If there is one thing Sam Zell foresaw correctly, it is this: The day after Zell announced he was buying Tribune for more than $8 billion, the real estate tycoon told Chicago Tribune reporters the deal would not change his lifestyle no matter what happened. But, he said, "it's likely to change yours."
How right he was. Just one year after Zell bought the company (BusinessWeek, 7/30/08), Tribune announced on Dec. 8 that it is filing for bankruptcy. That means Zell could lose a small fraction of his estimated $5 billion fortune. The reason: The man who likes to call himself "the grave dancer" put very little of his own skin in the game. Instead, employees of the Tribune properties will bear the brunt of the pain, as they technically own the company and hold its $12.9 billion in debt. Tribune reported $7.6 billion in assets.
Tribune comprises eight newspapers, including the Chicago Tribune, Los Angeles Times, and Baltimore Sun; a 31% share of Food Network; two dozen TV stations, including outlets in the three biggest U.S. markets; and the Chicago Cubs baseball team. The Cubs franchise was not part of the bankruptcy filing. While Tribune officials declined to comment on the decision to keep the Cubs franchise separate, there are provisions in a Major League Baseball franchise agreement that could come into play in a bankruptcy. If a Major League Baseball franchise is insolvent, the commissioner has the power to step in to operate the team, for instance, and ultimately sell it.
ESOP Used to Borrow
Tribune's bankruptcy will be complicated. For starters, figuring out the value of Tribune in bankruptcy could be problematic. Every day brings a slew of steadily worsening statistics on ad revenue and circulation, pummeling newspaper valuations. On top of that, Zell used complex financing schemes predicated on tax advantages in structuring his deal. Those arrangements now raise thorny questions.
One of the trickiest issues will be how to handle a financing scheme Zell used to buy Tribune that relied on a tax-exempt employee stock ownership plan, known as an ESOP. Although employees had no say over how the ESOP was used, Tribune's board approved Zell's bid, which used the ESOP as a vehicle through which he borrowed hundreds of millions of dollars to tax-efficiently fund the transaction. The scheme allowed Zell to pony up just $315 million of his own cash to wrest control of the company and made employees technically Tribune's owners.
But ownership came at a price: Tribune cut back its 401(k) contributions and committed to use a portion of its revenues to pay down the hundreds of millions in debt that a trust set up for the ESOP used to buy Tribune shares, according to employee stock owner plan expert Corey Rosen. "It was like a mortgage that you use to buy a house with no money down," says Rosen, who wrote a report that goes into detail on Tribune's ESOP arrangements.
Tax Gains at Issue
Early on in the deal, Zell tried to motivate his troops by telling them the financing scheme would result in tax gains that would give Tribune a big advantage and could one day make employees rich. "This business lends itself to ESOPs because you have a lot of people, at least in theory, who are intelligent," he said in the Chicago Tribune interview in April 2007.
Now, the ESOP's equity stakes will likely be wiped out, and the handling of the tax gains will likely become an issue in the bankruptcy restructuring. "If a company goes bankrupt, the equity runs the risk of not being worth much," says Standard & Poor's analyst Emile Courtney. "They will probably lose everything" in the ESOP, predicts tax expert Robert Willens, who has closely studied the Tribune deal.
In a Dec. 8 note to Tribune employees, Zell still addressed them as "partners." He said their payroll, benefits, and 401(k)s would not be affected by the filing. As for the ESOP, Zell said, "it is part of the ownership structure, so its value and role long term will be determined in the restructuring. We believe the structure is a valuable asset to the company and that there are strong reasons to preserve it."
Silver Lining for Employees
But the ESOP could raise governance issues about who should be in charge of reorganizing the company. As part of his financing scheme, Zell also obtained a warrant to buy 43% of the company. So, there's a question if it is "the ESOP trustees who preserve value for the ESOP itself? Or if it is Zell negotiating to protect his note?" says one bankruptcy expert who asked not to be named.
The bright side may be that Tribune employees didn't have a lot of time to put much money toward ESOP contributions. "In a weird way, the employees are better off that the company crashed today instead of seven years from now," says a banker familiar with the deal, who asked not to be named.