Behind McClatchy layoffs -- a mountain of debt

by Mark Fitzgerald, Editor and Publisher

The 1,400 McClatchy Co. employees targeted for layoffs can blame their job loss on the faltering newspaper economy in general, their company's specific concentration of papers in California and Florida where the housing collapse has been most acute -- and a forward-looking strategy once hailed as a way to avoid precisely this kind of pain.

When McClatchy borrowed heavily to buy Knight Ridder Inc. in 2006, it was following a strategy that Wall Street and other industry observers said made perfect sense for newspaper chains: grow top-line revenue through acquisitions funded by cheap credit. McClatchy added its own spin -- again to favorable reviews -- by quickly reducing much of the debt with the sales of a dozen dailies that didn't fit its company profile of serving "fast-growing" markets.

But, as the June E&P cover story -- titled "Til Debt Do Us Part" -- makes clear, everything went wrong for McClatchy after the applause faded.

The housing crunch depressed revenues, especially at such newly acquired properties such as The Miami Herald, and older California papers, such as its flagship Sacramento Bee. More than one-third of its total advertising revenue comes from papers in Florida and California.

McClatchy was quickly forced to scramble, and within a year was selling the Minneapolis Star Tribune at a loss, raising capital and creating a tax loss.

Wall Street's disenchantment with newspapers has also hit McClatchy particularly hard, with its stock collapsing more than 70% in the past year.

After taking $3 billion in non-cash goodwill impairment charges related mostly to those papers in 2007, the $4.6 billion Knight Ridder deal looks considerably less valuable -- but $2.5 billion in debt is not going away.

As the E&P story notes, high debt prevents reinvestment by forcing companies to devote more free cashflow to interest and principal payments.

"The interest on debt is a fixed charge that typically doesn't change with the prospects of the business," bond analyst Mike Simonton of Fitch Ratings told E&P. "So it's there what ever the financial results."

JP Morgan estimates McClatchy's current debt burden at 4.4 times debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization), a ratio it says it "modestly" above the average for the newspaper sector companies it tracks. Other analysts, however, estimate McClatchy's ratio is closer to 6x. By comparison, the E&P cover story reported a range of debt-to-EBITDA ratios from 1.6x for The New York Times Co. on the lower range to 6.3x for the acquisitive community paper publisher GateHouse Media.

But as the E&P story also notes, there is among analysts a real reservoir of goodwill for McClatchy.

For instance, even as Moody's Investors Services was nudging McClatchy's corporate debt rating to the edge of junk bond territory, and warning that it likely would downgrade its credit further, the ratings firm had kind words for the publisher.

"Good reader demographics and the depth and quality of reporting in local markets drive demand from advertisers, which along with the company's strong cost management deliver above average industry margins that support the cash flow," wrote senior analyst John E. Puchalla and Corporate Finance Group Managing Director Alexandra S. Parker.

If any company has a shot of emerging in good shape from the debt crisis, it's McClatchy, analysts say.

"McClatchy management is well aware of the situation they are in, and they are committed to bringing debt down to a manageable level," said Benchmark Capital Managing Director Edward Atorino. managing director, Benchmark Capital.

In a conference call with analysts after reporting first-quarter results, McClatchy CFO Pat Talamantes emphasized the company's efforts to pay down debt.

Talamantes noted McClatchy paid down $76 million in the first quarter alone, and said it would use a $185 million cash tax refund from the sale of the Minneapolis Star Tribune to further reduce debt.

"We continue to expect our debt balance at the end of 2008 to be approximately $2 billion," Talamantes said.

article originally published at http://www.editorandpublisher.com/eandp/news/article_display.jsp?vnu_content_id=....

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