- most of that business is gone forever.
Is this transition going to be easy for either the Star Tribune or the Pioneer Press? Of course not. But businesses still will need to connect with their customers, and newspapers will have a continuing role in helping their advertisers thrive and prosper.

Bruce, I think Alan was talking about not knowing just what share of their ad budget customers can/will spend on print - or on still-unknown online products - even when the Great Recession ends.

But I get your point that the Strib sales staff is not clueless about its customers. And to buttress your point about Sunday classifieds - and all other days - John Morton in Part 1 notes that the newspaper has already lost whole categories, so going forward, those losses have been recognized and newspapers might gain off their vastly reduced base.

That said, ad sales have shrunk 50 percent in three years, and predicting a bottom is tough. I wish the Strib's cash flow was better able to absorb a wrong guess.

David - good report. I think the reason that the PE group wanted to keep the note component of the deal is that they likely have foreign investors. Per the code only certain types of income will provoke foreign withholding rules, interest not being one of them. It would be prudent from a tax perspective to have the original foreign investors in say Avista Capital Partners Fund X only own the debt. If this doesn't happen they Avista would have to create an SPV C-corp to prevent 35% withholding an dividends and other income. And 11% PIK not that high in alternative investment terms.

I agree with Bruce.

You keep making speculations about the future. If there is anything we know about the future, you cannot predict it.

The Strib is by far and away still the largest media in Minnesota with a website generating over 5 million unique visits (to be accurate, one must say technically 5 million unique computers, blackberries, etc.). Their last audit I saw says they sell on average over 500,000 Sunday newspapers.

There is no media out there - radio, broadcast television, or cable for that matter - that even comes close to those numbers. I am sure there will be an uptick in advertising once things settle down. To be honest, with the exception of the sports section and business I buy the Sunday newspapers for the coupons.

In a plug for the Pioneer Press over the weekend, they have done an OUTSTANDING job in writing an article on the recent Franken-Coleman recount. Extremely informative. I have not seen anything approaching that quality coming from a website blogger. Truly excellent work.

I hope both newspapers do well, and prosper when we come out of this economic doldrum. Our democracy requires it!

"But why would owners load up their balance sheet with debt?"

Because interest payments are tax deductible and profits can be subject to double income taxation.

The reason not to load up balance sheet with debt is to create equity in the company making it more salable, and perhaps it's stock more attractive. But no one wants to buy a newspaper so dressing up the balance sheet would be a classic example of putting lipstick on a pig.

How a corporation is financed and how that financing appears or doesn't appear on it's balance sheet are often a matters of choice. Debt can be put on a balance sheet or taken off. But one thing is fundamentally true, and that is that no amount of balance sheet manipulation, and really no amount of creative accounting of financing can ever change a bad business into a good business.

It's a widely held perception, and one that I share myself, that newspapers are a bad business, and that will hold true no matter how well they are run.

Basically, the Stribs owners are rearranging the deck chairs and polishing the brass on the Titanic, while hoping that the rest of the world will come to accept this big gaping hole below the waterline.

Hiram,

There are 1480 daily newspapers in the US. Ten (10) have filed bankruptcy. The issue isn't readership - between their print and digital editions they are growing their audience. That was the point I was trying to make. It is monetizing their audience that they are wresling with.

Television is splintering into several channels, and are also losing revenue to the internet. Radio is losing their audience to ipods and satellite radio. We are quickly evolving into webvision: a combination of the internet and television where you can watch any show you wish at anytime, subscribe to a movie service (Netflix), play games and listen to music from anywhere. But I will always want to know what is going on in my community.

To say that newspapers are a bad business is stretching it. All media companies are going through a huge change - including websites (ie how is Facebook going to deal now with Google Wave is a perfect example. I really like the Wave simply because it is easier to navigate than Facebook).

Some newspapers are not going to make it. Some will have to lower their expections, and change their business model. My point is that despite this onlsaught of the internet, the Strib is still selling 500,000 Sundays newspapers. Some people prefer print and getting coupons.

"There are 1480 daily newspapers in the US. Ten (10) have filed bankruptcy. The issue isn't readership - between their print and digital editions they are growing their audience."

I didn't mean to suggest that readership was the problem. Vastly more people read newspaper generated content than ever. They just aren't paying for it, and what newspapers used to get paid for, advertising, is drying up.

Television has problems that are not dissimilar as was indicated in the Emmys last night. People through several different technologies are eliminating advertising.

"To say that newspapers are a bad business is stretching it."

I really don't think so. Newspaper are closing everywhere and have been for a while now. Great newspapers like the New York Times have seen their stock prices plummet and are dependent on foreign financing. The Washington Post thrives only because they bought Kaplan, the SAT prep company. In an internet age, the model of hauling all that paper around just to deliver the news once a day is under severe pressure that will only get worse.

"Some newspapers are not going to make it. Some will have to lower their expections, and change their business model. My point is that despite this onlsaught of the internet, the Strib is still selling 500,000 Sundays newspapers. Some people prefer print and getting coupons."

The expectations they may have to lower is the idea of newspaper as a medium for news, as opposed to a vehicle for delivering advertising. The Sunday paper is an example of that. It still is the best way of delivering print advertising, including those coupons. But is that something that we need more than once a week?

Hiram,

You make some interesting points.

No one is disputing some newspapers will not make it. However, the impression the whole industry is out the door when their websites are attracting millions is absurd. No other media - including Minnpost - comes anywhere near those numbers. I believe the Strib beat CBS evening news the day Favre was announced. That is an unbelievable number.

It will take a radical repositioning of their business models. Do we need print every day? Maybe it turns into a weekend edition only. Do they adopt a 'Freemium' model? That makes the most sense given the huge audience. Upsell to a small percentage of the audience thereby paying for the newspaper content.

I just think you are jumping the gun to assume something with a massive audience is doomed.

Where are these aggregators going to get their content? Huffington Post and Politico are not profitable even with free content from newspapers like the Times. How will they become profitable if they have to pay for their own content?

I don't dispute the fact that huge numbers of people get news from newspapers. In that respect, they are doing considerably better than the network evening news shows, which are really looking like the relic of a bygone era these days. I can't recall the last time I watched a major network evening news show, all the way through, and I am a total news junkie.

As for weekend editions only, you can't make money if you have nothing to sell. And the fact is, the weekly new publications, the magazines Time and Newsweek, are in just as much trouble as the newspapers in identifying what their mission is in this era of the internet.

I don't want to jump any guns. I love newspapers. I read several a day, and watch "All the President's Men" and "Teacher's Pet", whenever they show up on cable. But I am old and I seem to get frailer by the day, and there seem to be anyone out there who is going to replace me. The day of the general interest mass market newspaper for which thousands of trees give their lives is coming to a close. There is simply no way around that, however much codgers such as myself, might regret it.