Employees of the World: BEWARE
Tuesday, April 10, 2007 | Dylan Jovine
THE RICH HAVE BEEN DOING IT TO THE POOR SINCE THE BEGINNING OF TIME.
Why would now be any different?
That's the first thought that entered my mind when I heard about two deals currently in the works:
(1) The deal billionaire investor Sam Zell made to acquire the Tribune Company (SYM: TRB), owners of the Chicago Tribune and the Los Angeles Times, and;
(2) The deal billionaire investor Kirk Kerkorian is proposing to acquire Chrysler from Daimler Chrysler (SYM: DCX).
What each deal has in common is that you have two billionaire investors buying two separate businesses that are both slowly dying.
But the other key thing that these two deals have in common is that, as always, small investors will get left holding the bag.
Let me explain using the Tribune deal as an example:
The deal Mr. Zell proposed creates an Employee Stock Ownership Plan (E.S.O.P.) that will become the majority owner of the Chicago Tribune company.
Of course, that's after the current shareholders (the Chandler family, etc.) pay out most of the cash the business has left to themselves and saddle the remainder of the company with a boatload of debt.
The bottom line is that by the time this is all said and done, The Tribune will be a private corporation whose STOCK is 60% owned by employees and 40% owned by Mr. Zell.
Now you might think that's a great thing. Whenever employees own stock, it means they have serious "skin in the game."
But the reality is that the equity (stock) will be close to worthless. Why?
The answer is simple really: By the time the Chandler family (and the rest of them) are finished raping the company, it will have over $13 billion in debt.
Think about that for a moment.
The Tribune Company generates $1.4 Billion in cash flow each year. With $13 Billion in debt, the company will have a debt load that is 9.2 times its annual cash flow for the year!
Now remember folks: DEBT or EQUITY is just a CLAIM on the cash flow that the business generates.
And it just so happens that one of the main differences between debt and equity is that debt holders get FIRST rights to that claim.
That means that the debt holders are first in line for that $1.4 Billion in cash flow that the company generates each year.
Let's not forget two things ...
A healthy company could have problems carrying a debt load in excess of six times its annual cash flow. That would mean the Tribune Company's debt load should not be greater than $8.4 Billion ($1.4 Billion in annual cash X 6).
But that's with a healthy company.
In the case of the Tribune, the business is getting worse and worse each year. Indeed, many analysts expect the newspaper business as a whole to decline by 5 - 10% each year.
If the business declines by 5% each year, the annual cash flow that the company generates would decline from $1.4 Billion to $1.08 Billion in five years!
Now think about that for a minute.
Imagine you earned $100,000 in salary each year and there was a good chance that it was going to decline to $78,000 within five years.
And as a strategy to combat the inevitable, you decided to INCREASE your debt load from $100,000 to $1 Million (ten times your cash flow) AND you paid out ALL of your savings to boot!
Not too clever ... unless, of course, you're the Chandler family and you can sell this dog - fleas and all - to a group of investors who either (a) didn't know better, or (b) didn't have much of a choice.
Naturally, the next two questions on your mind are:
(1) Why did employees agree to such a deal?
(2) Why did a savvy billionaire investor like Sam Zell agree to such a deal? (His agreement calls for him to own the equity of the new entity, not the debt.)
Let me answer that question by first explaining why an investor like Mr. Zell (who refers to himself as a "grave dancer" because of the low prices he pays for assets as a result of seller distress) is doing it.
For starters, let me first say that Mr. Zell is my kind of investor, because he knows the golden rule:
"If you don't buy a company when it looks absolutely terrible, you'll NEVER buy a bargain!"
In that context, Sam's bet is that (a) the newspaper business is close to bottoming out, and (b) he can maximize the value of assets like CareerBuilder.
That's why he's agreed to invest $315 million for the right to purchase 40% of the equity (stock) of the company.
What happens if everything goes according to plan and he's right?
If he's able to use the full amount of the cash generated by the business each year ($1.4 Billion), he'll get to pay down the debt over the next 9.2 years.
To even have a sliver of a chance, he'll need to maximize the heck out of those assets to increase revenue and to lower costs, just to offset the decline the company is facing in its newspaper business.
Assuming ZERO net growth in cash flow, in 9.2 years Sam will own 40% of a company generating $1.4 Billion per year in cash.
Since there will be no debt holders by that time, that means all the cash will go to him and the other equity holders.
Again, based on today's cash flow of $1.4 billion, that $560 million each year will be his (40% of $1.4 Billion).
If the company was sold for ten times cash flow (close to the deal that was just structured), that would be $14 Billion.
40% of $14 Billion would mean $5.6 Billion on his end, which is 17 times the $315 million he invested!
With a couple of billion already in the bank, it's easy to see why this was a risk worth taking for Mr. Zell (there also seems to hint of a "vanity play" here, with the ability to be a hero by saving his hometown paper and local landmark in one shot).
Now, you remember that I started this article by saying that the rich have been doing things like this to the poor since the beginning of time.
In this case, however, the employees of the company don't have much of a choice, and the Chandler family knew that.
Let me explain.
It's no secret that employees in newsrooms across America have been feeling the pinch, and, as a result, many of them are upset.
That's why the Los Angeles Times has had so much turmoil recently: both their editor and publisher resigned over the past year in protest over the budget cuts the corporate office imposed on them.
Of course, Mr. Zell knows that. He structured the deal so that employees would have some "skin" in the game.
But it's almost like the Chandler family forced them to make a deal with the devil: "Invest in this company for the chance to protect your job."
That's a tough one.
That's why I want to share one piece of advice to employees of the Tribune:
Take this as seriously as you would if you were making the biggest investment of your entire life.
Why? Because you are.
While Mr. Zell can turn a $315 million investment into $5.6 billion based on today's cash flow, you can make $8.4 billion based on the same thing.
That's because you will own 60% of the stock (as opposed to Mr. Zell's 40%).
The question you have to ask yourself is the same question Sam asked himself: what do you need to invest up front, in return for that kind of upside.
My advice is to do the math.
Don't forget that you are being asked to make an investment in a company. In exchange for that investment, you are seeking to protect your salary.
But that investment, like all investments, comes at a real price.
And Mr. Zell didn't become a billionaire by not knowing how to calculate that price.
So if there's one piece of advice I could give you, it is this: pretend that you are making an investment (in this case pretend you're buying a junk bond).
You are being asked to make an "upfront" investment in the form of wage concessions, lower retirement funds, health coverage, etc.
In return for making that investment, you have the ability to get a return in ten years.
Of the 60% that the employees will own, what is your share? You need to know that so you'll know that in ten years, if the company is sold for $14 billion and employees like you get 60% of that ($8.4 Billion), how much of that will come into your pocket.
If, for example, the number is 3 million bucks, consider whether or not that is a worthwhile "return" for the "investment" you are being asked to make right now (wage cuts, etc).
If the answer is "yes," then fight as hard as you can to make this opportunity work for you.
Toss aside any egos, personalities, preconceptions or pre-conceived notions you may have about the newspaper industry, the media business, the internet or anything else.
Toss aside any silly rallying cries about the "good ol' days" (they're never as good as you remember them anyway), job protection, the importance of the "fourth estate" or anything else.
From this point forward, you have one goal and one goal only - to deliver the best product possible (content), to as many customers as possible (multiple formats), for the lowest cost possible (period).
And if you cannot honor that basic premise, I advise you to search for a different job.
It's one thing to put yourself in harm's way economically. But it's another thing entirely to hurt the members of your team who will be counting on you.
Last but not least, may GOOD LUCK be with you.
Never forget that you are attempting to accomplish a fundamental corporate turnaround on a scale that puts the odds of success strongly against you.
But don't let that get you down ...
People have been betting against me (and Chris and Teeka and Jason and the rest of us here) our entire friggin' lives, and nothing feels quite as good as slam dunking the ball right in their faces!
Knock em dead,
(Please let us know what you think about Dylan Jovine's article.)
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Dylan Jovine
Chief Investment Officer
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