Philly's full-court press
By: CHRIS NOLTER
The Deal Magazine
May 14, 2010

The auction of The Philadelphia Inquirer and the Philadelphia Daily News in late April was hardly just another routine sale of yet another bankrupt company. Instead, it featured high drama, controversy and personalities well beyond the relatively small-dollar bids and the strictly local nature of the business. In fact, it provided something of a thrill a minute. In the frenzied week before the auction began, prominent Philadelphians led by housing tycoon Bruce Toll yanked an offer that was supposed to have provided the starting point for the bidding. Pennsylvania's irrepressible governor, and former Philadelphia mayor, Ed Rendell reportedly approached Yucaipa Cos. LLC's Ron Burkle about joining the local buyout group. While Burkle stayed away, the family of billionaire Ron Perelman emerged to head that group.

By the time bidding for Philadelphia Newspapers LLC began, the atmosphere was highly charged. Management had run a controversial advertising campaign portraying the sale as a battle between local saviors who would preserve the venerable dailies and an opposing group of indifferent financial institutions. No less than three courts heard litigation about auction rules, and the 3rd U.S. Circuit Court of Appeals issued a decision that barred lenders from using hundreds of millions of dollars of secured claims as currency in the auction. The ruling required the banks to instead put up cash for the assets and may affect future auctions in other bankruptcies. The final contest played out for 30 hours in a midtown New York law office, with roughly a dozen rounds of bidding.

While sales of other marquee papers such as The Boston Globe, Chicago Sun-Times and The San Diego Union-­Tribune fizzled or produced negligible sale prices, the Philadelphia auction proved to be lively and competitive. There were three participants, although the Perelman-led local investors and the coalition of pre-bankruptcy lenders dominated. "The lenders were determined to get the papers and recoup their losses," says J. Scott Victor of SSG Capital Advisors LLC, a court-appointed auction monitor. "The local investor group was equally determined and passionate about keeping local ownership."

The stakes were high. The bidders for the Philadelphia papers had individual motivations that shaped their perception of value. The banks were trying to salvage more than $300 million in bad loans and stand to recoup their cash or take equity in the company. The local investors were trying to salvage Philadelphia institutions, although they certainly expected a return on their investment.  And there was widespread anxiety about the fate of the two papers in Philadelphia. The two newspapers, the broadsheet Inquirer and the tabloid Daily News, are deeply rooted institutions in the U.S.'s fourth-largest media market. Their loss would deal a blow to Philadelphia's status as a major city in its own right rather than a satellite of its prominent neighbor to the north. As one observer says tartly, "People in Philadelphia don't want to have to read The New York Times."

The story begins with the 2006 leveraged buyout of Philadelphia Newspapers. When McClatchy Co. acquired the Inquirer and the Daily News in its purchase of Knight Ridder Inc., the company immediately said it would flip the papers. Toll and local ad man Brian Tierney put together a Philadelphia group including the Carpenters Pension and Annuity Fund of Philadelphia and Vicinity to buy the dailies for $562 million. Citizens Bank of Pennsylvania and a group of lenders provided a $295 million loan and other financing. While the industry's problems were evident at the time of the LBO, prominent investors including Toll and real estate magnate Sam Zell, who took Tribune Co. private, evinced a contrarian confidence that daily papers were valuable brands that could withstand the challenges of the Internet.

They were wrong. Misjudging the potential damage wreaked by the Web and an advertising crunch like many other publishers, Philadelphia Newspapers sought Chapter 11 protection in February 2009.  From the beginning of the reorganization, the debtor rankled its lenders. Philadelphia Newspapers abandoned talks with the lending group over Chapter 11 financing on the eve of bankruptcy, opting for debtor-in-possession financing from local firms. The parties sued each other for much of the bankruptcy before the debtor and lenders agreed to a financing package. Tierney accused one bank representative of illegally recording loan negotiations. Fitting the pattern of the overall bankruptcy, Tierney's charges went to court, but no final ruling has been made.

The debtor also launched a "Keep It Local" advertising campaign that touted the virtues of ownership by Philadelphians and set up its own Facebook and Twitter accounts. The lenders called the campaign "a high-stakes game of chicken" in pleadings, but it may have created an anti-­lender bias in the city and created the impression, fairly or not, that the papers' owners might not treat the lenders fairly in an auction. To ensure there was no favoritism, the debtor, the unsecured creditors' committee and a group of pre-­bankruptcy lenders asked the bankruptcy court to appoint two auction monitors. "It provided us with a layer of insulation," says the debtor's Philadelphia-based co-counsel Larry McMichael of Dilworth ­Paxson LLP of the unusual step.

Indeed, the auction rules could not have been more thoroughly scrutinized. Three courts heard arguments about the sale procedures, particularly the lenders' right to use $318 million in secured claims in lieu of cash at the auction through a so-called credit bid. The litigation delayed the sale for roughly half a year. In the debtor's Philadelphia bankruptcy case, Judge Stephen Raslavich threw out the credit-bid prohibition in an October ruling. The debtor won on appeal to the U.S. District Court for the Eastern District of Pennsylvania, however. The lenders asked the U.S. Court of Appeals for the 3rd Circuit to consider the issue. The 3rd Circuit heard arguments in December but did not rule until March, delaying the sale while a three-judge panel considered the dispute.

In a typical Chapter 11 auction, as outlined under Section 363 of the Bankruptcy Code, lenders have the right to credit-bid, or to use their secured claims as currency. The logic is that the lenders can prevent a bid that they believe undervalues their collateral. The debtors had argued that because their auction was incorporated into a reorganization plan rather than a discrete 363 auction, the Code technically did not mandate that they accept a credit bid. The 3rd Circuit agreed and required the lenders to bid cash. From one perspective, the ruling would seem to have little bearing on the outcome. The lenders held the most secured debt in Philadelphia Newspapers, after all, and would be the recipients of any cash they provided the estate. They would essentially be paying themselves.

However, the ruling presented a substantial challenge for the lenders. The group's members included very different institutions, from commercial banks to hedge funds, that provide loans or acquire distressed debt. Ponying up cash for an auction, with no set price tag, was not exactly in the DNA of some of them. As SSG's Victor says, "Management was betting that once the lenders' right to credit-bid was denied, the lenders could not or would not come up with a cash bid."  In this case, management underestimated what it increasingly viewed as its enemies.

As a starting point for the auction, Toll's local group put forward a stalking-horse bid, which, if nothing else, demonstrated how much value had been lost since the buyout. The offer included $35 million in new equity, a $17 million letter of credit that would make more cash available and the company's headquarters at 400 North Broad Street, valued at some $30 million.

Days before qualifying bids were due, the stalking-horse became a walking horse. The local investors withdrew their bid, saying they would make another offer by the April 23 bid deadline. The group did not explain the move, but after it withdrew the bid, Toll significantly reduced his stake. With the uncertainty about the bidding group, people involved with the case said the Democrat Rendell began to woo Burkle, a longtime Democratic contributor and close friend of Bill Clinton. Burkle, who has a reputation for labor-friendly buyouts, has looked at newspapers before through his Yucaipa investment vehicle and is currently involved in an activist play at bookseller Barnes & Noble Inc.

Perelman and his nongenarian father, Raymond Perelman, a lifelong Philadelphian, instead stepped in to lead the local group. Raymond Perelman committed to a $12.6 million equity investment, and Ron Perelman's MacAndrews & Forbes Holdings Inc. agreed to $4.4 million in equity plus a $10 million loan. Their outlay would grow once bidding began. Meanwhile, the lenders had vowed to bid with cash when the 3rd Circuit denied their right to submit a credit bid. Fred Hodara of Akin Gump Strauss Hauer & Feld LLP, counsel to the lenders, says that a group of the lenders came together to guarantee the cash needed for the bid. Other secured lenders were able to opt for cash or equity in the publisher as part of the reorganization.

Hodara says the cash backstop was crucial to the lenders' ability to bid effectively, and suggests that other secured creditors may follow the model in future auctions. "That made it possible for lenders to comply with the 3rd Circuit's requirement that the bid be in actual cash," he says. The lending group and its counsel declined to name the firms that backstopped the bid. Sources involved in the auction suggest that hedge fund Alden Global Management provided much of that liquidity, though the New York firm declines to comment.

Alden was not among the original lenders that financed the Philadelphia Newspapers LBO. It's not clear how much debt the firm acquired, although the debtor has pushed the court to force lenders to detail their individual holdings. Alden placed another significant bet on traditional media in April, joining with Emmis Communications Corp. founder Jeff Smulyan to take the radio group private in a $440 million leveraged buyout. Other lenders, such as Citizens Bank of Pennsylvania, the agent for the banks, and Angelo, Gordon & Co., had a much higher profile during the case.

The third bidder, Stern Partners Inc., was the only true outsider in the auction. The Vancouver, British Columbia, firm owns the Winnipeg Free Press and other papers throughout Canada. Though it played a less active role in the auction, Stern was hardly a casual participant. The firm spent weeks conducting due diligence and submitted a bid for Philadelphia Newspapers that included a substantial amount of equity. With the absence of a stalking horse, bidders had no minimum threshold to exceed. To qualify, bidders needed to make a $3 million deposit and demonstrate that they could provide $25 million in exit financing. The trio of the Toll and Perelman local group, the lender group and Stern did so.

April 27 was auction day. The debtor and its advisers gathered at 7 a.m. at the Manhattan offices of the publisher's co-counsel Proskauer Rose LLP on Broadway near Times Square to discuss the offers. The bidders, the unsecured creditors' committee, and a mob of lawyers and bankers arrived at 11 a.m. At its peak, the gathering may have included 100 people. Tierney and a group of 50 to 60 would remain throughout the night. Neither Bruce Toll nor the Perelmans were physically present. Both Perelmans were in constant phone contact until early in the morning, however. McAndrews & Forbes CEO Barry Schwartz was present, as was another member of the local group, David Haas, an heir to the Rohm & Haas chemical fortune. One of the monitors, Arlin Adams of Schnader Harrison Segal & Lewis LLP, a former judge for the 3rd Circuit, resigned before the auction because of previous ties to Raymond Perelman. SSG Capital's Victor remained the sole monitor.

Greg Milmoe of Skadden, Arps, Slate, Meagher & Flom LLP, who has done work for MacAndrews & Forbes, served as the lead attorney for the local bidding group. Hodara and Abid Qureshi of Akin Gump Strauss Hauer & Feld, along with financial adviser Flip Huffard of Blackstone Group LP, represented the lenders. Bernstein, Shur, Sawyer & Nelson PA attorney Robert Keach represented Stern Partners.

For roughly 16 hours, the parties negotiated terms to make the bids more comparable on an apples-to-apples basis. For Stern, equity in the reorganized company accounted for a substantial part of its bid. The local investors and the lenders were mostly bidding cash. The local investors' bid included a subordinated note, but they agreed to make the debt senior.

A clause in the lenders' bid then attracted scrutiny. The group required that if they prevailed, the debtor would have to terminate its employees, with the provision that the lenders would rehire more than 50% of them. Some participants argued that the clause is typical among asset purchase agreements and that Stern's initial bid contained similar terms.

But debtor's co-counsel McMichael of Dilworth Paxson raised concerns that the proposal could have triggered a strike and argues that the debtor would have had to apply a deduction to the lenders' bid to account for the possibility of a labor stoppage. "Look, we can value equity," McMichael says. "Strike risk is very difficult to quantify."

After arguments back and forth, the lenders agreed to replace the clause. The group conditioned its bid on reaching an acceptable agreement with the unions.  At midnight the parties were asked for revised bids. Over the next two hours, each changed their offer. Patience was wearing thin. "From our standpoint, waiting 14 to 16 hours to start was frustrating," says Stern counsel Keach. "I'm not sure there were material advances in understanding the bids that couldn't have been figured out by starting the auction."

After the midnight revisions, the local investors' and lenders' bids were each valued at $65 million to $70 million, mostly in cash. Stern's offer came in at $85 million to $90 million and contained equity, preferred equity and some cash. A committee consisting of McMichael, Mark Thomas of Proskauer Rose, restructuring adviser Joseph Bondi of Alvarez & Marsal LLC and investment banker Marshall Sonenshine of Sonenshine Partners evaluated bids.

Bidding officially started shortly before 4 a.m. The local investors and the lenders were "neck and neck," in McMichael's description. The debtor's advisers did not name one of the bids superior.  Auction participants say lenders put forward a $70 million offer, which the local group raised to $75 million. The lenders then raised their offer to $85 million.

The bidding proceeded for about a dozen rounds, increasing in increments of $5 million to $10 million but sometimes in smaller amounts.  Stern was asked three times whether it would increase its bid but did not. Keach says it became evident that the bidding was "a little overheated" and that the offers exceeded what Stern deemed fair value.

The parties broke for about two hours in the morning, and the bidding continued until 3 p.m. The local investors' final bid came to $95 million in cash plus the $30 million headquarters. McMichael notes that $65 million of the cash came from the Perelmans, undermining the argument that local investors were all insiders with ties to management.

The lenders offered $105 million in their own cash and the building (both local investors and lenders included $4 million in legal retainers and other cash already at the company that would be transferred to the estate). The lenders can opt to receive a share of the cash or equity in the newspapers. While a credit bid would have produced the same result, ownership by the lenders, the auction did produce liquidity for some creditors.

Shortly after 4 p.m., Tierney wearily conceded that the banks had won. The outgoing publisher acknowledged the new owners' commitment to the papers and its employees and promised a smooth transition. After 14 months of litigation, the final chapter of the wrangling took some 29 hours.

What makes financial sense here? It's difficult to apply traditional valuation metrics to the bids. The debtor projects about $12.6 million in 2011 Ebitda, which would put the cash portion of the price at 7 or 8 times. By comparison, Gannett Co. and New York Times Co. trade at multiples of about 6 times Ebitda. The lenders are protecting collateral with a $318 million face value. The local bidders have their own reasons for valuing the newspapers above public market rates.

Buyout comps present their own challenges. The Inquirer and the Daily News have average weekday circulations of about 356,000, according to the Audit Bureau of Circulations. The Chicago Sun-Times, with a weekday circulation of nearly 270,000, sold in a tepid bankruptcy auction. The New York Times was unable to field an adequate bid for The Boston Globe, with its weekday circulation of over 230,000, with offers reportedly totaling about $35 million. Platinum Equity LLC acquired The San Diego Union-Tribune, with a weekday circulation of about 250,000, for an unnamed sum.

Still, the lenders put up the highest bid, although they still need confirmation by the bankruptcy court and have to reach labor agreements with the unions at the two papers. "We believed both the goals of the lenders obtaining significant recovery on their loans and of the papers surviving and thriving could be and would be achieved," says Andrew Kassner of Drinker Biddle & Reath LLP, counsel to Citizens Bank of Pennsylvania. "We believe that's exactly what's going to happen here."

It is obviously too soon to tell if that prediction will hold. One thing is certain, though. This drama isn't quite over. McMichael argues the case was not as acrimonious as it has been portrayed. Still, there are pending suits over the alleged improper recordings and the disclosure of the secured lenders' holdings. And Philly still has to wait and wonder about the fate of its two local newspapers.

Sonenshine Partners is a leading independent investment bank focused on providing integrated strategic, financial and corporate advisory services.  The firm was founded in 2000 and is headquartered in New York City.