With The US. Prime Rate At 0.25% and Newspapers Getting Loans at 14-16% You Figure Lenders Are Pricing In Big Risk?

Philip M. Stone May 26, 2009 Follow on Twitter

Eyebrows were raised a few months back when the New York Times did a deal with Mexican entrepreneur Carlos Slim that basically loaned $250 million at around 14%, and now McClatchy, that owes some $2 billion, has put forward a deal to stay out of the claws of bankruptcy by exchanging around half of that debt which falls due in the next couple of years at some 5 – 7% interest for much reduced debt at about 15.75% but also with the advantage of buying a few extra years to pay it off.

The US prime rate is at 0.25%, and we know financial systems are still in some turmoil so loans aren’t as easy as they once were, but it would seem newspapers are considered just about as bad a risk as one could invest in these days. Thus McClatchy has to entice bondholders with a 15.75% interest rate on its debt deal in which it wants bondholders to write down $1.15 billion in debt by 80% in exchange for $60 million in cash and $175 million in new five year bonds carrying the 15.75% rate. If the bondholders don’t accept then they could risk losing almost everything if McClatchy goes to Chapter 11 bankruptcy.  

Wall Street seems to think the new loans are just the ticket to really keep McClatchy away from Chapter 11. In two trading days after the announcement the company’s shares rose 44% to 0.91 cents each and now, at least, the company can boast a single share costs more than a single newsstand copy of any of  its 30 newspapers, a claim it has not been able to make since January, except for a couple of days earlier this month.

The Fitch and Moodys rating companies say the swap puts McClatchy debt at default status, something the company strongly rejects. “This exchange does not cause any default on our existing bonds under the indentures governing them, nor is it a default under our bank credit agreement,” said McClatchy spokeswoman Elaine Lintecum.

McClatchy is showing that the best defense is indeed a good offense while taking full advantage of its very dire financial situation. Since its current bonds are valued so low in the open market then why not offer to buy some of it back now at slightly higher than market price and get a lot of debt off the books? Bond holders must decide whether it is worth their while to exchange bonds at 80% below par value even if the new bonds pay three times the interest rate while recognizing the move may keep the company out of bankruptcy where the current bonds would be near worthless.

But it is a roll of the dice.

For McClatchy the exchange gets rid of nearly half its $2 billion debt taken on mostly for the Knight Ridder buy three years ago and provides extra time to pay reduced debt, even if at a very steep interest rate. Since McClatchy’s loan covenants are based on formulas involving total debt burden via-a-vis its cash flow, getting a large part of total debt written off gives the publisher much more breathing room even if cash flow continues down. It’s a great example of a company leveraging a possible bankruptcy to get debt holders to cave in.

For the bond holders, their current debt paper is worth in the open market just around 20 cents on the dollar and that will be next to nothing in a bankruptcy, so why not give up the ghost of any thought of ever getting par value and instead settle for the best possible deal outside of bankruptcy? But while the increased interest rate on the new debt is enticing, even if on a far lower value of debt, the debt holders will still ask themselves whether McClatchy can make even those payments even if they are at the highest repayment priority – will advertising return to newspapers even after the economy picks up -- or is the new debt just deferring the inevitable bankruptcy?

Complicating matters even further, some debt holders have insurance on their current debt that only pays off only if McClatchy does file for bankruptcy so it would be in their best interests not to help the company, rather their best chance of getting their money back is to have McClatchy declare bankruptcy – that’s one reason Chrysler couldn’t reach agreement with some of its debt holders and went into Chapter 11 – it just wasn’t in some debt holders interests to make a deal.

The offer ranges between 18 cents and 33 cents on the dollar for the various debts involved. That paper had been trading at prices of 13 cents to 24.5 cents per dollar ahead of the offer, so there is the carrot for current bond holders to accept. And the very heavy stick for those who don’t? They will see their current debts lose all repayment priorities – the company saying the new debt takes precedent over all other debt payments but the current debt will go to the bottom of the repayment list for “all existing and future debts and other liabilities.” To fund the cash part of the deal McClatchy renegotiated its bank line of credit, naturally at a higher interest rate.

There should be no jumping for joy at all of this by the employees. For those who will be left after the next really serious cull – they’ll say the newspapers are focusing on digital and don’t need such large newsrooms even if they still have larger newsrooms than anyone else in their market –by the time the dust settles times will be even harder for several years to come as priority one will be to meet those much larger interest payments even if on lower debt.

All of this comes from a McClatchy backdrop in which in Q1 alone print ad revenue dropped $117 million from the year before – that’s down 30% – and ad revenue for all of 2008 fell by 18%. The company has culled 4,000 of staff –some 30% of the workforce --  in the past 12 months, and it has frozen salaries and stopped paying dividends, but its newspapers last year still turned in around an 11% profit margin – good but not good enough to for existing loan requirements, but the new debt levels will make that far more manageable.

It will be a sweet deal for McClatchy if the bondholders go along and could well be a signal to others close to bankruptcy that there may be another route.