TRB - Part One: how to pick acquisition stocks

**CrossProfit** Tue Sep 11, 2007 4:45 pm

TRB - Part One: how to pick acquisition stocks
Posted on 09/07/2007 on http://www.crossprofit.com

For the past six weeks, several articles have appeared that question the wisdom and eventuality of the Tribune privatization deal. All of the articles base their hypothesis on the debt load burden in one form or another. Some claim that the numbers simply don't work, others claiming that the industry has taken a sudden turn for the worse that could not have been foreseen back in April of this year.

To all the fear mongering article writers whether disseminated by Fitch, Bloomberg or the Motley Fool, hear this; stating a few facts before writing such utter nonsense should be of elementary courtesy to your readers. To be fair, Fitch never actually wrote that the Tribune deal was in jeopardy. However, readers are left to conclude this on their own.

First, I put to you a sample 'deal breaker' article circulated by Media Post Publications;

Red Alert: Financial Firms Issue Somber Warnings on Newspapers
by Erik Sass, Friday, Aug 31, 2007 7:15 AM ET

TWO LEADING FINANCIAL FIRMS HAVE issued reports giving a "thumbs down" on the newspaper industry this week, reflecting the deepening crisis in the business. Fitch Ratings lowered its already negative year-end forecast for the newspaper industry to reflect new bad news in the second quarter. Earlier in the week, Moody's Investors Service lowered its rating for the New York Times Company to "negative."

As Fitch acknowledged in its August 29 report, it already had a negative outlook for newspapers based on soft revenue and profit pressures. However, the newspaper industry underperformed even by these lowered standards, due to a combination of weakness in the economy, especially the real-estate market, and so-called secular (as opposed to cyclical) trends, permanent declines that were unlikely to reverse.

At Gannett, ad pages fell 17% and real-estate classifieds 20%; Tribune's total classifieds fell 18%; McClatchy saw real estate tumble 26%; and even Dow Jones--a relative success story--saw ad volume fall 20%. Dow Jones' total classifieds revenue also slumped 14%.

While Fitch acknowledges that some downturns are due to cyclical economic factors, it estimates that these account for no more than 50% of the losses, attributing the rest to secular decline. In fact, the company suggests that the cyclical losses will reinforce the secular drops, looking to the examples of employment and auto classifieds, which failed to recover after a similar downturn in 2001-2002.

Moreover, Fitch had a lukewarm outlook on newspapers' online revenues. It concedes they will continue to grow, but also warns that "the proliferation of emerging media" is giving "advertisers many new alternatives for reaching their fragmenting audience bases."

Worse, Fitch's analysis seems to imply that the proposed sale of the Tribune Company to real-estate billionaire Sam Zell is in jeopardy. Other observers have warned that Tribune could fail to meet even the modest performance goals that are a precondition of the deal. Now, Fitch predicts that "companies that did not already pursue highly leveraged acquisitions or leveraged recapitalizations are less likely to pursue those types of transactions in this funding environment." The Tribune deal was not specifically mentioned.

The Fitch report followed a highly critical analysis of the New York Times Company by Moody's Investors Service, lowering NYTCO from "stable" to "negative." Moody's noted the pressure on NYTCO ad revenues, particularly retail and classified advertising. Again, the downturn in the housing market was the main culprit in the classified slump.
~~~

The Final Offer

Below is an excerpt from a Tribune Press Release that pertains to shareholders;

[04/02/2007]

The agreements reached between Tribune, the ESOP and Zell and announced today include the following transactions:

The ESOP will immediately purchase $250 million of newly issued Tribune common stock for $28 per share.

Zell will invest $250 million in Tribune and join its board of directors. Of this initial investment, $50 million will purchase approximately 1.5 million newly-issued shares of Tribune common stock for $34 per share and $200 million will purchase a note exchangeable for common stock at a $34 per share exchange price. The Zell investment will be completed upon expiration or early termination of the Hart-Scott-Rodino waiting period, subject to other customary conditions.

Tribune will launch a tender offer to repurchase approximately 126 million shares of its common stock for $34 per share, returning approximately $4.3 billion of capital to shareholders. The tender offer will be subject to the completion of financing arrangements, receipt of a solvency opinion and other customary conditions; it is expected to be completed in the second quarter of 2007.

Following the tender offer, Tribune and the ESOP will merge and all remaining Tribune stock will be converted to cash at $34 per share. The merger will be subject to Tribune shareholder approval, FCC and other regulatory approvals, receipt of financing and a solvency opinion, and other conditions reflected in the definitive agreements that will be filed later this week with the SEC. If the merger has not closed by Jan. 1, 2008, shareholders will receive an additional amount of cash based upon an 8 percent annualized "ticking fee" that will accrue from Jan. 1, 2008, until the closing.

Up to the time of shareholder approval, Tribune’s board of directors will be entitled, subject to specified conditions, to consider unsolicited alternative proposals that may lead to a superior proposal. In the event such a superior proposal is selected, the break-up fee to Zell would be $25 million.

In conjunction with the execution of these agreements, Tribune will suspend its regular quarterly dividend.

Upon completion of the merger, Zell’s initial $250 million investment will be redeemed and Zell will make a new investment through the purchase of a subordinated note for $225 million with an 11-year maturity and a warrant for $90 million with a 15-year maturity. The warrant can be exercised by Zell at any time to acquire 40 percent of Tribune’s common stock for an aggregate exercise price initially of $500 million.

The company will be led by a board of directors with an independent majority. Dennis FitzSimons, as Tribune president and chief executive officer, will remain a member of the board, along with at least five independent directors and an additional director affiliated with Zell.
~~~

Now let's go through this step by step.

1) "The ESOP" - done, stock issued.

2) "Zell will" - done, $250 million invested and Zell is a director.

3) "Tribune will" - done, $4.3 billion repurchased from shareholders.

4) "Following the" - this has three parts. I will elaborate on this in a minute. For now let's continue going down the list.

5) "Up to" - done, current deal is final.

6) "In conjunction" - done, dividend has been suspended.

7) "Upon completion" - of course this will be concluded but as a shareholder, once I get my money this is Zell's problem, not mine.

Now back to where we are now. The fourth item contains three parts and a covenant with shareholders. The three parts are;

1) Shareholder approval - done.
2) FCC and other regulatory approvals.
3) Financing and solvency opinion.

The consensus is that the FCC will not object to the deal. It is superfluous to say that as the Tribune's board actively solicited the final bid from Zell in order to approve the final offer as superior to the (Chandler and) Broad & Burkle offer, they would not have done so without first getting assurances that the FCC would not object to the Zell/ESOP configuration. Anything else would be gross negligence and a total breach of their fiduciary duties.

This is the only part that has yet to be completed!

The so called fly in the ointment that some pundits are harping on is the financing and solvency opinion. Well I have news for you. This is done as well. Once the first $7 billion in debt was refinanced, the banks are committed to the remaining $4.2 billion or so. The Tribune has openly stated and recently reiterated that all financing is in place.

Deal breaker pundits then focused on a clause in the financing agreement that requires the Tribune to pay down $1.5 billion in debt within a year. Yes, there is a financing agreement in place!

Tribune Press Release 04/02/2007

Tribune has financing commitments from Citigroup, Merrill Lynch and JPMorgan Chase to fund the transactions. In the first stage, Tribune will raise $7.0 billion of new debt of which $4.2 billion will be used to complete the tender offer and the remaining $2.8 billion will be used to refinance existing bank credit facilities. In the second stage, Tribune will raise an additional $4.2 billion of debt which will be used to buy all the remaining outstanding shares of the company. Tribune’s existing publicly-traded bonds are expected to remain outstanding.
~~~

The company has stated that there is no concern regarding any of the obligations stipulated in the agreements, including the $1.5 billion debt reduction. Actually this is easier than you think; see 'Reducing the Debt' below.

I don't know what the deal breakers will come up with next, but rest assured that with a little due diligence you can uncover the fallacy in their claims.

The little talked about covenant with shareholders has monumental consequences and literally is far more important than most realize. In plain English, the agreement stipulates paying the remaining shareholders (118 million shares) that could not cash out in May a fixed 8% per annum interest starting 01/01/2008 calculated on $34 per share of common stock…more below.

The Legal Ramifications

Given all that has transpired until now, we now have a situation where 126 million shares have already been repurchased from shareholders. The Chandlers are out of the picture and are amongst the shareholders that have cashed out.

Tribune Press Release 06/04/2007

Chandler Trust No. 1 and Chandler Trust No. 2 and certain affiliated stockholders have agreed to sell all remaining Tribune shares through a block trade underwritten by Goldman, Sachs & Co. The shares will be offered pursuant to the shelf registration statement that Tribune filed with the Securities and Exchange Commission and that became effective on April 25, 2007. Tribune will not receive any proceeds from this transaction.
~~~

The general public has been promised that this deal will conclude in the fourth quarter 2007. In addition, if for any reason including reasons beyond the control of the Tribune, the deal does not conclude before 01/01/2008, shareholders will be compensated handsomely for any delay. Rest assured that no one partaking in this deal relish the prospect of paying 8% interest to shareholders.

As I stated in my first article, ESOP, Zell and the Tribune's board all have vested interests in seeing this deal through. The alternative was consummating a similar offer with Broad & Burkle. Any attempt by any of the parties to withdraw now would create a humongous legal liability. Class action suites by the remaining shareholders would be filed immediately, ultimately triggering the 8% clause as well. Not only would shareholders receive the same $34 per share that other former shareholders have already received, but based on the company's own admittance, the penalty for late payment is predetermined.

I also stated in an update to my first article that anything under $29 per share is a safe bet. This was a worst case scenario calculation. In the odd unbelievable chance that the last part of the deal doesn't go through and shareholders are forced to sue, legal action can easily take two years to resolve. In the interim, the Chandlers can come back and steal the company for $31.70. It is totally unrealistic to assume that the Chandlers would return $1.6 billion and undo what has already been done out of the goodness of their heart.

Alternately, if for some crazy reason the ESOP/Zell deal falls apart, there is always Broad & Berkle coming back with $32/33 offer. Shareholders would cash out between $31.70 and $33 while maintaining their class action for the difference between what was received in cash and the $34 price tag with an 8% interest accrual basis. Not bad for a $29 investment (interest alone is over 9.3%).

Just to make this absolutely clear, when I stated that buying today at $29 or below is a safe bet, it is based on the worse case scenario. Realistically up to $32.70 should provide a handsome profit by yearend.

Far worse than the shareholders class action would be the nightmare that the Tribune's board would face from Broad & Burkle. Now these guys play for keeps and would go after each board member personally not to mention Zell himself. Zell has already expressed his 'love' for Broad & Berkle and it is probably safe to assume that the feelings are mutual.

Washington Post 04/05/2007

"If somebody calls me and says 'I want to be a partner' and the next day tries to stick a knife in my back, tell me again why I would want to do business with him?" Zell told the Tribune. Representatives for Broad and Burkle declined to comment.
~~~

The Implementation Process

As mentioned above, the only remaining hurdle to overcome is the FCC. There is no way that I can assess the bureaucratic timetable, though the FCC is still within the targeted 180 day self imposed timetable (currently at 120 days). The Tribune has more experience with this. Based on the 8% penalty clause I deduce that FCC approval should be forthcoming sometime between the end of September to mid October. The reason for this is that once FCC approval is obtained, it will take anywhere between two to four weeks to iron out all the requirements and close. The board has to keep in reserve four to six weeks to resolve any hiccups that might arise. This is the only safe way to avoid the interest penalty.

When the Tribune was reviewing the Broad & Berkle offer, one of the considerations favoring the Zell offer, as asserted by the Tribune's board, is that Zell would close the deal sooner than Broad & Berkle. Initially, Broad & Berkle used a broad timetable that did include the end of the year as a possible closing date. In order to differentiate between the two offers, Zell included the 01/01/2008 interest penalty fee. With or without the penalty component, should the deal close towards the end of the year, Broad & Berkle will scream foul play. Both have already accused the board of favoritism and in my opinion, both the Tribune and Zell are not looking to give Broad & Berkle any more ammunition.

International Herald Tribune 04/01/2007

The Tribune board have favored Zell's bid over the Burkle-Broad bid, in part because Zell's offer is more detailed and could be finished more quickly, the people close to the talks said.
~~~

As an aside and as a nutty conspiracy theory, perhaps all the deal breaker articles are being nurtured by deliberate leaks by the Broad & Berkle camp. We do know that even after the Tribune handed down its final decision, Broad & Berkle attempted to negotiate a side deal with Zell. Like I said, this is nutty but when it comes to big bucks you never know the reasons why certain things just seem to happen or the true motives for behind the scene shenanigans. It is far more likely that all the negativity surrounding the deal is emanating from holders of the Tribune's $5.5 billion seven year term loan B, issued in May 2007.

In any event, according to the 'deal breaker' theorists the deal will close by late October early November. Those who consider the ever weakening revenue picture a threat must also acknowledge that the Tribune is not obliged to amend projections for the fourth quarter until the latter part of November. If the revenue stream really goes into a tailspin, this can not possibly be projected by mid October. Closing the deal by then avoids any possibility of the banks activating any clauses in the financing agreement. Even then, in another worst case scenario, the Tribune has until May 2008 to correct the situation.

The banks rely on the last published quarterly report and any amendment to guidance. Based on the feedback from results and guidance to date, no one has alleged that the Tribune is in default of the requirements stipulated in the financing (credit) agreement. Deal breakers tend to assume that the Tribune will be in default sooner or later. If that is the case then both the Tribune's board, ESOP and Zell know that the sooner the deal gets done the faster everyone can breathe easier and call it fait accompli.

Reducing the Debt

There is no argument that Zell knows the real estate business. What Zell is less known for is turning around faltering businesses. His methodology is straight forward. Zell tends to keep business in homogenous units. In other words, a shoe store concentrates on selling shoes and not speculating in real estate. Likewise, a media conglomerate should not be in real estate or own a baseball team. Zell has stated that he has no intentions of downsizing the media segment of the Tribune's empire though some believe that selling some television networks is inevitable.

For now it is obvious from following Zell's actions over the past few months that both Tribune buildings and the Chicago Cubs are for sale. By adding up the publicized deals that are in the works, you get very close to $1.5 billion. Remember that these are not fire sales as Zell has an entire year to come up with the money.

Orlando Sentinel / Los Angeles Times 08/31/2007

The historic former Warner Bros. studio on Sunset Boulevard, now occupied by television station KTLA-Channel 5, has been put up for sale by Tribune Co. amid a wave of high-stakes real estate investment in Hollywood.
~~~

Likewise, Zell has some other valuable properties to choose from. As a last resort, Zell has kept an open line with Geffen who is still interested in the L.A. Times for about $2 billion.

Washington Post 04/05/2007

"Yes, I continue to want to buy the Los Angeles Times," Geffen said in an interview yesterday.
~~~

Washington Post 04/26/2007

A flurry of activity has followed Tribune's acceptance of Zell's offer. A source close to entertainment mogul David Geffen confirmed that he wants to buy the Los Angeles Times from Zell or at least enter a joint-venture partnership that would give him editorial control of the newspaper, which is Tribune's largest and biggest moneymaker. Geffen's office said yesterday that he had no comment on his talks with Zell.
~~~

A recent Financial Times article totally ignores the 8% interest payment to current shareholders starting 01/01/2008. Obviously, current debt holders have a vested interest in claiming that the Tribune can continue to operate indefinitely as a half privatized company. The fallacy in this argument is that legally this is impossible.

Financial Times 09/06/2007

“It is collective wisdom that no one wants to see that last USD 4.2bn come out,” said one lender, adding that its looming presence is partially reflected in the trading levels.
~~~

Even those that are dead against the Tribune adding $4.2 billion in debt to its books admit that the Tribune is well within the 9 x EBITDA requirements according to the credit agreement, as stated in the FT article. Note that in reality the sale of the Cubs is a cushion that has yet to be factored in. In other words, the reported 5.9% YOY drop in revenue hasn't pushed the Tribune over the 9 x EBITDA level.

The Tax Angle

Ironically, the concept of using an employee ownership tax shelter is a Board & Berkle game plan. I can just imagine the expression on the faces of Board & Berkle when they first learned that the original Zell offer was based on a play taken from their game book.

Naturally, Board & Berkle immediately amended their own offer to reflect ESOP ownership. In any event, this did not help and the Tribune went with Zell even though the two offers were very similar. The estimated savings or increase in retained earnings is about $120 to $150 million a year, assuming the Tribune maintains 2006 P&L levels.

The latest news item that shows that this deal is on track pertains to the tax angle. A Tribune Press Release states that Arnold & Porter are amongst Zell's leagal advisors. Going through the list of advisors it is obvious that Arnold & Porter are the advisors dealing with tax implications regarding the privatization and employee ownership.

Tribune Press Release 04/02/2007

The financial advisors to the company and its board of directors were Merrill Lynch and Citigroup. The financial advisor to the special committee was Morgan Stanley. Legal counsel to the company and its board of directors were Wachtell Lipton Rosen & Katz, Sidley Austin LLP and, for ESOP matters, McDermott Will & Emery. Legal counsel to the special committee was Skadden Arps. Duff & Phelps served as financial advisor to the ESOP trustee and its legal counsel was K & L Gates. The financial advisor to Zell was JPMorgan Chase , and legal counsel to Zell were Jenner & Block, Arnold & Porter, Morgan Lewis, and Dow Lohnes.
~~~

Now here is how you get inside information. Who would know better than anyone else if the deal was going through or not? Obviously the answer is Zell's legal counsel. If you could get a straight answer from them that would be great, but you know they are not going to talk to you about the deal. The next best thing is if one of them does something that indicates the deal's status. Guess what, Blake Rubin just played his hand!

Washington Business Journal 09/05/2007

McDermott adds 3 tax partners from Arnold & Porter

Washington Business Journal - 10:32 AM EDT Wednesday, September 5, 2007
by Neil Adler
Staff Reporter

The growing tax department at McDermott Will & Emery LLP has hired three lawyers from Arnold & Porter LLP.

Blake Rubin, former head of Arnold & Porter's tax practice, Andrea Whiteway and Jon Finkelstein have moved to McDermott's D.C. office as partners.

Rubin worked at Arnold & Porter in D.C. for seven years, and before that he was at Steptoe & Johnson LLP in D.C. for 13 years. Whiteway also worked at Steptoe & Johnson with Rubin. Finkelstein joined the two of them at Arnold & Porter in 2002.

Rubin said he's known people at McDermott for more than 20 years. The opportunity to work for an expanding, and larger, tax group appealed to him, Rubin said. McDermott "is going in the right direction," he said, adding that the tax department is "very strong substantively already."

Thomas Milch, chair and a partner with Arnold & Porter, said the move to McDermott is a "great opportunity" for Rubin, Whiteway and Finkelstein. Milch said his firm had been looking for people to add to its tax department, which currently has about 25 lawyers, even before Rubin, Whiteway and Finkelstein left for McDermott.

Milch said that from the end of 2002 until the end of 2006, the number of lawyers at Arnold & Porter decreased from 710 to slightly more than 600. However, Milch said that from July through the end of 2007, Arnold & Porter will hire about 80 lawyers, including some that already have come aboard.

Rubin said that Arnold & Porter's lawyer base has been shrinking, while McDermott's is expanding. That was a factor in his decision to head to McDermott.

Rubin specializes in federal taxation, with a particular emphasis on matters relating to partnerships and other pass-through entities, as well as real estate taxation. His clients include real estate mogul Sam Zell, who is buying the Chicago-based Tribune Co., as well as Bethesda-based Host Hotels & Resorts Inc.

Whiteway focuses on partnership and real estate taxation. She regularly advises clients on, among other things, issues involving tax advantaged dispositions, acquisitions of real estate, structuring of private real estate investment trusts and corporate mergers and acquisitions.

According to McDermott, Rubin is founder and president of the Washington, D.C., Center for Public Interest Tax Law, a nonprofit corporation that provides pro bono representation to low-income taxpayers before the U.S. Tax Court. Whiteway is executive director of this organization.

Finkelstein practices primarily in the area of federal taxation, with an emphasis on tax matters related to partnership and corporate transactions. He has experience advising clients on issues such as joint venture and fund formations, acquisitions, dispositions, recapitalizations and reorganizations.

McDermott's tax department has more than 100 lawyers, including close to 40 in the District. The law firm's D.C. office has added 13 lateral partners since January, said Bobby Burchfield, co-head of McDermott's District office. The firm's lateral partners include several tax and benefits lawyers beyond the three latest hires from Arnold & Porter.

Rubin said "it's possible" that other lawyers from Arnold & Porter could come to McDermott. He said that his new employer treats its homegrown lawyers and lateral partners equally, and that's enticing to him.

Overall, McDermott has more than 225 lawyers in D.C., where it opened an office in 1978 with two lawyers. Burchfield said that 40-plus lateral partners have come to McDermott firm-wide since the beginning of the year. McDermott has about 1,200 total lawyers at numerous offices in the U.S. and abroad.
~~~

You don't make partner at a top notch firm like McDermott unless you bring with you a client base that provides a sufficient revenue stream. If Rubin had lost Zell as a client, he wouldn't be moving. In this case, Rubin took with him another two zealots (as in Zell supporters); Andrea Whiteway and Jon Finkelstein.

Perhaps it would be enough just having Zell as a client for Rubin to make partner at McDermott. But for all three to make partner…give me a break. One $8.4 billion deal is not enough, so I'm wondering what other megabucks deal the three have going. The Cubs need to get sold and a couple of Tribune buildings over the next 12 months; all providing a steady revenue flow, however we are talking about three new partners, not one.

It is so obvious that without the income from the Tribune deal this would not be happening that it just doesn't get any better.

Disclosure: Long TRB again (see previous article on CrossProfit site).