Pinch Sulzberger's Achilles Heel: The Bondholders

Shielded by a two class system of shareholding allowing his family to elect a majority of the board of directors, New York Times Company CEO Pinch Sulzberger's hold on his job hasn't depended on keeping ordinary shareholders happy. That's why the loss of 60% of the shareholders' market value hasn't resulted in him losing his job, even as the company's stock once again hit new lows last week. 

This may trigger more unrest among shareholders like the fruitless showdown earlier this year with Hassan Esmasry of Morgan Stanley.  Morgan Stanley's agitation was not only driven by the under-performance of the stock but likely by an interest in transaction fees for taking the company private at the peak of the media private equity craze. In the end, there was no reason for the Sulzbergers to give up the already sweet arrangement of super voting shares in exchange for the hassles of high leverage and demanding new private equity holders, presumably with greater influence than the helpless Class A shareholders unable to vote in a majority on the board.

Alas, the private equity window is probably closed for now, so that's no longer an option.

After Morgan Stanley's run at it, the Sulzbergers' super voting share arrangement would seem to be pretty bullet proof.  But while ordinary shareholders may have no recourse, the bondholders just may. The Times may be bullet proof, but it ain't impregnable.

The New York Times Company has almost $1 billion in long term debt and revolving credit lines outstanding.

The shorter term revolver debt is trading at a discount, yielding 9%+ interest with a coupon below 5%. The most recent trades of the long term debt show a premium spread approaching 1% on a 4.5% coupon. The pricing for all debt classes is still in the low to mid 90 cents per dollar range. This indicates the market is demanding a premium over the coupon, but these prices would not be considered distressed.   

But recently, bondholders have become much more aggressive enforcing non-monetary default covenants. Beazer Homes is being pounded by bondholders for missing report filing deadlines. Of course, the Wall Street jackals' real motivation is to pressure Beazer to take them out at a premium or, save that, get control of the company in bankruptcy.

Non-monetary defaults are promises for such things as making certain reports on a timely basis or meeting minimum net equity requirements. The Times discloses that their credit agreements have a minimum net equity requirement of $652 million in the most recent quarterly SEC filing. The previous annual filing showed a net equity requirement of $618 million and this covenant was waived. As of July 1, 2007, the New York Times Company shows net equity of $876 million, leaving them just a $224 million cushion.  

The proxy statement shows the company intends to pay out $125 million in dividends or 87 cents a share this year. In the first half, the company only earned 29 cents a share. Reaching par with the dividend is going to be very difficult. They will have to earn double what the company earned in the first half, a tall order in this difficult environment for newspapers. If they earn 40 cents they will have to take an equity hit of $30 million. This is cause for great concern to bondholders.

The need to maintain or even increase earnings to fund the dividend in the face of bond convenants underlies the company's announced intention of cutting $130 million in expenses in the year 2008, a level of belt-tightening that will involve real pain for many employees. Maintaining an  recently-increased dividend while inflicting cuts on employees hardly squares with the traditional spin of a newspaper long critical of greedy managements in other industries, and full of left-leaning journalists suspicious of the logic of a high return on invested capital as the ultimate goal of their work.

One possible event that could send the company over the edge would be an impairment charge against the $650 million they are carrying as goodwill. Goodwill is the difference between the acquisition cost and the "fair value" of the company. Since internet properties have very little in the way of hard assets such as real estate and equipment, there is typically a large difference between the fair value and the acquisition cost in these transactions.  The most prominent example of such a write-down is Time Warner, which booked and later wrote down some $50 billion in goodwill in its acquisition of AOL.

Of the $650 million in current New York Times Company goodwill, $344 million is attributable to their
about.com acquisition. Based on about.com's first half results of $16 million in income, they should be able to avoid a write down, but it might be tight.

The New York Times Company already is no stranger to big write offs. In February of this year it took $814.4 million write down in the value of its New England newspapers.

One other interesting development: In 2006, the New York Times Company dismissed its longtime statutory auditor, Deloitte & Touche, and replaced them with Ernst & Young at the end of the calendar year.  The SEC requires onerous disclosures for changing auditors, including attesting that there were no disagreements between the company and the auditor regarding accounting policies, and that there are no pre-agreements with the successor auditor as to the application of specific accounting policies for certain transactions.

Barely more than a month after Ernst & Young took over the account, the New York Times Company announced the write down the value of its New England newspaper properties, whatever significance may or may not be understood by this interesting timing. Press reports indicated the company was studying the matter during 2006, when Deloitte was still its auditor. There is no reason at all to believe Deloitte was insisting the company write down their about.com goodwill. And Ernst & Young could not have agreed to any conditions on such a matter if they were retained, for this would be a violation.  Whatever the details behind the dismissal of Deloitte & Touche, changing auditors at a public company is a very big deal.

The New York Times Company is walking a real tight rope. One false move could send it over the edge. The Moveon.org misstep, offering a substantial discount for a full page ad and having the existence of such private discounts made public, is much more damaging than something like the Jayson Blair scandal, because it deals with the life blood of any newspaper, advertising. In the financially precarious position in which the New York Times Company finds itself, the last thing it needs is a scandal that focuses on ad sales and rates. 

Pinch Sulzberger's rise to rule over the Times was a modern corporate form of hereditary monarchy, as he inherited the job from his father. Mel Brooks wrote the immortal line, "It's good the be the king" for his 1981 classic comedy, The History of the World, Part I, and even used it again in the hit stage play version of The Producers.  As a catch phrase, it has entered the national memory as an insouciant comment on outrageous privilege on the part of the powerful.

Pinch Sulzberger would be well-advised to view the 1981 film and notice that the phrase first appears in the context of pre-revolutionary France.  Corporate reorganizations never result in use of guillotine, of course, but heads sometimes do roll in the wreckage following the fall of corporate monarchs.

Update 2/11/08:

I suggested that the dividend increase was inching them dangerously close to violating the equity covenant. Rereading the notes to the financial statements and the bond indentures, turned up some inconsitencies that needed resolution. I contacted the Times Investor Relations Department to discuss the matter and they explained the $800 or so million in non-cash writedowns for the New England Media Group and other impairments is added back to stockholders equity for the purposes of this bond covenant.

In the short term, this means that they are not in danger of any non-monetary defaults. Strategically, this restricts their future options. In 2006 rumors surfaced that Jack Welch was considering a bid for the Boston Globe.  Prior to the writedown, in early 2007 management strenuously denied these rumors and affirmed their commitment to the business. Until the company renegotiates the default language of their credit agreements, they are pretty much stuck with their New England properties.  

Shielded by a two class system of shareholding allowing his family to elect a majority of the board of directors, New York Times Company CEO Pinch Sulzberger's hold on his job hasn't depended on keeping ordinary shareholders happy. That's why the loss of 60% of the shareholders' market value hasn't resulted in him losing his job, even as the company's stock once again hit new lows last week. 

This may trigger more unrest among shareholders like the fruitless showdown earlier this year with Hassan Esmasry of Morgan Stanley.  Morgan Stanley's agitation was not only driven by the under-performance of the stock but likely by an interest in transaction fees for taking the company private at the peak of the media private equity craze. In the end, there was no reason for the Sulzbergers to give up the already sweet arrangement of super voting shares in exchange for the hassles of high leverage and demanding new private equity holders, presumably with greater influence than the helpless Class A shareholders unable to vote in a majority on the board.

Alas, the private equity window is probably closed for now, so that's no longer an option.

After Morgan Stanley's run at it, the Sulzbergers' super voting share arrangement would seem to be pretty bullet proof.  But while ordinary shareholders may have no recourse, the bondholders just may. The Times may be bullet proof, but it ain't impregnable.

The New York Times Company has almost $1 billion in long term debt and revolving credit lines outstanding.

The shorter term revolver debt is trading at a discount, yielding 9%+ interest with a coupon below 5%. The most recent trades of the long term debt show a premium spread approaching 1% on a 4.5% coupon. The pricing for all debt classes is still in the low to mid 90 cents per dollar range. This indicates the market is demanding a premium over the coupon, but these prices would not be considered distressed.   

But recently, bondholders have become much more aggressive enforcing non-monetary default covenants. Beazer Homes is being pounded by bondholders for missing report filing deadlines. Of course, the Wall Street jackals' real motivation is to pressure Beazer to take them out at a premium or, save that, get control of the company in bankruptcy.

Non-monetary defaults are promises for such things as making certain reports on a timely basis or meeting minimum net equity requirements. The Times discloses that their credit agreements have a minimum net equity requirement of $652 million in the most recent quarterly SEC filing. The previous annual filing showed a net equity requirement of $618 million and this covenant was waived. As of July 1, 2007, the New York Times Company shows net equity of $876 million, leaving them just a $224 million cushion.  

The proxy statement shows the company intends to pay out $125 million in dividends or 87 cents a share this year. In the first half, the company only earned 29 cents a share. Reaching par with the dividend is going to be very difficult. They will have to earn double what the company earned in the first half, a tall order in this difficult environment for newspapers. If they earn 40 cents they will have to take an equity hit of $30 million. This is cause for great concern to bondholders.

The need to maintain or even increase earnings to fund the dividend in the face of bond convenants underlies the company's announced intention of cutting $130 million in expenses in the year 2008, a level of belt-tightening that will involve real pain for many employees. Maintaining an  recently-increased dividend while inflicting cuts on employees hardly squares with the traditional spin of a newspaper long critical of greedy managements in other industries, and full of left-leaning journalists suspicious of the logic of a high return on invested capital as the ultimate goal of their work.

One possible event that could send the company over the edge would be an impairment charge against the $650 million they are carrying as goodwill. Goodwill is the difference between the acquisition cost and the "fair value" of the company. Since internet properties have very little in the way of hard assets such as real estate and equipment, there is typically a large difference between the fair value and the acquisition cost in these transactions.  The most prominent example of such a write-down is Time Warner, which booked and later wrote down some $50 billion in goodwill in its acquisition of AOL.

Of the $650 million in current New York Times Company goodwill, $344 million is attributable to their
about.com acquisition. Based on about.com's first half results of $16 million in income, they should be able to avoid a write down, but it might be tight.

The New York Times Company already is no stranger to big write offs. In February of this year it took $814.4 million write down in the value of its New England newspapers.

One other interesting development: In 2006, the New York Times Company dismissed its longtime statutory auditor, Deloitte & Touche, and replaced them with Ernst & Young at the end of the calendar year.  The SEC requires onerous disclosures for changing auditors, including attesting that there were no disagreements between the company and the auditor regarding accounting policies, and that there are no pre-agreements with the successor auditor as to the application of specific accounting policies for certain transactions.

Barely more than a month after Ernst & Young took over the account, the New York Times Company announced the write down the value of its New England newspaper properties, whatever significance may or may not be understood by this interesting timing. Press reports indicated the company was studying the matter during 2006, when Deloitte was still its auditor. There is no reason at all to believe Deloitte was insisting the company write down their about.com goodwill. And Ernst & Young could not have agreed to any conditions on such a matter if they were retained, for this would be a violation.  Whatever the details behind the dismissal of Deloitte & Touche, changing auditors at a public company is a very big deal.

The New York Times Company is walking a real tight rope. One false move could send it over the edge. The Moveon.org misstep, offering a substantial discount for a full page ad and having the existence of such private discounts made public, is much more damaging than something like the Jayson Blair scandal, because it deals with the life blood of any newspaper, advertising. In the financially precarious position in which the New York Times Company finds itself, the last thing it needs is a scandal that focuses on ad sales and rates. 

Pinch Sulzberger's rise to rule over the Times was a modern corporate form of hereditary monarchy, as he inherited the job from his father. Mel Brooks wrote the immortal line, "It's good the be the king" for his 1981 classic comedy, The History of the World, Part I, and even used it again in the hit stage play version of The Producers.  As a catch phrase, it has entered the national memory as an insouciant comment on outrageous privilege on the part of the powerful.

Pinch Sulzberger would be well-advised to view the 1981 film and notice that the phrase first appears in the context of pre-revolutionary France.  Corporate reorganizations never result in use of guillotine, of course, but heads sometimes do roll in the wreckage following the fall of corporate monarchs.

Update 2/11/08:

I suggested that the dividend increase was inching them dangerously close to violating the equity covenant. Rereading the notes to the financial statements and the bond indentures, turned up some inconsitencies that needed resolution. I contacted the Times Investor Relations Department to discuss the matter and they explained the $800 or so million in non-cash writedowns for the New England Media Group and other impairments is added back to stockholders equity for the purposes of this bond covenant.

In the short term, this means that they are not in danger of any non-monetary defaults. Strategically, this restricts their future options. In 2006 rumors surfaced that Jack Welch was considering a bid for the Boston Globe.  Prior to the writedown, in early 2007 management strenuously denied these rumors and affirmed their commitment to the business. Until the company renegotiates the default language of their credit agreements, they are pretty much stuck with their New England properties.