Posted by: Jon Fine on April 3, 2007
UPDATE 4/6: Oooh—thesis below turns out to be wrong. Or at least incomplete. For a correction, an explanation, a mea culpa, and a couple of additional questions, read this post.
But the tax issues that made the deal unlikely in the first place, persist, the New York Times’ Laura Holson and Sharon Waxman point out. Key paragraph:
Media analysts said that the way Mr. Zell’s deal is structured, it would make little sense financially to sell The Times soon, because the tax bill would eat up about 40 percent of the sale price. They said a proposal by Mr. Geffen, the entertainment executive, to pay $2 billion for the paper would probably be insufficient for that reason.
Some more detail (empahsis added) on this from the Chicago Tribune:
The new company structure depends on the creation of what’s known as an S Corp. ESOP, which is essentially a sole-proprietorship encased within an ESOP trust. The attractiveness of the structure, according to one source, is that it eliminates most of the corporate taxes Tribune would otherwise pay, which boosts the cash flow and allows the company to support a heavier debt load. If the structure had been in place in 2006, for instance, Tribune would have been able to avoid paying $348 million in taxes.
For the first 10 years of an S Corp. ESOP, the trade-off is that the company has to pay capital-gains taxes on asset sales. That could explain why Zell has said he has no intention of breaking up the company, since most of the company’s long-held assets would generate big capital gains. After 10 years, however, the company can sell assets without paying capital gains. So, at that point, the glue holding the company together might not be so strong.
If a publicly-traded Tribune couldn’t rationalize selling the L.A. Times for $1.2 billion after taxes, there ain’t no way an incredibly leveraged Sam Zell-owned Tribune will be able to. It’s going to need every penny of cash flow to make its debt payments.
(Disclosure: When Tribune did not sell the Los Angeles Times to David Geffen, I won a bet with Los Angeles-based colleague, who now owes me an extremely caloric meal at Roscoe’s.)