How?fs This For A Smart Newspaper Investment ?| Use Your Own $100 Million, Borrow Another $430 Million And Within The Year Write-Off 75% of Your Cash and See Your Debt Valued To About 50 Cents On The Dollar

Philip Stone May 8, 2008

When McClatchy sold the Minneapolis Star Tribune to New York?fs Avista Capital Partners and others for some $530 million last year the buzz was what a great deal the private equity company got and what an embarrassment for McClatchy selling a newspaper at a firesale price that it had paid $1.2 billion for some nine years earlier.

Well, McClatchy is not doing much laughing these days with its share price under $10, a Q1 loss,  and almost daily announcements from its newspapers that they are severely reducing staff and outsourcing functionality, but if there is a smile in the McClatchy corporate boardroom it is surely because at least they don’t have the Minneapolis disaster on their hands.

Minneapoilis is frightening for showing how quickly things can go wrong. One has to assume that the Avista people are not stupid – they went through the Star Tribune’s books, they saw the cash flow, they thought knew what they were getting into, believing that the cash flow would handle debt and operate the business with very little need for any major cutbacks. And yet in less than a year that investment has gone so sour that although the newspaper insists it is not in a bankruptcy situation and it can still handle debt this year it has brought in a another private equity firm to analyze its balance sheet.

“Analyze its balance sheet” is usually a eupherism meaning that in order to get more money then some equity is going to have to change hands. But the question is with the newspaper in such dire financial straights even if the current owners held their own firesale would anyone come? If there is no sale or monetary infusion then bankruptcy may be the only way out.

The financial calamity in Minneapolis is amazing for its swiftness. No one could have imagined how bad  2007 and 2008 would be for American metropolitan newspapers. No one saw the real estate sub prime fallout and while there was writing on the wall that real estate and auto classifieds were migrating to digital platforms no one saw the bottom falling out of the real estate market and the havoc that brought to newspaper bottom lines

And so Avista dropped its bombshell this week that it has written down the value of its $100 million investment by 75%.  And in a statement, rather understatement,  the private equity firm said, “In the past year, the newspaper industry has suffered greater than expected declines in circulation and advertising revenue, particularly in print classified advertising. The outlook in the near to medium term remains uncertain.”

The New York Post had written at the beginning of the week that the Star Tribune  faced bankruptcy, but Avista said, “The Star Tribune currently has sufficient liquidity and is up to date on all its debt payment obligations.” But Avista acknowledged that while there have been significant cost savings (staff layoffs) such savings cannot fix the current financial underperformance . Thus either advertising picks up real fast – and there is no sight of that – or a financial restructuring is on the way.

Avista was not the only one who had no idea how badly things could get so quickly  --obviously Credit Suisse and Royal Bank Of Scotland didn’t see a problem in loaning some $486 million to finalize the sale from McClatchy. The debt was considered so solid that investors were actually buying it at the time at a 1% premium – paying  $1.01 for $1 in debt. A year later and it is down to 55.9 cents on the dollar.

Standard & Poors Leveraged Commentary & Data service summed up the situation, “Star Tribune investors are weary from a string of negative news—both company specific and industry-wide – following the syndication in February, 2007, near the market peak.”

When debt falls by near half as has happened here the credit industry considers it to be at a “distress level” meaning there is great doubt that the company will make good on that debt. Of course the question could be asked that if things are so bad then how come the debt price hasn’t actually fallen lower?

The answer probably is hope that that either the banks pump in more money in exchange for equity – but in today’s financial environment banks aren’t exactly looking to take on  newspaper equity --  or more likely that Avista might be looking for a buyer, or that it might actually pump in more good money after bad. It can afford  to do the latter  – the original $100 million to Avista is not much more than petty cash, witness its $4.1 billion purchase with Nordic Capital Fund  of Bristol-Myers Squibb’s ConvaTec business announced this week.  Avista actually had a pretty good 2007 – the value of its portfolio including other media investments, healthcare and energy – rose some 22% last year.

But edgy debt holders still believe that bankruptcy might be in the air. Publisher Chris Harte says the newspaper  “currently has sufficient liquidity” but the suspicious ones look at the word “currently” and given what is happening in the newspaper business these days they ask what guarantee is there to the longevity of “currently”? Harte says he is constantly in talks with the bankers and none of them say they want to own the newspaper which is what a bankruptcy filing would end up doing.

Harte says the main priority now is that the newspapr continues to turn out “the best and most comprehensive news and Internet services in this region.” He doesn’t want staff distracted by what he calls the “big challenges and many struggles ahead.” Easier said than done.

And what a perfect financial environment for the union negotiations that have begun to reduce costs.