Sam Zell's Deal from Hell

The turnaround maven should have seen the problems ahead in the newspaper industry. His blind side may cost Tribune Co. its very life

by Emily Thornton, Michael Arndt and Ronald Grover

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Zell, at his office in Chicago, expected only single-digit revenue declines Len Irish

The Los Angeles Times building, which is for sale Reed Saxon/AP Photo

Lipinski, the Chicago Tribune's editor, left during the latest round of job cuts E. Jason Wambsgans/Chicago Tribune/MCT

Hiller, the paper's publisher, left during the latest round of job cuts

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"It's the deal from hell," says Sam Zell, never one to mince words. "And it will continue to be the deal from hell until we turn it around." Zell is talking, of course, about his $8.5 billion purchase of Tribune Co. in December 2007, a transaction that's shaping up to be one of the most disastrous the media world has ever seen. Zell is a real estate tycoon, and his plush office reflects his decades of success: Giant even by CEO standards, it brims with paintings and statues and looks out on a private garden above the Chicago River. One item that stands out among the clutter is an upside-down map of the world, a prop presumably intended to convince visitors that they're in the presence of an iconoclast. Zell, 66 and fiercely devoted to blue jeans, has burnished that image carefully over the years.

Were it not for the Tribune debacle, there would be no reason to question Zell's brilliance as a businessman. He describes himself, immodestly, as a "grave dancer" who buys properties at fire-sale prices and resells them for a profit. His biggest coup came in late 2006, when he orchestrated a bidding war for his real estate trust, Equity Office Properties. EOP eventually went to Blackstone Group (BX) for $39 billion, in what was then the biggest leveraged buyout in history. Weeks later he thumbed his nose at the dealmaking world with a satirical song, posted on the Web, that predicted the credit crunch soon to sweep the globe. It seemed he could do no wrong.

Then Zell bought Tribune and stumbled into a calamity of plunging sales and rising costs. He had expected only single-digit declines in newspaper ad revenue. Turns out he was off by a factor of two or three. "If current trends in advertising are permanent," he says, "we have a really serious problem."

He should have seen it coming. Tribune comprises eight newspapers, including the Chicago Tribune, Los Angeles Times, and Baltimore Sun, which together generate 76% of the company's revenues; more than 50 Web sites; 25 television stations, including superstation WGN America; a 31% share of the Food Network; the Chicago Cubs baseball team; and real estate and other holdings. Tribune had been slumping for years, courting buyers for more than 18 months before Zell ambled onto the scene in early 2007. Against that bleak backdrop, he loaded the already strapped company with more than $8 billion in fresh debt to pay for the deal, leveraging Tribune to within an inch of its life.

The payments, $1.4 billion by June 2009 alone, have proven crippling. Tribune's junk-level credit rating has fallen since Zell took over, and some of its bonds are fetching 35¢ on the dollar. Zell has been forced to cut costs far more than he anticipated. It may not be enough to avoid a default. "The colossal debt Zell piled on is forcing Tribune to take more and more desperate actions," says media consultant Alan D. Mutter.

On paper, Zell's plan looked great. He would quickly sell the Chicago Cubs, Wrigley Field, and a 25% stake in Comcast SportsNet Chicago to pay off debt, and focus on making Tribune's newspapers zippier and more ad-friendly. The strategy was based on an innovative financing scheme that used Tribune's tax-exempt employee stock ownership plan as the vehicle through which to fund the transaction. That would allow Tribune to save big on taxes: It paid $245 million annually on average over the past three years. Zell's financing arrangement required the billionaire to pony up just $315 million of his own cash to wrest control of the company, with a warrant to buy 40% more for as little as $500 million. What's more, Zell turned Tribune into a so-called S corporation, a designation usually reserved for small businesses. That could allow Tribune to sell assets in 10 years without having to pay capital-gains taxes.

Zell doesn't need Tribune to thrive; merely keeping it alive could earn him an astronomical return when it comes time to sell. That has always been the goal. "When we first undertook this project, we viewed Tribune as 60 ways to get lucky," Zell says. But amid the credit crunch, the quick asset sales haven't panned out. With the newspaper business deteriorating, his seemingly clever strategy has thrown the whole Tribune enterprise into jeopardy.

The question for the company's 18,500 employees is whether Sam Zell is the guy to save it. Although he owned a radio company called Jacor Communications that was acquired by Clear Channel Communications (CCU) in 1999 and spends his weekends in Malibu, Zell is no media mogul and hasn't mixed well in that world thus far. Early on, he told Tribune executives he would "cut off their ties" if he caught them looking so formal at future meetings. Prone to off-color jokes and profanity, he's more like "that guy you see on the Mexican beer commercial," says Jeff Peterson, owner of Geoffrey's Malibu, a restaurant frequented by Zell and his wife, Helen. "He just seems like a down-to-earth guy's guy."