Tribune Should Have Seen Bad News Coming
One of the things they teach in journalism school is that you have to do your homework if you expect your story to come out right. That's a lesson that the nation's third-largest newspaper firm, Tribune Co., could profit from.
Last week, Tribune took a $1 billion hit and saw its stock fall to a four-year low because it lost an income-tax case that it didn't analyze properly when it bought Times Mirror Co. five years ago. Times Mirror, owner of the Los Angeles Times, Baltimore Sun and Long Island's Newsday, was famous for its ever-more-aggressive tax-avoidance schemes, and the tax court loss should have come as no surprise to anyone who'd followed the case.
And there's more. Tribune may soon have to take a sizeable hit to its earnings because it discovered years after purchasing Times Mirror that Newsday's circulation numbers were vastly inflated.
Before we proceed, you should know that Tribune's tax loss is my gain. When Times Mirror did the 1998 deals that now haunt Tribune, they smelled so bad that I wrote a column predicting the Internal Revenue Service would try to knock them out. More disclosure: I worked at Newsday when Times Mirror owned it, and wrote several columns there (and more at Newsweek) criticizing tax games played by Times Mirror and its controlling Chandler family.
To give you the short version, in 1998, Times Mirror claimed it had disposed of its Bender legal-publishing and Mosby health-publishing businesses in a tax-free way. Times Mirror got the use of $1.8 billion of cash, while the companies that forked over the cash got Bender and Mosby.
Times Mirror told the IRS that these were tax-free corporate reorganizations, but told Wall Street it had made more than $1 billion on the transactions. Just in case it had to ultimately cut the IRS a check, Times Mirror set up a $180 million tax reserve. But this was just an accounting entry that reduced the reported gain on the transaction -- there was no cash set aside. After Tribune bought Times Mirror, it began adding interest to the reserve, which is now about $250 million.
The reserve offsets some of the damage to Tribune's earnings statement, but doesn't make it any easier for Tribune to come up with $1 billion of cash money to pay federal and state taxes and years of interest. Times Mirror's shareholders are long gone, and now it's Tribune that has to pay.
Tribune told me that it did plenty of checking before the deal closed. It said it got an analysis from its own tax experts, in addition to relying on opinions from Times Mirror's outside lawyers. As for Newsday's circulation numbers, Tribune says, it interviewed the paper's managers, relying on circulation statements from the paper's publisher that had been verified by the Audit Bureau of Circulations.
Nevertheless, Tribune didn't come up with the right answers. I suspect the company was so eager to conclude the biggest newspaper purchase in history that it donned rose-colored glasses, figuring that the $8.3 billion deal would work out.
Tribune chief executive Dennis FitzSimons said in a conference call last week that the tax issue was "fully considered" when Tribune bought Times Mirror. "The initial suggestion by outside attorneys was this was a difficult case in tax court," he said, adding that, "We became more optimistic as the tax court proceeding went forward." He said Tribune expects to win on appeal.
However, Lehman Brothers tax expert Robert Willens has his doubts. "The judge based her decision on narrow technical grounds, obviously because she wanted to diminish Tribune's chance of a successful appeal," he said.
Then there's Newsday. A lawsuit filed on behalf of a disgruntled ex-employee in 2004 led to the revelation that Newsday had for years inflated its daily and Sunday circulation by about 98,000 papers, an overstatement of about 15 percent.
Because advertising rates are based on circulation, a Newsday with fewer subscribers is clearly less valuable than the paper Tribune thought it bought. And accounting rules require companies to write down assets whose value has been permanently impaired.
When I asked if Tribune plans to take such a charge, a spokesman said in an e-mail, "No." The explanation? "In its core markets of (New York's) Nassau, Suffolk and Queens counties, Newsday has some of the highest penetration levels of any newspaper in the country. It is a very valuable part of our newspaper group." But that doesn't address the question of whether Newsday is now worth less than the value at which it's carried on Tribune's books. We'll see what the company's outside auditors have to say.
The Times Mirror acquisition was widely praised at the time, but Tribune shareholders are paying for it now. So are Tribune employees, whom the company will squeeze harder than ever to keep its profit margins up.
The bottom line: Do your homework very carefully when you're shelling out billions of dollars. As the tax ruling reminds us, corporate character matters. When you lie down with dogs, you get up with fleas.
Sloan is Newsweek's Wall Street editor. His e-mail email@example.com.