PATE IN PURSUIT

One of Zell’s key assets is his ability to surround himself with bright people who are in the business of knowing everything they can about all kinds of diverse industries, including cargo containers, fertilizer, wineries, and real estate. Some of them even know a thing or two about the publishing business.

As soon as Zell spied blood in the water at Tribune, he put William Pate, one of his top lieutenants, in the lead search boat. Though Pate is not well known outside the walls of Equity Group Investments, his role is pivotal, as he runs Equity’s non-real estate investment portfolio as chief investment officer.

What Zell lacked in publishing smarts, Pate made up for in spades. It just so happened that the roots of his family tree were buried deep in the business. His father started the Madill Record, a weekly paper in the tiny town of Madill, Oklahoma, and Bill Pate is now the third generation of the clan. Two generations of Pates are memorialized in the Oklahoma Press Hall of Fame in Oklahoma City. But tragedy forced the family to sell the Record to a family friend, after Pate’s older brother was killed in a small-plane crash in 1990.

Bill Pate remembered many long hours of his youth working the printing press, and he saw firsthand how important the local newspaper was to the community. Unlike Zell, Pate said he had “an appreciation for journalism and what journalists do.”¹

Having served him since 1994, Pate also had some keen insight into Zell’s core investment philosophies—do your homework to uncover distressed opportunities, manage them to health, and sell them off for a bundle. A Harvard grad with magna cum laude honors, Pate settled in as a financial analyst at a New York investment bank before joining private equity giant Blackstone Group. There he first met Zell. Immediately the two clicked, their philosophies aligned, and he signed on.

Over thirteen years, Pate rose in the ranks to become the top investment officer of Zell’s non-real estate investments. Among the companies he helped nurse to health were Covanta Holding Corp., a New Jersey-based trash-to-energy concern, whose sales grew from $531 million to nearly $1.3 billion in just three years.

Early on, Pate, like Zell, well understood the two largest impediments to making Tribune work—the rivalry between Chicago-based Tribune Co. and its largest property, the Los Angeles Times, and the need to change the company’s culture. Pate also acknowledged that the Tribune buy was not without its perils and pitfalls. “This is a risky deal,” Pate said. “If we stumble on this investment, this will mark Sam’s career.”²

ANY BIDDERS? ANYONE?

Through the fall of 2006, Tribune bidders were few and far between, and those expressing any interest were lukewarm on the company. Several well-heeled private equity players took a peek, and the trophy Los Angeles Times attracted a few local business magnates who deigned to kick the tires, but serious offers failed to materialize.

Part of the problem was timing. The newspaper advertising market was hitting the skids, and Tribune’s financials were tracking on a steeper freefall trajectory than the company’s top brass had expected. That minor point set potential bidders on edge.

Tribune’s special committee had set a deadline of January 17 for initial bids. Three months later, by March 31, it would declare a winner. By the January deadline, only three major bidding groups had emerged.

First up was a rather dynamic duo comprising two of the West Coast’s toughest and most staunchly Democratic businessmen. Supermarket magnate Ronald Burkle was the son of a Los Angeles grocery store manager. He was a self-made man, having run major grocery chains—Dominick’s, Fred Meyer, Food 4 Less, and Ralph’s. Flamboyant and often dubbed the “Billionaire Playboy,” Burkle had a net worth of around $2.5 billion and owned an interest in the National Hockey League’s Pittsburgh Penguins.

Burkle was no stranger to deal making. His Yucaipa Companies, a private equity investment firm named after his California home town, had invested in more than thirty companies and banked on none other than Bill Clinton as an advisor. In 1999, Burkle sold Fred Meyer to Kroger for $13.5 billion, pocketing a tidy $1.8 billion in the process.

He also was no stranger to politics and the occasional scandal. Burkle often flexed his political muscle by throwing Democratic fund-raisers at his sprawling Beverly Hills mansion, known as Greenacres. In 2006, he became the subject of a scandal when he accused New York Post gossip columnist Jared Paul Stern of trying to extort money in exchange for good press. The columnist was never charged but sued Burkle and Bill and Hillary Rodham Clinton for defamation. That suit was tossed out by a judge in June 2008.

The second partner in this odd-couple arrangement was octogenarian Eli Broad. Another self-made entrepreneur, Broad is most noted as the founder of Kaufman & Broad Home Corp. (later shortened to the simpler KB Home), a national home-building firm and the largest builder in California. He also took a turn in the financial services sector as the founder of SunAmerica, a multi-billion-dollar financial services firm specializing in retirement planning.

Broad was much wealthier than Burkle, with an estimated net worth of $6.5 billion, placing him among the wealthiest men in Los Angeles. Broad is a noted civic booster, often contributing to causes that are close to his heart. He was responsible for much of the redevelopment of downtown Los Angeles and has donated some $600 million to the Broad Institute, of the Massachusetts Institute of Technology and Harvard University, for genetic research.

In an unlikely arrangement, these two Los Angeles billionaires met up through a mutual business acquaintance. Their primary interest was in keeping Tribune’s crown jewel, the L.A. Times, under local ownership. In November 2006, Burkle and Broad launched a $34 a share bid for the company and began burning up the air miles flying back and forth to Chicago. But as soon as early January, in the wake of weaker than projected financials at Tribune, they had restructured their offer to pay out a $27 per share dividend to shareholders.

Under the Burkle-Broad deal, current shareholders would retain a stake in the new company’s stock and thus would reap any gains the duo might manage over time. On the flip side, it would also heap $10.7 billion of new debt on the company, and they did not present a concrete plan for paying off that debt through existing revenue sources.

The second bidder was—surprise!—the Chandler family trusts. On the deadline date of January 17, through attorney Stinehart, they made their first—and, it turned out, only—formal bid to take over Tribune. In essence, they proposed taking control only of Tribune’s newspapers, while spinning off the broadcast properties into a separate entity called Tribune Broadcasting. Doing so, they reasoned, would yield a one-time shareholder dividend of $18 to $20 a share.

A third bid group was led by Washington, D.C.-based private investment firm Carlyle Group, which counts among its advisors former presidents George H. W. Bush and Bill Clinton, as well as Louis Gerstner, the former head of IBM. While several private equity firms reviewed Tribune’s books, Carlyle was the last of the serious bidders. According to reports at the time, Carlyle saw the most value in Tribune’s broadcast properties and made a bid of $4 billion.

Early on, movie mogul David Geffen had also expressed interest in owning the L.A. Times. Geffen is the “G” in Dreamworks SKG, a movie production partnership formed by Steven Spielberg, Jeffrey Katzenberg, and Geffen in 1994. He also was a well-known L.A. local, having founded Asylum Records there in 1970 and Geffen Records in 1980.

Geffen’s bid for the Times? A cool $2 billion. At that point, little did Geffen know that he and the would-be owner of Tribune, Zell, owned homes only minutes apart along the beach in tony Malibu, north of Los Angeles.

Tribune’s special committee rejected all three overtures as inadequate. This left Tribune and the Chandlers in the rather unenviable position of needing a new suitor. On February 7, the same day the Equity Office board of directors was voting on the monumental takeover deal with Blackstone, Pate whispered something in Zell’s ear that got his attention—the Tribune bids had stalled. They quickly approached the Tribune board with an offer, the terms of which were kept under lock and key. Regardless, it fell on deaf ears.

By early March, Zell was back knocking on Tribune’s door with a new bid of $33 a share, along with a uniquely structured employee stock-ownership program, or ESOP. Zell knew that this structure—though fraught with complexity and decidedly unconventional—would appeal to the Chandler family’s well-known proclivity for tax avoidance. He had remembered the unique tactic from two years earlier, when he tried it with the purchase of his Covanta Holding Corp. “We came to what we thought was a risk conclusion, and the conclusion was there was a lot of future in the newspaper business and we certainly didn’t think it was going down an elevator shaft,” said Zell.³

In essence, Zell’s plan was to convert Tribune into a Subchapter S corporation owned entirely by a new employee stock-ownership plan. The tax advantages of this arrangement were enormous. As an S corporation, Tribune’s taxes would be paid by its largest shareholder, the tax-exempt ESOP. So theoretically Tribune’s operating profit would be untaxed, freeing up some $300 million in cash for other corporate uses, based on the previous year’s results, anyway. Also, gains on the sale of corporate assets would go untaxed if held for at least ten years after the conversion to S corporation status, meaning 2018 or later.

Despite its ingenuity and obvious tax aversion, Zell’s bid was met with a cold reception by Tribune’s special committee. It appeared almost too complex, and the committee was loath to put the company’s employee retirement plan at risk. Essentially the committee was telling Zell they “just didn’t get it.”

Still, beggars can’t be choosers, and time was running out to decide the company’s fate, now that the Saturday deadline of March 31 was looming ever so closer. Finally, after six months of tepid response, a funny thing happened on the way to the closing—an auction broke out. Several name-brand corporate chieftains, including GE’s former chairman and CEO Jack Welch, News Corp. chairman Rupert Murdoch, and a host of others rattled their sabers and threatened to enter the fray.

At the same time, Tribune’s special committee was increasingly skeptical of their own management’s ability to implement a sound restructuring plan. So it took it upon itself to reignite discussions with Zell on March 15. For his part, Zell agreed to raise his bid to over $33 a share. It’s interesting that Tribune demanded only a measly $25 million breakup fee, a pittance considering the enormity of the deal’s potential value.

Zell felt confident enough in his staying power to meet any and all bidders, and with only a week to go until deadline day, he looked on track to seal the deal. At the same time, and unbeknownst to anyone outside their inner circles, Burkle and Broad held private talks with Zell about partnering, making love rather than war, as it were. But Zell declined the offer, saying he would resume talks after he won Tribune, at which point he would entertain selling off pieces of the company.

Feeling spurned, Burkle and Broad decided not to go away quietly into the balmy Los Angeles night. In a letter to Tribune’s special committee, they formally objected to what they viewed as favoritism for Zell’s plan. Instead, they were ready to initiate their own version of a copycat ESOP package if they were given more time to digest Tribune’s financials.

On Thursday March 29, the Burkle-Broad team made good on their word, issuing a revised last-ditch bid amounting to $34 a share, which included a one-time investment of $500 million and the by then obligatory ESOP (proving that there really is no such thing as a new idea). Zell felt that he still had the upper hand, because the special committee had already embraced his pitch and spent countless hours vetting his proposal. Surely they would be less inclined to review a similar offer.

On the fateful decision-crunch weekend, Zell was so confident of his advantage that he decided to stick to his somewhat routine habit of flying out to Los Angeles every other weekend. He valued the chance to relax, and certainly his $14 million John Lautner- designed weekend home, overlooking a rocky point in Malibu, provided a change in scenery. Throughout his many years of travel, it was the one place that Zell could relax, but his peace and quiet on this particular weekend would be broken by incessant interruptions. He was staying tuned to the Tribune proceedings via constant phone updates from Pate. Though physically far from the action, this was a huge deal even by his own standards, and he was totally engaged in the battle.

Just as Zell was heading out of town on Friday, the Tribune board played a bit of a gambit. Faced with two similar bids, they decided to test Zell’s resolve and ask him to raise his bid yet again. Zell was now feeling the kind of pressure he normally inflicts on bidders for his own companies. He quickly countered with another offer on Saturday, deliberately testing Tribune’s patience by coming in just under the Burkle-Broad bid of $34 a share. On Sunday morning, the Tribune board rejected Zell’s offer, asking him to raise it to match Burkle-Broad’s. And the board gave him only twelve hours to do so.

When given the news, Zell was incensed and ready to walk away from the bargaining table. He felt he was being played, and yet he still wanted Tribune. To a true corporate turnaround artist, it represented the ultimate test. It was no longer only about the money; it was about the prize itself and what it would mean if he could turn Tribune’s fortunes around. His quick analysis of the numbers on a higher bid showed a razor-thin margin of error. He gave himself the green light to proceed.

Reluctantly, late on Sunday, Zell raised his equity commitment from $225 million to $315 million, or the equivalent of $34 a share, equaling the Burkle-Broad bid. In a late-night session at Tribune Tower, the board met at 10:30 P.M. and approved Zell’s bid in less than thirty minutes. Pate immediately relayed the good news to Zell via phone. In Los Angeles, it was still only 9:00 P.M., but Zell opted for a quiet celebration with his wife. He had won the prize, but now came the hard part—could he find enough polish to make the trophy shine?

ESOP’S FABLES

Monday, April 2, 2007, dawned cool and crisp over both Chicago and Los Angeles. For Burkle and Broad, the deal was over. If they wanted a piece of Tribune, they would have to deal with Zell. For Zell, the work to close the deal was just getting started. It would take another eight months to complete the complex transaction in December, over a year after Tribune was originally put on the auction block.

The structure of Zell’s winning bid was so complicated that it required a three-page press release from Tribune just to explain it all. There was no question, however, that it was a sweet deal for Zell. After all, he had only $315 million of his own skin in the game versus $8.2 billion in new debt. That translates to an equity stake of less than 4 percent. Once again, the grave dancer had danced his jig over an ailing industry. But this time, as he would soon discover, he had to contend with a uniquely pessimistic group of employees, which would make a turnaround of the troubled media company all the more complicated.

First, it would take many months just to explain the ESOP structure to Tribuners. According to Corey Rosen, executive director of the National Center for Employee Ownership, companies controlled through an ESOP structure generally perform better than non-ESOP firms. And though Rosen found nothing “subversive” in Tribune’s ESOP, it did seem a poor fit for the economic times. “The vast majority of ESOPs are set up in companies that are successful at the time they are set up and become even more so down the road. This is unusual in that respect, that you had a company that was in more difficulty at the time it was set up,” explained Rosen.⁴

One misperception was that if employees essentially “owned” the company, then they would be in control. Not so. No matter how you sliced it, Zell was both pilot and crew. “When we researched the companies where employees did have more control rights, we didn’t find that the decisions that they made at the corporate level were significantly different,” said Rosen. “So there’s this perception that if the employees are on the board that they would run things differently. Well, the economic circumstances probably are more important in dictating what kinds of decisions get made. Changes at that level are not the cure-all that some people think they are. In this case it would probably be symbolically important. It’s doubtful it would change anything in terms of how the company was run. But it might create greater transparency and a sense that people at that level are willing to listen to employee concerns.”

On structural grounds, at least, Rosen essentially affirmed Zell’s control over the ESOP, stating, “Contrary to what most of the stories say, the employees didn’t invest their own money in this transaction. They got a stake in the company and their benefit plans would end up being in theory slightly to much better if this thing worked out even reasonably well. Should they get something when they haven’t put any equity in directly, which Zell did, in terms of governance rights? That’s a tough question. Most ESOPs don’t.”

But Rosen saw tremendous upside in changing the company’s former management style so that employees have greater influence on decisions about how their jobs are done. “That’s what really makes ESOPs more or less effective, and it’s a lot harder to do that than to stick an employee or two on the board of directors and call it good. That really is the challenge that the Tribune or any ESOP company faces. As far as I know, the Tribune hasn’t taken the steps to do that kind of comprehensive day-to-day involvement, and I think had they done that, they would be better off. Our research shows that makes the difference.”

TRYING TIMES

It took more than eight months to close the Tribune deal, but why? Some pundits speculated that Zell got cold feet and tried to back out in the summer after Tribune’s financial health slid closer and closer to the intensive-care ward. Revenue from classified and real estate advertising was dropping like a rock in early 2007 and showed little sign of ending its downward spiral as the months passed. Tribune revenues continued to nose-dive through the summer and into the fall of 2007. There seemed no end to the sour results.

Plus, there was the little matter of the bankers. They were getting nervous. Four of America’s largest financial institutions—JPMorgan Chase & Co., Merrill Lynch, Citigroup, and Bank of America Corp.—backed Zell’s Tribune deal but were beginning to fear that the huge debt load would ultimately doom the company. Collectively, during the delay in closing, the banks would see some $500 million in losses on the loans and high-yield bonds needed to fund the transaction. But once again, Zell’s reputation won the day. “We believe in this transaction because we believe in Sam Zell,” said James B. Lee Jr., JPMorgan’s vice chairman.⁵

Another stumbling block to the sale involved Zell’s all-time favorite partner of choice, the U.S. government. Tribune asked the Federal Communications Commission to waive its cross-ownership rule forbidding any company from owning both a television station and a daily newspaper in the same major market. Tribune had been granted temporary waivers for cross-ownership in New York, Los Angeles, Hartford, and South Florida. In Chicago, where Tribune owned both WGN-TV and the Chicago Tribune, the FCC had issued a permanent waiver of the rules.

By mid-October, Zell and his team were getting antsy. They needed approval soon to close the Tribune deal before year’s end. That approval came on November 30 in a sharply divided FCC vote.

The day of the closing, as agreed, Tribune CEO Denis FitzSimons announced his resignation, effective January 1, 2008. According to SEC filings, he also walked away with a tidy $38 million golden parachute in combined severance and stock after twenty-five years with the company.

Inevitably, questions immediately arose about Zell’s focus and engagement with his new media empire. After all, he had a number of enterprises to run. “I think that’s the 4,812th time in the last twenty years that someone has posed that exact question to me,” Zell responded when questioned. “Each time I look at them and say, I don’t know the answer to your question other than history says that Sam pays enough attention to everything Sam does, and Sam surrounds himself with a lot of very high-quality people with a lot of authority, and I don’t think you’ll find very many examples of any businesses Sam has touched that can claim that we ignored them or claim they didn’t get enough of Sam’s time. I think the same will be true here.”

Zell installed himself as CEO but promised not to retain the mantle forever, saying he preferred to be an owner who could make decisions and cut through the notorious Tribune red tape. “I think the definition of CEO as you have historically known it has changed since yesterday (deal closing). Maybe I’m asking the $64,000 question, if the company even needs a CEO. We’re going to find out. The answer is, I’m sure not going to be a conventional CEO. At the same time, I am one hundred percent accessible, and I’m going to do whatever it takes to achieve the objectives. Do I have enough time? Yep. Do I have enough ambition? Yep. Do I have enough determination? Yep. So you don’t have to worry about that one.⁶

Zell would quickly find that the layers of dissent among Tribune’s employees ran deeper than he anticipated, and the complexity of the situation would drain every last ounce of his management skills.