The Deal from Hell

by James O'Shea

  In his letter, Stinehart outlined a strategy for going forward and exploring “strategic alternatives,” which included: “breaking up and selling or disposing in tax-free spinoffs some or all of its newspaper properties and the possibility of an acquisition of Tribune as a whole at an attractive premium.” The Chandlers’ outrage put enormous pressure on the board to sell the company, but before Tribune could be sold, it had to unwind the Chandler trusts. Shortly thereafter, FitzSimons and the Chandlers struck a compromise, and the Tribune board created a “Special Committee” of directors led by William Osborn, a respected Chicago banker from the Northern Trust Company, the Tribune Company’s bank. The special board was established to explore strategic options, the financial market euphemism for a “For Sale” sign. The acrimony with the Chandlers didn’t end there, though. By virtue of their large stockholdings, the Chandlers were not on the Special Committee composed of outside directors, a ploy to deny them the opportunity to leak board proceedings.

  On Wall Street, the same investment banks that had sung Tribune’s praises for its earnings and had pressured the company to keep posting sky-high cash flow margins had hammered its stock to about half of its all-time high per share. Analysts complained of soft ad markets, competition from the Internet, and, of course, declining circulations. The present may be okay, market analysts at places like Merrill Lynch assessed, but the future was bleak. The Tribune’s Special Committee hired Morgan Stanley as an adviser, while Tribune Company hired a collection of firms under the Citigroup banner and Merrill Lynch, their longtime investment banker. The two largest shareholders hired advisers, too. The Chandlers hired Tom Unterman’s private equity firm, Rustic Canyon Partners; the McCormick Foundation hired the Blackstone Group. The race for solutions was on.

  Overall, Tribune investment bankers reached out to thirty-six parties to gauge interest in the company, ranging from huge private equity investors like Madison Dearborn Partners in Chicago and the Carlyle Group to the Chandlers, Eli Broad, and Ronald Burkle, a Los Angeles billionaire and close friend of President Bill Clinton. As the potential buyers pored over Tribune’s books, though, the thirty-one firms that voiced interest dropped out one by one, and, by the time I arrived as editor of the Los Angeles Times, only a handful remained.

  Down in the ranks, everyone watched anxiously as the bankers put the company up for grabs. Through pension, profit-sharing, and discounted stock acquisition plans, Tribune employees owned 11 percent of Tribune stock, making them the third-largest shareholder. Employees like myself had bet retirement plans, college tuitions, and financial security on Tribune stock. Hiller soon asked me to go to the Sidley Austin offices in the Gas Building in downtown Los Angeles to meet with the Chandlers, who’d assembled a room full of young analysts with big binders, all wearing blue shirts and ties, and explain where I wanted to take the paper. The sameness of the group made them resemble a room full of robots. Unterman was leading the discussion, while Stinehart sat quietly, his bloodless eyes taking it all in.

  Capitalism had built the American newspaper industry. Tycoons like Chandler, McCormick, and Cowles had made a lot of money off newspapers, and most of the capitalists were hardly angels. But they built something useful, a business that created wealth but also served a socially useful purpose and employed people. By early 2007, Wall Street had undergone a dramatic transformation. The investors and investment bankers circling Tribune were out to make a buck by creating fee-laden packages of loans that could be converted into securities and peddled to big pension funds, institutional investors, or hedge funds and make even more money. If they created jobs, they were inside jobs designed to enrich themselves through the huge fees their clients forked over in exchange for access to the hordes of cash sloshing around on global markets.

  The Tribune Special Committee hired Morgan Stanley to the tune of an unusually high $10 million, a large fee that reflected the bank’s inability to participate in the lucrative loans Tribune would need to fund the various schemes under consideration. Advising the committee on which loan to pick would put the firm in a conflict, particularly if it stood to profit from the deal it told the committee to select. The Special Committee approved the fee, which was enough to fund four to five years of Iraq war coverage for readers of both the Times and the Tribune. Yet a few months later, Morgan Stanley would try to muscle its way into the loan-packaging deal, provoking howls of protests from bankers at Citigroup, the Tribune’s prime banker, and Merrill Lynch, or “Sam’s bank,” as one banker would refer to the firm. After Michael Costa, the Tribune’s man at Merrill Lynch, challenged Morgan Stanley’s math in its financing proposal, Crane Kenney, the company’s general counsel, remarked, “Always said the banking intramurals were ugly, but this is probably the worst example I’ve seen. You are right to be upset,” Kenney told Costa.

  As each of the bankers lined up behind competing financing schemes created for a healthy company that had essentially created a fire sale, nerves frayed and tempers flared. At one point, the Chandlers considered selling the family’s stock to the McCormick Foundation, but they could barely bring themselves to speak to the foundation, whose board included FitzSimons, Madigan, Hiller, and Smith, whom the Chandlers considered an extension of Tribune management. And sure enough, before long, the idea of a sale degenerated into the insults that characterized relations between the California family and the boys from Chicago.

  “We looked out and saw a ski slope,” Stinehart later recalled. “Management looked at the ski slope as though it [were] a bunny hill you can traverse across by cost cutting and [by catching] the Internet chairlift and go to the top, but what the [Chandler] Trusts saw was a four-star black-diamond run headed straight downhill. Cost cutting gets you nowhere, and the chairlift’s broken. Essentially there were two different versions of where the world was going, and we wanted off the ski slope.” Morgan Stanley was concerned that the Chandlers were pushing yet another alternative scheme because it would generate a tax windfall for the family but not necessarily for everyone else.

  Once Kaplan had convinced Zell to reconsider an investment in Tribune, the dynamics changed overnight. The mere thought of doing a deal with the legendary Zell made the investment bankers’ mouths water. He had the ability to open doors. Zell had invested in everything from radio stations and cruise ships to trailer parks, not always successfully, but his calling card was his genius at real estate investments. Editors like myself, weary of FitzSimons and his penny-pinching ways, welcomed the idea of Zell, even though he was known as a financial buccaneer. He had just sold his Equity Office Properties real estate venture to the Blackstone Group for $39 billion, adding to his reputation as an investor with a Midas touch. Just as Los Angeles Times journalists once welcomed Willes because of his reputation as a financial wizard, we welcomed Zell as a savvy entrepreneur who might have some good ideas about getting Tribune back on track and succeeding at mission impossible: making Tribune shareholders and its journalists happy.

  Despite my many years in Chicago, I didn’t know Zell. He had a reputation for being secretive, crude, tough, and dismissive, but also incredibly loyal to trusted colleagues and widely admired for his unbelievable capitalistic instincts and addiction to deals. He loved to brag about how many people he’d made millionaires and always seemed to have someone with him. Yet he also seemed alone, even in a room full of people. Despite his high profile and billion-dollar deals, precious little had been written about him. A Chicago Tribune magazine article by Greg Burns that ran in the paper when I was managing editor was a rare exception. The lack of sound information on Zell made us all curious to find out with whom we’d be dealing.

  While he was reporting the story, Burns had talked to many people who knew and praised Zell, but he also uncovered court files that showed how Zell, early in his career, had turned state’s evidence and testified in a court case involving a tax-fraud scheme, a Caribbean bank, and a Nevada high-rise. His testimony had helped prosecutors win a conviction and a two-year prison term
for one of his co-conspirators—his brother-in-law, Roger Baskes, who told Burns years later that he didn’t bear a grudge.

  Burns’ piece closely examined Zell’s remarkable career, including his sometimes acrimonious relationship with his father, a strict, demanding Polish Jew who came to America in 1941 to flee the Nazis and promptly shortened the family name from Zielonka to Zell. Zell declined Burns’ request for an interview: “This Is Your Life is not my kind of thing,” Zell told Burns in reference to a popular TV show from the 1950s, but even without his subject’s participation, Burns nonetheless detailed his amazing rise from a University of Michigan–trained lawyer working for $58 a week to one of the globe’s largest owners of real estate. Zell hated the piece and would complain about it for years. Few other reporters had the guts to do such a story on Zell, and few papers, other than the Chicago Tribune, had the backbone to run it. Now the company that owned the offending paper was being considered an investment opportunity by the man himself.

  To put together a bid, Zell activated an “A” team at Equity Group Investments, his privately held company. Years before, Zell had instructed a colleague to go out and hire the smartest person he could find. The search led to the door of William Pate, a lawyer whose family had owned the Madill Record, a tiny weekly and pillar of the community that helped two generations of Pates land in the Oklahoma Press Hall of Fame.

  While at law school at the University of Chicago, Pate rented out the basement of his Hyde Park building. It was there that he met Nils Larsen, a New Hampshire native and bearded environmentalist who was driving through and had spent the night on the couch of Pate’s tenant. Pate and Larsen chatted and hit it off, particularly after Larsen told him he had quit his job as a Wall Street investment banker because he found the atmosphere stuffy. After Pate joined Zell’s venture, the company hired Larsen, too. It was a good fit for bright young people who could bike to work in jeans and look the other way when a colleague had an occasional extramarital affair. Within thirteen years, Pate rose to become Zell’s top investment officer, and Larsen became a managing director at Zell’s investment arm. Together they put together a bid for Tribune.

  The ingenious proposal that Zell, Pate, and Larsen crafted demonstrated that Zell indeed had a great eye for talent. A few years before, Zell had invested in a waste energy firm, Covanta, which he picked up out of bankruptcy court. A bank that submitted a competing offer for Covanta wanted to use an employee stock ownership plan, known as an ESOP, and a tax-advantaged S corporation to fund its bid. The tactic didn’t work, but the idea stayed in Pate’s mind. When he took a look at Tribune Company, he wondered if a similar scheme would work with a company that owned newspapers, assets that were close to his Oklahoma roots.

  The offer that Equity Group built puzzled many of the investment bankers involved in the Tribune deal. Most of them had little knowledge about ESOPs, and hardly anyone had ever seen a scheme marrying an ESOP with an S corporation. Essentially, Zell proposed that Tribune borrow enough money to buy all of the stock owned by the Chandlers, the McCormick Trust, employees, and other shareholders and take the company private—or remove its stock from public markets—as an S corporation owned by a nonprofit ESOP that would be owned by Tribune employees and be exempt from federal income taxes. The idea would saddle the company with about $12 billion to $13 billion in debt, a staggering sum to mortals but not such a big deal to a real estate tycoon who loved to operate with other people’s money. Indeed, after Zell got interested, Pate called Brit Bartter, a Zell contact at JPMorgan Chase, and informed him about the Tribune multibillion dollar deal to gauge the bank’s interest in providing financing. A mere five days later, Bartter told Pate that JPMorgan Chase was “there for them on their big project.”

  Zell’s proposal had some intriguing benefits, too. To repay the Tribune’s debt, the new company could rely on the $1.3 billion that Tribune already generated each year in cash flow plus another $300 million to $500 million the company would no longer have to pay in income taxes by virtue of being owned by a nonprofit ESOP. Ditto for the $200 million to $300 million a year it had been paying to shareholders in dividends. The total level of debt could be cut by selling off assets that didn’t contribute to cash flow—like the Chicago Cubs baseball team, which was valued in excess of $1 billion. And the new company wouldn’t have to cough up the $60 million to $70 million a year it had paid to employee 401(k) plans because employees would receive benefits as owners, thanks to the ESOP categorization. Initially, Zell said he would personally invest $200 million in Tribune and that existing shareholders, including employees, would get around $30 a share for their stock, a price that would have been laughable even two years earlier but now had to be considered. Once the debt was repaid, everyone would be fat and happy.

  The idea of an ESOP would probably have gone nowhere without Zell. Even with his backing, financial advisers like the Special Committee’s Thomas Whayne of Morgan Stanley didn’t know what to think: “What was novel was that it was an S-Corp. ESOP. That was the part that was truly unprecedented. I’d never seen that done. I subsequently became educated that it had been done for other private companies. But I’m still not aware that it had been done in other public companies.” Some bankers involved in the deal were cool to the idea. Julie Persily of Citigroup’s leveraged finance department, a unit that would have to eventually peddle the billion-dollar loans to other investors, said she had talked to Merrill Lynch about it: “I spoke to ML. They are on board with this silly ESOP structure. I am unequivocally not on board.... But ML explained why they think it works. ML is Sam’s bank. They’ll do anything for him.”

  But Citigroup had never corralled Zell as a client despite its strong local Chicago banking ties to companies like Tribune. In reference to Zell, Persily said she was “in awe of him,” and others at the bank noted that lending money to the Zell-backed ESOP could have its own benefits. Christina Mohr, a managing director in Citigroup’s mergers and acquisitions wing, liked the ESOP idea and got an e-mail from Paul Ingrassia, one of the bank’s managing directors, that suggested just how meaningful an “in” with Zell could be for business: “Christina. If we end up helping Sam, if appropriate, please let him know how important his relationship is to our [other operations] and real estate teams, and that we were consulted. We are trying to win a book position on his IPO of Equity International.”

  In the newsrooms, Tribune journalists, blissfully ignorant of the behind-the-scenes skirmishes, worried about whether we would restore an editor or two to a depleted news or copy desk rather than about the very real threat of how the company’s heavy debt would trigger the need for drastic budget cuts. Even FitzSimons and Smith, who viewed budget cuts as a simple matter of fact, worried about employee reaction. But Zell was a rock star, a new face that appealed to news junkies in newsrooms. Everyone liked the idea that Zell had eclipsed FitzSimons.

  Zell, too, started to get pumped as the deal developed the kind of rhythm that made his heart beat. When Costa, the Tribune’s banker, expressed his disappointment to Pate that Zell’s bid wouldn’t command more than $30 a share, Zell upped the ante to $33 per share. Sweetening the pot didn’t immediately win over big Tribune shareholders like the McCormick Foundation, which favored a “self-help plan,” a leveraged buyout in which the company’s management would line up the loans to buy the company and continue to run it as a private entity. Truth be told, Madigan and FitzSimons, like many in the Chicago business establishment, viewed Zell as a crude, uncouth maverick who was tolerated because of his billions.

  The McCormick Foundation also raised a legitimate issue. Any plan would require approval by the Federal Communications Commission (FCC) because broadcast licenses would have to be transferred and Zell’s initial offer would take nine months to close, a long time in which anything could happen to derail the deal. On this point, the Chandlers actually agreed with the boys from Chicago. But Zell had an answer: To minimize the risks to Tribune’s existing shareholders, he would split the pr
oposed deal into two phases. His deal called for acquiring 50 percent of the stock in May 2007 (thereby giving the company’s shareholders a chance to cash in on half of their earnings soon), and the other 50 percent by December 2007 after the company got approval from the FCC.

  Mohr recalled how FitzSimons and the Chicagoans were hot and cold on the two-phase ESOP deal: “It wasn’t as if we all looked at Zell and said let’s do it. We thought about it, pushed back among financing teams and adviser teams. This was something that had not been done on this scale.... People got up some mornings and were comfortable, other mornings people said they were uncomfortable with the risk.... It was live, dead, live, dead, dead, live.”

  At one point, the back and forth that plagued Tribune Company also frustrated Zell, who called Tribune General Counsel Kenney and demanded,“So do you think I’m some sort of schmuck?” When Kenney said, “No,” Zell barked, “Well then, why are you treating me like one? Do you have anyone there who knows how to do a deal?” FitzSimons also got frantic phone calls, not from Zell but from Tribune’s longtime New York lawyer, Marty Lipton of Watchell & Lipton, who had built the company’s anti-takeover defenses: “Marty called me one morning and said, ‘You know, I was tossing and turning all night, I couldn’t sleep, and I think we really have to think about this very, very carefully given the scrutiny that it’s going to receive down in Washington.’”

  Tribune Company had already received terrible press when it misread the depth of the opposition to an earlier FCC rule change, one that it had pushed to ease the level of media concentration permitted under federal regulations. “The press,” FitzSimons said, “loves boardroom drama, and they love it even more when you have a media company involved.”