I: PRUITT'S FOLLY: IS THERE A SMOKING GUN IN THE STRIB FIRE SALE?
When the McClatchy Company bought the Star Tribune from longtime local owners Cowles Media in March 1998, the transaction set a new high-water mark for newspaper sticker prices. The $1.2 billion McClatchy coughed up for the paper amounted to roughly 16 times the Strib's operating cash flow—its gross profits, essentially, before the additional costs of taxes and interest and sundry other accounting tricks were applied. Analysts routinely calculate newspaper values as a fluctuating multiple of the paper's cash flow, and no one had ever paid such a staggering premium for a single newspaper, let alone a "minor major" like the Strib. The price tag suited McClatchy CEO Gary Pruitt just fine, he assured the paper's ace business reporter, the late Terry Fiedler: "We're not in this to buy on the cheap and operate on the cheap."
No. He was only in it to sell on the cheap, as it turned out. The December 26 punting of the Star Tribune to Avista Capital Partners set a new industry benchmark of its own, as the new record low price for a prominent daily newspaper. The $530 million paid by the fledgling Avista equaled just 44 cents on every dollar McClatchy had ponied up less than nine years before. The price reportedly reflected a valuation of just 7.4 times cash flow (the Wall Street Journal later said 6.5)—in a year when, as analysts later pointed out, other daily papers had been selling for nine to 12 times cash flow.
Pruitt defended the deal in a same-day memo to McClatchy staff, citing "very specific conditions involving the Star Tribune and today's changing media landscape." Speaking in the Wall Street Journal, Pruitt further pronounced the Strib the chain's worst-performing paper in terms of profit margins and overall revenue growth, suffering a tumble of 6.1 percent in 2006 receipts while McClatchy as a whole was posting very slight gains for the year.
Another "very specific condition" of the sale concerned McClatchy's tax bill. Publisher Keith Moyer made it more explicit in an email to staff, alluding to "unique financial tax advantages" that only the unloading of the Star Tribune could afford McClatchy. By virtue of the paper's high 1998 sale price, the 32-paper Sacramento-based chain will be able to claim a whopping $450 million-plus loss on the Strib sale, in turning allowing Pruitt and company to write off $160 million of an estimated $500 million in capital gains taxes they owe after turning around and reselling 12 of the Knight-Ridder papers they acquired last summer. (The reported take from those 12 sales, which included the St. Paul Pioneer-Press: $2.1 billion.)
Analysts quoted in the first days after the announcement were floored by Pruitt's decision to dump his flagship paper for a few dimes on the dollar. But they also framed the matter more or less as Pruitt had: It was a financial decision, regrettable but motivated only by the workaday economic demands of Wall Street. As John Morton, one of the most visible industry watchers, told City Pages, "This was basically a financial deal. McClatchy, in my opinion, is acting rather coldly in its financial interests by discarding a good newspaper whose operating revenues aren't up to expectations. For the most part, publicly owned companies are more interested in profit and loss than in publishing good newspapers."
But Pruitt may be a lucky man if the worst they call him is cold-hearted. Even after you acknowledge the unique tax breaks contained in the deal, and grant in principle that publicly traded newspaper companies care more about quarterly profits than quality papers, there is still plenty that seems odd about the sale.
To see why, stop and consider the extent of the Star Tribune's market dominance, and its strategic importance to McClatchy, even in its present declining state:
- The paper commands about 40 percent of the Twin Cities' roughly $1 billion a year ad market, with revenues of $402 million in 2005 and (reportedly) around $390 million in 2006.
- Of that $390 million, about 18 percent, or $70 million, were pre-tax operating profits. Meaning that, after taxes, the Star Tribune delivered a tidy $50 million or so to Sacramento's bottom line.
- By McClatchy's own account, the Strib delivered over $1 billion in operating profits to Sacramento from 1998 to the present. The paper proved so lucrative, in fact, that McClatchy was able to pay off its debt on the purchase ahead of schedule, in just seven years.
- Despite the paper's declining circulation and profitability, and a whole spate of demographic trend lines that were headed south, the Star Tribune's operating profits still have not slipped outlandishly by historic measures. In 2005, they stood at 19 percent; last year they slipped a point to 18; in 1998, the year McClatchy bought the paper, they were 18.6.
- One of the ways McClatchy has distinguished itself in recent years is through the commitment of time and money to their websites. As far back as 2002, one of the company's express goals was to have the number one site in every market where it owned a newspaper. Toward that end, they concentrated most of their web-development efforts, and a disproportionate amount of their online staffing, at startribune.com, launching two major new web efforts, Vita.mn and Buzz.mn, in the past six months alone.
Gary Pruitt said that the Star Tribune was dragging down McClatchy's bottom line, and strictly as a matter of earnings ratios, it was: The Strib's 18 percent operating profit last year lagged substantially behind the corporate average of 25 percent-plus. But ask yourself whether it's plausible that Wall Streeters have gone mad enough to prefer a gain in company-wide rate of return of less than 1 percent over the $50 million the Star Tribune added to McClatchy's bottom line in 2006. The answer would appear to be no. Wall Street, so far, is emphatically underwhelmed by the new, Strib-free McClatchy. After advancing almost 2 percent on the day the sale was announced, to $43.07 a share, McClatchy stock began slipping again, shedding almost 5 percent to $40.97 by the end of last week.
So again: How exactly does selling off this paper at this moment, for considerably less than prevailing industry standards would have dictated, constitute prudent fiscal management?Mike Meyers thinks he knows the answer: It makes no sense at all. The paper's 57-year-old economics reporter is a figure legendary around the newsroom for his gruffness, acuity, and anti-sentimentality. ("Don't ask me how I feel about the sale," he growled by way of a howdy-do when I phoned him. "I don't deal in feelings. What matters is the set of facts surrounding the sale, which are very clear.") He has no compunction about sharing his theory of events ("no, on the record. I hate people who go off the record"), which is simple and to the point: McClatchy management fucked up and put itself in a position where it had to sell something to pay its tax bill.
"It's very straightforward," Meyers said. McClatchy execs "bought something they couldn't afford" when they purchased the Knight-Ridder chain for $4.1 billion plus another $2 billion in assumed debt in March 2006. "And they had to sell the family silver to make their first mortgage payment. They had to sell 12 papers up front to help pay for it, and it seems obvious that it was only later on they realized that the capital gains from those sales were going to mean a big tax bill. The Knight-Ridder [sell-off] deals were sealed in June. The Star Tribune was sold very abruptly at the end of December. That suggests the tax implications weren't fully addressed when they made those [sales]."
There are at least two other bits of circumstantial evidence that the sale of the Strib was a rush job, in Meyers's view. First, "If they're paying the top capital gains rate of 35 percent in this deal, as I assume, that means they sold us for about $457 million less than we were worth. The fact they didn't take more time and set up an auction for the paper suggests a hurried sale in which the ticking clock was a factor."
And this: "Back in the fall, from September 15-18, we had the McClatchy board of directors traipsing through town getting the cook's tour of the largest paper in the chain, the crown jewel. They were here to meet people and kick the tires. Why would you do that if you know you're on the verge of selling it? It seems to me that something important happened after that visit." That something, Meyers believes, was the belated realization that McClatchy faced a much bigger tax bill than it had cash on hand to pay.
Business analyst John Morton dismisses that scenario out of hand: "I'm sure they considered [the tax implications of the KR sell-offs] very carefully." But one California media consultant with friends inside McClatchy HQ said of Meyers's theory, "I think that sounds absolutely right. The Star Tribune was McClatchy's pride and joy. They routinely touted it on all the Wall Street analyst calls. And inside the company they were foreseeing a better competitive climate for the paper due to the Pi-Press's new management, which they didn't think was as formidable a competitor as Knight-Ridder had been. So there was even optimism about improving the [profit] margins. It's hard to believe they'd choose to sell it except under duress."
II. A FEW MORE REASONS MCCLATCHY BAILED
To subscribe to Mike Meyers's theory about the sale is to believe that, at the end of the day, McClatchy sold the Star Tribune mainly to fix a serious cash-flow crisis in the face of a looming tax bill. But that hardly explains in full why it was the Strib they decided to toss overboard. Yes, selling this particular paper meant "unique financial tax advantages," but it wasn't the only option at hand. If Pruitt et al. had really believed in the paper's future, McClatchy could have financed its tax obligations by borrowing, despite the beating it likely would have taken from Wall Street for it. Or the company might have been able to devise a package of smaller papers to sell, albeit for less cash and a more modest loss. But McClatchy bosses did none of those things. They sold off the biggest paper in the chain, and the fact they did so points to other factors, general and local, that augured for disposing of a property like the Strib.
Big market = bad business. In 2006 the newspaper industry saw its fortunes decline more precipitously in major cities than in small-to-medium-sized ones. The biggest factor remained the internet—in particular, the continued spread of free classified ad sites like craigslist and of specialized ad sites that cannibalized such traditional print classified category leaders as jobs, cars, and real estate. The trend has moved from city to city in the past five years, looking less like a wave than a virus—reaching different cities at different times, affecting newspaper revenues to differing degrees of severity and in differing ad categories. Newspaper display advertising is also taking a beating in top 15 or 20 metro areas, where national advertising tends to dominate the market. Besides the fact that newspaper demographics are not that desirable anymore, it's much tougher, practically speaking, to do a national ad buy for print as opposed to broadcast or the web, since newspaper ad prices and size standards vary from city to city. Newspapers used to make a lot of national ad money from the free-standing inserts routinely larded into Sunday editions, but they're expensive to produce and advertisers have largely abandoned them.
Conversely, says the California media consultant, "People in smaller markets are still going to place ads in local media when they want to rent out a room or sell their stereo. And there isn't much point in trying to sell your car on a national cars website, since you're hoping to sell it to someone in your town and they're not going to be on that site. As far as your display ad base is concerned, independently owned businesses of some size are going to be a bigger factor in small-to-medium markets."
Media analyst Rick Edmonds thinks it's entirely plausible that big-market economics played a role in McClatchy's decision. "After the sale was announced, [Media News CEO and Pi-Press manager] Dean Singleton made the comment, why would you sell your biggest paper? But you could say that if you're going to sell something, why not sell your biggest paper? That's the most problematic part of the industry now."
The Star Tribune's bigger-than-average '06 circulation decline. Twice a year the Audit Bureau of Circulations (ABC) releases comprehensive figures on daily newspaper circulation. In 2005 the fall numbers made the Strib out to be a relative winner, losing just a quarter of 1 percent of its circulation while papers like the San Francisco Chronicle (16 percent), Boston Globe (8 percent), and Washington Post (4 percent) were posting huge losses. But last fall's ABC numbers were bad news locally. While the business as a whole saw a 2.8 percent drop in circ from September 2005 to September 2006, the Strib was losing 50 percent more than the industry average, 4.2 percent. One probable factor is the Twin Cities' extraordinarily wired populace: According to a representative of the market survey firm Media Audit, Minneapolis/St. Paul has a higher concentration of regular web users than any other US metro area.
But many newsroom staffers think the magnitude of the circulation plunge owes a lot to the paper's high-profile October 2005 redesign (the occasion that prompted Gary Pruitt to call the Strib "a model for a 21st century newspaper"—see sidebar). The new-look Star Tribune featured a more open, graphics-intensive design—and, reporters were quick to note, shorter articles. Writers accustomed to getting 60 inches for an important story learned that they would have to make do with 30 inches. Metro section columnists saw their soapboxes shrink from 800 words to 500. Privately, a lot of staffers call the redesign a "dumbing down" of the paper. A common refrain: How do you shore up print readership by retooling to suit the tastes of people who are never going to read print anyway at the expense of people who still do?
It isn't just the print edition that's suffered since the relaunch 15 months ago. Startribune.com launched a redesigned and re-engineered website at the same time, and it has been plagued ever since by issues of usability (a terrible search engine, for starters) and timeliness (the process of posting to the website and reshuffling its home page contents became more complicated, involving web personnel in Raleigh as well as Minneapolis). The Strib does not publish traffic data for its site, but numbers posted at the traffic-monitor site Alexa.com suggest that startribune.com's unique users declined by roughly 1/3 during 2006.
On Wall Street, "union shop" just means "impediment to cost-cutting."And what's true on Wall Street is increasingly what's true in the McClatchy boardroom as well. Some longtime newsroom vets have had the feeling for several years now that McClatchy was moving to kill the union. They claim the company has slowly but steadily ratcheted up its challenges to Newspaper Guild members by means such as flouting work rules (union members filed just 12 grievances against the company in the eight-year period from 1995 through 2002—and 23 more in the four years since) and forcing grievances to arbitration rather than trying to settle them.
When an arbitrator ruled against the paper on its use of non-Guild writer Paul Douglas, the WCCO weatherman, in March 2005, management spent more than a year appealing the decision in court. After losing in federal court, they appealed for a second time, in Eighth District Circuit Court, where they eventually lost again, in June 2006. Last fall, half a dozen reporters withheld their bylines from a series on ethanol to protest the editing of the series by a non-Guild employee. McClatchy's distaste for Guild newsroom was made manifest last summer when execs picked the 12 Knight Ridder papers they would resell. The list included all but one of the unionized newsrooms KR had owned. In dumping the Star Tribune, Pruitt got rid of one more.
III. THE NEW BOSSES: HOW MUCH DO THEY STRIP, HOW SOON DO THEY FLIP?No one in the Strib rank and file has a clue about their new owners, Avista Capital Partners. "We're reporters," Guild officer Chris Serres sighed in exasperation last week, "so we're calling people we know in the industry and at the buyout firms to assemble a dossier on Avista. But they've only been around for a year. They haven't owned any companies long enough to judge their track record in dealing with employees." (Serres asked Chris Harte, a former daily publisher who will manage the property for Avista, to meet with the Guild during a visit to town last week, but "he said he didn't want to meet with us.")
One point most insiders are taking for granted is that there is no such thing as an investment banking group that does not yearn to liquidate some assets immediately. Everyone in the world expects a quick sale of the paper's extensive downtown real estate holdings, some five blocks in the neighborhood of the Metrodome. Economics reporter Mike Meyers thinks the parcels will fetch $100 million or more. "If you want to be comforted," he said, "the real estate should be comforting. That sale could give them a serious return very quickly. This land is more valuable than it used to be, whether the stadium's built there or not.
"[Avista] could run it for a while, skim off some cream, and everybody lives happily ever after. I'm not that worried about this sale. I'm worried about the next sale, to a company that won't have a ready asset like that land to sell."
But most people presume there will be cutting at the paper, too. A January 6 Wall Street Journal profile of Avista sketched in some additional background about the buyers and the deal: "Thompson Dean and Steven Webster have been well known in the buyout community for more than a decade. They ran a group that generated returns of about 50 percent from buyout investments for Donaldson, Lufkin & Jenrette, which was acquired by Credit Suisse in 2000.... Avista hasn't said how much of its fund's own cash it will use for the purchase price and how much of it will come from debt it will pile on the paper."
According to the story, Dean refused to address the question of downsizing, saying only that the road to improved profits "may not be about staff cuts."
Everyone is bracing for cuts of some kind; the question is, how deep and in what manner? Some staffers note that the Strib's Guild contract contains an unusual provision granting members a five-day window in which they can trigger a buyout in the event that the paper is sold. The terms of that buyout are two weeks' severance pay for each year of service, up to a cap of 40 weeks. This is similar to the buyout package that 37 Pioneer-Press employees, including 21 people from the newsroom, took in late 2006. (The Pi-Press likewise paid two weeks per year but set the cap higher, at 52 weeks' wages.) But Chris Serres doesn't think that offer will find many takers.
"That's a bare minimum severance package," he said. "I think anyone who's been here for at least 10 years is going to want something more than that. If they offered something comparable to the Cleveland Plain-Dealer's buyouts—two and a half years' pay for everyone over the age of 50—then we're dealing with a serious buyout package. There could be 20-30 people who would take that. But it's really difficult to say how many people might opt out until we know what the company's going to offer."
If Avista doesn't want to offer premium severance packages, it could rely on attrition or simply start laying people off. But straight layoffs are unlikely, at least among reporters. Guild rules dictate that people with the least seniority go first. The youngest—and most ethnically diverse, and cheapest—people in the newsroom would therefore be hit hardest. Never mind the obligatory lip service to diversity, but what cost-slasher wants to jettison his cheapest resources as a first resort?
So for the near term, the likeliest prospect is that Avista will try to take out cash and fatten the operating margins through some combination of land sales, staff buyouts, and efforts to undermine the Guild, whose current contract expires in mid-2008. As for the longer view, well, there really is no longer view at the moment. A lot of the Stribbers I spoke to held out the stubborn hope that this private equity firm might be different from the vast majority of them—that it might actually sacrifice some short-term gains to build a solid future for the product.
John Morton of Morton Research takes a mixed view. "Something good [Avista] did was to hire Chris Harte, who's a respected newspaper executive. It should be comforting to the people there that they will have him instead of a bean-counter. Having said that, private equity investors don't buy out of love. Typically they want to flip the property in five to six years for a large gain. What remains to be seen is what they'll do to make the newspaper more profitable."
The growing fear among industry watchers on both the print and online sides of the divide is that the siege on newspaper revenues, and editorial staffs, is in effect de-capitalizing the gathering of news. "What's happening is not as simple as readers moving from print to online," said Poynter analyst Rick Edmonds. "A lot of it is purely on the business side. You can sell your car or fill a job by using craigslist, so why use a newspaper? That particular tradeoff doesn't have much to do with the quality of a paper or whether people like it. But it spills back into the news equation in the form of financial pressures on the budget. 'Death by a thousand cuts' is probably a good way to put it."
And as newspapers continue to hemorrhage ad revenues, it isn't as if those dollars are just moving to newsgathering organizations in a new medium. They're going dozens of places, to specialized ad platforms on the web (think jobs, cars, and real estate), to blog networks, to TV—or, as in the case of classified ads and craigslist, simply evaporating. So who will assemble the resources to do even halfway substantial journalism in a post-newspaper age?
"That's my major concern," said Morton. "Only newspapers are economically organized to collect a large amount of news. I fear that as the newsprint model declines, there will be—and there already has been—a reduction in journalistic efforts: cuts in staffing, reducing of news holes, closing of bureaus. It's all been happening for the last five years, and it all diminishes newspapers' ability to do what they're supposed to do."