The Denver Post Bankruptcy In Context

First, the Rocky Mountain News shut its doors.

Then, the company that owns both the Denver Post and Boulder Daily Camera filed for bankruptcy. These companies aren't going out of business. They are doing what homeowners are not being allowed to do (due to a bar on "cramdowns" for personal residences in the bankruptcy code, something allowed in business Chapter 11 bankruptcies for property other than personal residences). They are writing off their debts to principal amounts commensurate with the current value of their assets, so that their debt load is low enough to allow them to continue to operate normally.

The design of the pre-packaged and pre-approved bankruptcy is rather elegant, and is the product of considerable negotiation with lenders over an extended period. According to the Denver Post's own coverage of the deal:

Last spring, MediaNews reached an agreement with its lenders to make interest-only payments on its debt and started to negotiate a restructuring. The company worked out a separate agreement to rework loans used to finance The Denver Post's operations last summer, avoiding a bankruptcy filing.

As explained by the Denver Daily News, the long term debt of the company is an obligation of Media News Group, which owns subsidiaries that operate its 54 daily newspapers. Only the parent company is going bankrupt, so the customers, trade creditors and employees who deal with the subsidiaries are unaffected.

The Terms of the Deal

Creditors of the parent company get, in the aggregate, about 17 cents on the dollar, with the $930 million of debts owed to them trimmed to $165 million, and a non-controlling 80% equity stake in the surviving company. But, different creditors come out differently. Senior creditors get about 29% for the amount they loaned back as debt with collateral, and share in the 80% equity state in the company that creditors will receive. Subordinated debt is all but wiped out, receiving only stock warrants that are worthless unless the company's stock increases in value.

Specifially, Publisher and Media News Group principal Dean Singleton, together with Media News Group President Joseph J. Ludovic IV, will control class A shares that name a majority (4) of the seven members of the Board of Directors. According to the Post story (and contrary to other reports that this increases Singleton's stake from 10% to 20%), "Singleton, who once owned as much as 45 percent of MediaNews Group and currently has 29 percent, will see his interest fall below 20 percent," while "Singleton and MediaNews president Joseph Lodovic will own 20 percent of the equity, with rights to additional shares in the future." One does get the impression that Singleton will own the lion's share of the 20% of the stock (and majority of the voting rights) retained by these two senior managers, although the exact split is not disclosed in any of the reporting that I have seen.

The $590 million owned to senior debt gets them a pro-rata share of the remaining $165 million secured term loan (presumably the collateral consists of subsidiary stock), and 80% of the economic value of the company in company stock, with a minority (3 board member) say on the Board of Directors.

Subordinated debt, to the tune of $326 million of notes, will get warrants for future equity (i.e. currently worthless stock options) but nothing more.

Stockholders in the privately held company other than Singleton and Ludovic get nothing. The shareholders in the privately held old company who lose their shares include the Scudder family and the Hearst Corp.

The deal was reached with "a Bank of America-led consortium of 116 banks and 49 bondholders leaves Singleton in full control of MediaNews. . . . The restructuring plan was approved by 95 percent of the banks and 91 percent of the bondholders. Because all sides have agreed to its terms, Affiliated should be able to exit bankruptcy in about 30 days[.]"

A bankruptcy company that is reorganizing can deny any creditor receiving less than they would have in a Chapter 7 bankruptcy any vote on a plan, so any deal even marginally better than a Chapter 7 liquidation of the company is likely to be approved by creditors by an overwhelming margin.

Since according to the press release, all but one of the underlying newspaper subsidiaries are profitable, and the new secured loan amount was set by management at a level that management thought that it could pay, one presumes that the equity in the reorganized company that is owned mostly by the creditors is worth something even on day one.

Analysis: Another Case For A Trade Creditor Preference

A key point of this deal, which is typical of many of the most successful and clean Chapter 11 reorganizations (including the Lehman Brothers and Bear Sterns collapses) is that only financing debt was reorganized. Trade credit, obligations to customers, business property leases, obligations to employees and similar obligations all of which are creditor's claims under the formal definition used in bankruptcy law are left untouched.

Those who are having their rights adjusted under this plan intentionally entered into long term transactions to finance this business with cash or the equivalent, after evaluating the creditworthiness of the business, and unrelated to any particular operational need of the operating companies. The junk bond holders (i.e. subordinated debt) and equity holders knew in advance that their debts involved particularly high risk because they were leveraged by all of the other obligations of the company. They consciously made a risk and return calculation that didn't pan out.

Limiting the affected creditors to these kind of long term financial creditors dramatically reduces the number of creditors affected by the bankruptcy, and keeps disruptions of operating activities to a minimum. Notably, this kind of bankruptcy looks very much like the FDIC brokered transactions that are arranged for failed banks, and the deals for non-FDIC financial institutions that were arranged by the Fed and other government players at the height of the financial crisis. This reorganization is also similar in structure to that used by the two collapsed investments banks, Lehman Brothers and Bear Sterns.

This plan also has considerable similarity to a significant share of successful Chapter 11 reorganizations that involve large non-financial institutions that manage to ultimately leave bankruptcy and conduct ordinary operations again.

In contrast, a large share of smaller Chapter 11 reorganizations ultimate result in the shut down of the business, frequently with tax creditors receiving a large share of all of the assets of the enterprise. And, a significant share of larger Chapter 11 reorganizations that go beyond a mere bankruptcy assisted refinancing of long term debts also ultimately fail to produce a viable reorganized company that emerges from bankruptcy.

Greater priority for the claims of employees and trade creditors in bankruptcy would increase the frequency with which relatively uncomplicated and benign long term debt refinancings could be facilitated through a quick bankruptcy process with a modest litigation and administration cost that does not disrupt the web of commerce, even in cases, unlike this one, where there are holdout creditors or creditors who can not be located or are unresponsive.

Bankruptcy, unlike government facilitated bailouts, place the losses from business failures squarely on the private investors who financed these businesses, and don't involve appropriations of public funds or assumptions of private risks by government agencies. They also allow the private sector to respond to a financial crisis without much regard to who currently holds political power or their political interests.

This would come at the costs of modestly greater losses for unsecured general creditors of bankrupt companies, but would make day to day conduct of business more secure which would discourage the kind of crippling distrust seen at the height of the financial crisis when big banks started to refuse to buy commercial paper from large creditworthy companies, and expensive administrative burdens, that have encouraged the government to look for non-bankruptcy alternatives to resolve the affairs of overleveraged businesses that are otherwise viable.

Analysis: Governance

The good news about the Media News Group bankruptcy is that it reduces the size of the ownership group that might have an interest in how the business is run. So long as it can make payments on the $165 million of debt that remains on the books and doesn't need more financing, it doesn't have to listen to creditors at all.

Singleton's considerable percentage stake in the equity of the company gives him an immense upside interest in making the business profitable, while also giving him a potential for downside losses that are far greater than those of a typical Fortune 500 senior executive who has stock options rather than stock ownership. His interests are aligned more closely with his new shareholders than your typical big business CEO.

The former senior creditors who are now the owners will have to hope that this incentive provides all of the governance guidance that Singleton needs, because as minority shareholders they will have almost no say in corporate decisions short of a corporate takeover or Singleton's inability to continue to run the company due to death or some other serious distraction like a major scandal or an issue in his personal life.

Singleton can effectively run his newspaper empire as a dictator with a free hand.

Singleton doesn't have any particular biases favoring short term, over long term gains, although his creditors do, because most of the shareholders need to unload their new stock holdings within five years as large equity interests in real economy firms acquired by foreclosure are not assets that commercial banks are permitted to hold in the long run. Generally speaking, commercial banks are in the lending business, while investment banks and investment funds are in the equity business. Most of the new company's consortium of equity owners will have to start looking for investors to buy them out, or consider a public offering of the company, soon. It takes many months to arrange these deals, so they need to have an exit plan in place by early 2014, and must judge how long they need to stay on as owners to maximize their returns by showing that the reorganized company has value without making them so "motivated" as sellers that they much offer firesale prices for their stakes.

How does this impact the way that the papers are run day to day?

It isn't easy to say, a priori, what makes a newspaper more profitable, although it is safe to guess that Singleton will be ruthless in seeking profits for his papers. While Singleton no longer has pressure from financial interests, he must still please advertisers, both with circulation and by not biting that hand that is feeding the enterprise. About 80% of revenues come from advertisers, so they, and not the customers, are ultimately calling the tune.

The pool of advertisers won't be much different than they were immediately before the bankruptcy, so the media bias pressures on Singleton may shift now that he has more freedom to pursue medium term relationship building deals, instead of short term liquidity maximizing deals. Singleton's own editorial preferences likewise, cannot be expected to be much different than they were before the bankruptcy.

This bankruptcy was a financial transaction, but it wasn't driven by any obvious new business ideas. The PR for the deal has emphasized continuity, not new, company saving ideas. If the basic business model in place now is working (and there is every reason to doubt this assumption), then that isn't a problem. But, if the basic business model in place now is not working, the bankruptcy only buys time to come up with another one.

Analysis: An Industry In Crisis

The Denver Post's publisher is not alone in seeking bankruptcy protection:

The Associated Press estimates that at least 13 U.S. daily-newspaper publishers have filed for bankruptcy since late 2008. In Denver, the Rocky Mountain News ceased publication in February 2009, with owner E.W. Scripps Co. of Cincinnati citing major losses in the market.

The Denver Post's own coverage of its publisher's imminent bankruptcy spells out that point in detail:

Newspaper publishers and broadcasters have struggled with slumping advertising sales, a trend the recession accelerated. Sustained double-digit revenue declines have left many publishers unable to support their debt payments. More than a dozen media companies are trying to reorganize or have already done so.

The Tribune Co., owner of the Chicago Tribune and Los Angeles Times, sought bankruptcy protection in December 2008 and expects to have a plan filed next month to deal with $13 billion in debt.

Last September, Freedom Communications Holdings Inc., owner of the Orange County Register and The Gazette in Colorado Springs, sought a bankruptcy plan that left existing holders with only 2 percent of the company.

And on Thursday, Morris Publishing Group, which own 13 daily newspapers, said it would seek a prepackaged bankruptcy filing next week. . . .

MediaNews Group is the nation's second-largest newspaper publisher by circulation, with 54 daily newspapers and more than 100 non-daily newspapers in 12 states. It also operates numerous websites, a television station in Alaska and several radio stations in Texas.

Other newspaper companies, like those that own the Washington Post, New York Time and Boston Tribune are also in dire straights financially due to falling advertising revenue and reduced circulation numbers. The financial crisis simply brought push to shove for an industry that has been suffering from a sustained period of slow but certain decline.

First, the afternoon paper concept died, as more and more afternoon papers either shifted to a morning format or went out of business. They aren't all gone yet, but their numbers have dwindled dramatically and their circulations have fallen even more so. This led to industry consolidation, with fewer and fewer markets having two or more daily papers, despite tools like Joint Operating Agreements, like the one that used to be in place between the Denver Post and Rocky Mountain News that delayed the process. And, coincident with industry consolidation, the newspaper itself began to see slow but steady declines in overall circulation that seem to be continuing with no end in sight.

Who would have figured that purveyors of information would be on the losing end of the economy as we shift from an "industrial" economy to a post-industrial one called by many commentators some variation on the "information economy"?

It isn't clear where this ends. Media News Group may have a positive pro forma profit and loss statment in the immediate wake of its reorganization, but what are its long term prospects? Was it really simply overleveraged and overvalued? Or, is its current profitability unsustainable?