The Zell Deal for Control of Tribune

I am still somewhat flummoxed about the details of Sam Zell's successful deal for operating control of the Tribune Corporation.  In the first step of the transaction, the Zell Entity invests $250 million in Tribune for (1) 1,470,588 shares and (2) a promissory note of the company equaling $200 million, exchangeable at Tribune's option into 5,882,353 shares of common stock (equivalent $34/share).  Zell's entire first stage investment is cashed out in the second stage and replaced by another.  Presumably, the first stage was a combination stock lock up to discourage other bidders and an immediate cash infusion in the company that did not have to wait for the closing.  Also in the first stage is an ESOP's purchase of 9 million plus shares at $28 a share, which is a toe-hold purchase at $4 less a share than the closing price.

The guts of the deal for Zell is in the second part of the transaction.  Tribune borrows a bucket of cash ($2.105B incremental term loan & $2.1B senior unsecured bridge and the remainder long-term loans), and lends it to the ESOP to buy up the (126,000,000 outstanding) shares of Tribune at $34/share. The new ESOP-owned Tribune would have roughly $13.4 billion in debt after the deal, up from about $5 billion before it.  Zell provides subordinated financing ($325 million) to Tribune to help make this happen, and receives a warrant to purchase 40.3% of the company (43,378,261 shares) for $500 million (plus he pays the $90 million to purchase the warrant). Zell also gets the benefit of an Investors Rights Contract that gives him two seats on the board and veto power over major corporate decisions.

The return for Zell is in the warrant.  It is deep in the money.  If the true value of the company is $8.2 billion (at $34/share) and Zell exercises the warrant for a $3.2 billion interest in Tribune he will pay around $615 million. If the value of the company falls to $13 a share, less than half, he still makes a small amount money on the option.  How does he get such a great deal???   Who takes the hit???  The employees.  If the company does well and is worth more than $34 a share, the employees get the benefit.  If the company does not do well and is worth only $13 a share, the employees lose dollar for dollar while Zell stills brakes even.  What are the company's prospects?  Miserable.  The newspapers are showing dramatic declines in revenue.  The employees have, in essence, bet that the Cubs and the company's real estate is undervalued and can be sold for a huge gain over carried values.  Why did the employees go for this?  They put their pension plan on the line, not their wage package. 

To make matters worse for the employees, the company's creditors can force bankruptcy even if the company continues to have positive earnings.  The creditors have demanded debt coverage conditions (nine times revenue)  that, if triggered, would accelerate principle repayments and would trigger bankruptcy.  So even if the company continues to stagger along making smaller and smaller profits, the new creditors can pull the plug on the deal and the employees could be the big losers.