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Tribune Deal in Trouble

Sam Zell's proposed acquisition of the media company is looking shaky, but sources close to the deal say it's on track

Will Sam Zell be able to close his deal for Tribune?

Though declining earnings and jitters in the debt markets have raised doubts about whether the real estate magnate will go through with his $8.2 billion deal to take media giant Tribune (TRB) private, people close to the pact insist it remains on track. They argue that Zell, who recently joined the board of the company after sinking an initial $250 million into Tribune, is taking the long view and expects that a Tribune management sharply focused on newspapers and TV—not on ancillary properties such as the Chicago Cubs or on short-term results demanded by Wall Street—will make the deal pay off over time. Indeed, sales of assets such as the Cubs could fetch over $1 billion after taxes, which will go far to scale down the $13 billion in debt that the deal will initially drop on Tribune.

Uncertain Investors

Despite such optimism, investors appear far less sure. They've taken the company's stock down below $29 a share, well under Zell's offer of $34. In other words, they would earn a 20% return on their money if they bought shares now and held on until late this year, when the deal is expected to close. The spread in News Corp.'s (NWS) proposed acquisition of Dow Jones (DJ) is less than 11%, even though the Bancroft family that controls The Wall Street Journal's parent has yet to sign off on the agreement.

It has been a sharp decline in Tribune's stock. Shares zipped up to within 70 cents of Zell's offering price shortly after the deal was struck on Apr. 1. But since then, the price has tumbled, falling as low as $27.17 a share on July 24, before rebounding to close at $28.23 on July 25. Tribune shareholders are scheduled to vote on the deal on Aug. 21.

Certainly, Tribune's second-quarter results gave investors little to cheer about. The company on July 25 reported that operating profits slipped 27.6% in the first half of this year, to $377 million, while net income plunged 93%, to $12.9 million—largely because of write-offs and special charges. Reflecting an advertising climate for old media that Tribune Chief Executive Officer Dennis FitzSimons called "difficult," revenues in the first half fell 5.6%, to $2.53 billion. In the second quarter, operating profit fell 35.6%, to $195.8 million, while net income dropped 58.7%, to $36.3 million, and revenues slipped 6.8% , to $1.3 billion.

"Not As Bad As They Look"

Nonetheless, investors who lifted the stock after the earnings were disclosed may have taken heart from FitzSimons' unequivocal claim that the deal with Zell will take place. "Our going-private transaction is on track and the financing for it is fully committed," the CEO said in his earnings release. "We anticipate closing the transaction in the fourth quarter, following FCC approval, and expect to be in full compliance with our credit agreements."

Some analysts agree. Edward Atorino of the New York-based broker-dealer Benchmark argues that "it's better than 50-50 that they'll get this thing done." At worst, he says, Tribune may be forced to sell more assets than it expected to make sure that it can meet its loan obligations. He argues that Tribune's performance also will look better in the second half of this year because a relatively strong first half of 2006 led to troublesome earnings comparisons for the results so far this year. The latest results, he notes, "look pretty bad, but they're not as bad as they look."

Certainly, shareholders who have picked up the stock lately will pocket a handsome gain if the deal goes through. The challenge then will fall to debt holders, who lately are anything but optimistic. As the Bloomberg news service reported on July 20, the cost of credit-default swaps designed to protect debt holders against a default on Tribune's bonds have more than doubled since May, suggesting that speculators think a default sometime over the next five years is more likely. Backers of the deal argue that the rise in swaps costs, however, simply reflect general anxieties about the overall credit outlook, particularly with subprime mortgages generally plaguing the debt markets.

Rocky Credit Markets

A host of troubles has hit the credit markets in recent days. On July 25, the investment bankers that are working with Cerberus Capital Management on its acquisition of Chrysler (DCX) couldn't find buyers for some $10 billion of the deal's debt. As a result, the banks, including JPMorgan Chase (JPM), Goldman Sachs (GS), and Bear Stearns (BSC), will hold onto the liabilities themselves (see, 7/25/07, "A New Pileup in the Auto Sector?"). Separately, JPMorgan Chase, Deutsche Bank (DB), and other investment banks were left holding $10 billion in debt from Kohlberg Kravis Roberts & Co.'s deal for the British pharmacy chain Alliance Boots.

Tribune executives, who declined to comment publicly beyond their releases, plan to sharply reduce their tax burden and thus make it easier to handle the stiff debt by using an employee stock-ownership plan, which gives companies major tax benefits. The structure will eventually allow Zell to become a 40% owner of Tribune for as little as $590 million. Zell, a Chicagoan, argues that his investment in Tribune is driven solely by its ability to pay off financially, rather than by any sense of civic duty. He declined comment for this story.

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