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.
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.