Zell's modest outlay could make him the biggest winner

The Baltimore Sun

Sam Zell's taking effective control of Tribune Co. for a relatively modest cash outlay could make him the biggest winner in yesterday's proposed sale of the Chicago-based media company.

Zell, a Chicago real estate magnate, would gain control for an investment that might not exceed $500 million. That sum would give him 40 percent of the stock, with an employee stock ownership plan holding the rest.

But Zell might never need to go that far. His interest in the company would be vested in a warrant - essentially an option to purchase the shares - that could be exercised any time within 15 years of the completion of the deal.

Financial analysts said yesterday that Zell would be likely to cash out his warrant before its expiration. In the meantime, he would be in charge, having invested $315 million, and would be chairman of the company.

Whether Tribune's employees win or lose depends on whether the company's performance continues to deteriorate as the newspaper and television industries struggle.

All company contributions to employee pension plans would be funneled through the ESOP beginning next year, after the deal was complete. That would put those future pension contributions at risk, but employees would stand to profit, along with Zell, if the company did well. Existing pension obligations owed to workers would not be affected, company executives said.

Also benefiting would be the Chandler family, which controlled the Los Angeles Times for more than a century until its parent, Times Mirror Co., was bought by Tribune in 2000. The sale to Zell would serve the family's desire to leave the newspaper business while salvaging a fortune that had been eroding as Tribune's stock has slid.

The Chandlers' 20 percent stake in Tribune would be bought out for about $1.6 billion. But the payout would probably saddle the Chandlers with as much as $245 million in federal capital gains taxes.

Tribune's top five executives, who would hold shares valued at $51 million along with millions more in stock options, would receive a windfall.

Among the early losers would be the holders of Tribune's $5 billion in bonds and other long-term debt. The value of their holdings has plummeted as details of Tribune's big debt load have emerged.

The multistage transaction would require the company to obtain $8.4 billion in new debt, which could carry interest of at least 9 percent because Tribune is rated at junk-bond level.

That means interest charges would be at least $756 million a year, which credit analysts say is troubling, because revenue is declining in the company's core businesses, newspapers and broadcasting.

The leading credit reporting agency, Fitch Ratings, downgraded Tribune's outstanding debt because the new borrowing would strain the company at a time when "its revenue at cash flow have been declining."

The transactions would create hundreds of millions of dollars in tax benefits for the company, possibly eliminating its tax liability entirely. Its effective federal and state tax rate for 2006 was 34.5 percent, resulting in $348 million in taxes on $1 billion in operating income.

The key aspect of the deal is the conversion of Tribune into a subchapter-S corporation. Such entities pay no corporate income tax, but must funnel all profits directly to shareholders, who pay taxes on those distributions.

In this case, the sole shareholder would be the employee stock ownership plan, which is untaxed. The combination of benefits minght mean that the recapitalized Tribune would be essentially tax-exempt, a boon to a company with a strong need for every dollar of revenue.

Tax regulations sharply discourage any spinoff of assets by an S-corporation within 10 years of its conversion from a conventional corporate structure. That is because the gain in value of assets sold before the 10-year deadline is subject to taxes, excluding whatever value was accumulated after the conversion.

That would create an incentive for Zell to keep the company together for at least a decade unless tax losses accumulated by Tribune were enough to shelter the tax generated by a spinoff. After the 10-year period, that tax liability would disappear.

In the first step, Zell would invest $250 million in Tribune. Of that, $50 million would purchase 1.5 million shares of new stock at $34 a share, and $200 million would essentially be a loan convertible into shares at the same price.

Simultaneously, the new ESOP would invest $250 million lent by the company to buy stock at $28 a share. The lower price of its shares might have been designed to forestall any challenge to the deal based its fairness to the employee plan.

The company would then buy 126 million shares, about half of those outstanding, for $34 a share, a total of $4.28 billion. The tender offer would be financed by the $250 million infusion from Zell and from new corporate borrowings. The completion of that phase would be expected by June 30.

In the second stage of the deal, which would be expected to conclude at the end of the year, Zell would invest $65 million, bringing his total outlay to $315 million.

At that point, his investment would be a $225 million, 11-year loan to the company and the purchase for $90 million of a warrant giving him ownership of 40 percent of the company's stock. To exercise the warrant, he would have to pay an additional $185 million, which would bring his total to $500 million.

Tribune Chairman and Chief Executive Officer Dennis J. FitzSimons responded to criticism that the transaction would yielded more control to Zell than is warranted, noting that "this process was about maximizing shareholder value."

He also acknowledged that Zell's strategic vision for Tribune and his view of the community role of newspapers and television stations were not primary considerations in the weeks of negotiations leading to the deal. Tribune directors instead were focused on "the financial terms of the agreement," he said.

Michael A. Hiltzik writes for the Los Angeles Times. Times reporter Thomas S. Mulligan in New York contributed to this article.

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