Lee Enterprises & bankruptcy: What are the odds?

Sep 21, 2011 by

By Jim Gallagher, Treasurer United Media Guild

Lee Enterprises is struggling to refinance its debt, and that has implications for our jobs at the Post-Dispatch.   The Guild will vigorously defend  its members’ interest in this matter.  Members have been asking the Guild to explain what’s happening, and Shannon asked me to give it a try.

First, a caveat:  I’m the local’s treasurer and I’ve been a reporter at the St.Louis Post-Dispatch covering business for nearly a quarter century.  But I’m not a financial analyst, accountant, investment banker or a bankruptcy lawyer.  What follows is my take on the situation, but I may be wrong.

The first thing to remember is that we work for a profitable newspaper.  As stand-alone entities, Lee’s newspapers take in about 19 percent more money than it costs to produce them.  Lee doesn’t break out results by individual newspaper.  But the Post-Dispatch represents about a quarter of Lee’s revenue.  Lee would not have an operating cash flow margin of 22 percent  if the Post-Dispatch were losing money.

That has an important implication:  No matter what happens to Lee Enterprises, the Post-Dispatch will continue publishing.  Whoever owns it will need our labor, and the Guild will represent us.

Lee’s problem is $1 billion in debt.  The company owes more money than it would bring were it put up for sale.  That debt matures in April, and the company doesn’t have $1 billion to hand to its creditors. It must refinance that debt before the deadline, or Lee will be bankrupt.

Earlier this month, Lee announced that it had reached a refinancing agreement with more than 90 percent of the holders of the biggest portion of its debt.  This is good news for Lee, but the company still has significant hurdles to overcome in completing a refinancing.

For members who don’t want to read much further, here’s my amateur forecast:

The most likely scenario is that Lee will succeed in refinancing without a dip into bankruptcy court. That’s in everyone’s interest.

The second-most likely scenario is a “prepackaged” bankruptcy.  The idea is to walk into court with a plan in hand that the vast majority of creditors agree to.  They would then use the bankruptcy process to cram it down the throats of the holdouts.  Lee would be in and out of bankruptcy quickly.

The Guild’s contract with the PD would survive Scenario 1, refinancing, and it is highly likely that it would  survive Scenario 2, a prepackaged bankruptcy.  That would  preserve our pay, benefits and limited job security.

However, Lee’s interest burden would increase substantially in any refinancing. That means continued pressure on budgets and costs for years to come.  You and I are costs.  It could also place Lee at risk of failure should the economy face a substantial recession.  Basically, the company would remain a slave to its creditors.

Members may want to take this into consideration in planning their own careers.

The third scenario — least likely but still possible — is a drag-out, contested Chapter 11 bankruptcy.  In the end, the creditors would exchange some of the debt for ownership of the company.  Lee would emerge with less debt, and new owners.  That process would probably take many months.  I’ve seen bankruptcy cases go on for years when the sides get their backs up and the judge fails to crack the whip.

The company might attempt to shed our union contract and force union concessions as part of a contested Chapter  11. The Guild would defend the interests of its members in such a case, and money would be no object.   More on bankruptcy later.

Now, let’s examine the details:

Lee’s newspapers produce strong cash flow, meaning that Lee can afford to pay substantial interest on its debt.  That’s the key to its probable survival.

In fact, if Lee could keep the current interest rates on its debt, it could continue on for years, possibly forever.  It has paid down its debt by about $102 million over the past year.

But the debt matures in April and, given the risk profile of the company, no one would willingly lend it $1 billion at affordable interest.

Lee found that out the hard way in  May when it tried to refinance the debt by issuing junk bonds.  The market shut the door on the company, and the junk market was more amenable to iffy deals back then than it is today.  In May, the rating agency Moody’s  rated Lee a CAA – that’s deep in junk bond territory and indicates a significant risk of default.

So, Lee is going to have to persuade many of the existing creditors to extend their loans, and they’ll want something in return.

Lee’s $1 billion in debt comes in two big piles.  The biggest pile is $868 million, most of which Lee took on when it vastly overpaid for Pulitzer in 2005.  The creditors hold a first mortgage on the old Lee properties, excluding the Pulitzer newspapers.  For convenience, we’ll call this the Lee debt.

The second big pile is $142.5 million.  Lee inherited this debt when it bought Pulitzer.  It’s secured by a mortgage on the old Pulitzer properties, including the Post-Dispatch, minus Tucson.  We’ll call this the Pulitzer debt.

Note the difference in collateral:  Owners of the big debt have first dibs on the old Lee properties, while the Pulitzer creditors are secured by the old Pulitzer properties.  This will become important later on.

On Sept. 8, Lee said it had reached a refinancing deal with owners of at least 90 percent of the Lee debt.  The Lee debt would be divided into two parts.   Lee would pay 7.5 percent on $690 million of that debt and 15 percent on the remaining $175 million.

The difference is the level of collateral: the lower-interest debt provide a first mortgage on Lee, excluding the Pulitzer properties.  The 15 percent debt provides a second-lien only.

The combined interest burden would be 9 percent under the proposed deal.  Under current agreements, Lee is paying  4.25 percent on the Lee debt and 10.5 percent on the Pulitzer debt, for a combined rate of 5.1 percent.

So, even without knowing the Pulitzer results, it’s apparent that Lee’s interest burden will rise substantially.  It also will have to pay $40 million in the first year on the principal of the Lee debt, with higher payments in later years.

To sweeten the deal, owners of the high-interest debt also will receive a 13 percent ownership stake in Lee Enterprises.

For that, Lee would get a four-year breather, assuming it could make the payments.  The  lower-interest loan would mature in December 2015, and the high-interest loan in 2017 under the proposed deal.

Lee has yet to find a way to refinance the Pulitzer debt.  This is only my guess, but I suspect that the difficulty may lie in the collateral.  Back in 2005, when Lee bought Pulitzer, the Pulitzer properties were roughly half the value of the company, and I don’t think the situation has changed much.  So, the creditors with 15 percent of the debt have first claim on nearly half the company in a bankruptcy.

The Pulitzer creditors may feel that they’d come out of any bankruptcy with 100 cents on the dollar, or property worth 100 cents on the dollar.  On the other hand, the Lee creditors would have to take a substantial haircut in bankruptcy.  That may make the Pulitzer creditors harder to deal with than the Lee creditors.

On the other hand, that extra collateral might make a Pulitzer refinancing salable to another investor.  In a Bloomberg story, Lee’s CFO indicated that they may try their hand at the bond market to refinance the debt.  Junk investors who wouldn’t lend Lee $1 billion with weak collateral might agree to lend $144.5 million with stronger collateral.

We won’t know whether any deal will be affordable until we know the interest rate and repayment terms on any Pulitzer refinancing.  We’ve seen debt renegotiation deals that were so onerous that they simply delayed failure.  Working against Lee is the continued weakness in advertising, a reflection of the economy, and a secular shift of ad money to the Internet.

By the way, Lee’s agreement with the Lee creditors envisions that the company will wrap up a new Pulitzer deal by January, absent a bankruptcy filing.

If the company can refinance the Pulitzer debt, it has a very good chance of avoiding bankruptcy.  Companies can generally force a deal through outside of bankruptcy court if 95 percent of each class of creditors agree.  Lee says it has more than 90 percent of the Lee debt creditors aboard.

If it can’t get 95 percent approval, Lee says it will do a prepackaged bankruptcy.  It will walk into court with a plan that nearly all creditors agree upon.

Once in bankruptcy,  a vote of only two thirds of each creditor class is required to approve a deal.  With a Pulitzer deal in hand, and with 90 percent of other creditors aboard, my guess is that the remaining creditors would cave rather than endure the expense of a bankruptcy.

But I’m no expert in this.

There’s another wrinkle here.  Some of Lee’s creditors have changed since the company last had to renegotiate its debt, in 2009. Back then, it was a conservative group of banks and insurance companies.  The Wall Street Journal in May reported that some of the company’s debt has since been bought at a discount by speculators.  The speculators were betting that they’d be able to negotiate an ownership stake in Lee as Lee faced default.

Three of the sharks mentioned in that story seem to have signed on to the renegotiated deal: Goldman Sachs, Franklin Templeton and Monarch Master Funding.  The others — Alden Capital and Alden Global Capital and Marblegate Capital — aren’t mentioned in Lee’s filings describing the deal.

Now, let’s discuss bankruptcy and labor’s position in a bankruptcy case.

No business executive in his right mind wants to take a company through bankruptcy.   The mere rumor of a bankruptcy makes business harder to do: Vendors demand cash up front; other partners become reluctant to sign contracts.  Lawyers’  fees in bankruptcy are astronomical.  Creditors receive no interest while the bankruptcy process grinds on, and the damage to the business may reduce creditors’ recovery.

If we get into a contested Chapter 11 rather than a prepack, it’s very possible that current shareholders would be wiped out.  Lee’s board, representing shareholders, would try to avoid this.  Lee’s board members are shareholders, and so are its senior managers.

So, both Lee and its creditors will try to work something out short of bankruptcy.

A collective bargaining agreement remains in effect during bankruptcy unless the judge throws it out.  Companies can try to shed a union contact, but they must follow a procedure.  First, they must try to bargain concessions with the union.  If that fails, they can ask the judge to throw the contract out.  There would be a hearing to present evidence.

The judge can toss the contract if the judge finds that the concessions the company requested are “necessary” to the company’s emergence from bankruptcy, and that they treat “all parties fairly and equitably.”  That said, judges tend to favor companies over unions in these situations.

If a contract was thrown out, the company could implement working conditions no different than those in its last bargaining proposal.  The union then would be free to take economic action against the company, including a strike among other things.

Lee has not approached the Guild about renegotiating  the contract.

We believe that Lee would leave our contract alone in a prepackaged case.  The idea in a prepack is to get in and out of bankruptcy quickly, thus limiting the damage.  Going after our contract would cause delay and raise the possibility of a labor war – not something they need while trying to re-establish confidence from financial markets and customers.

Besides, our membership is small in the context of Lee, and we’ve already given concessions.  It’s difficult to argue that hurting our members is necessary to rescue a company making a good operating profit.

We simply can’t guess at how Lee might view our contract in a contested Chapter 11. If past practice was followed, our parent union in Washington would engage a good bankruptcy law firm to represent our local.  This would be at the parent union’s expense.  Our local is confident that past practice will be followed.

In a bankruptcy, we would stand in the position of a creditor – our contract requires them to pay us.  In past newspaper bankruptcies, the Guild has been quite successful in getting its representative onto the “creditors committee.”  This committee gets an inside view of the bankrupt company’s finances and negotiates a settlement with the company.  We would also represent our interests separately before the court.

In any case, the Guild will strenuously defend the interests of its members.  Your union has begun preliminary preparations for the possibility of a bankruptcy filing. Cost will be no object where members’ welfare is at stake.

 

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