By Steven Levingston and Terence O'Hara
Washington Post Staff Writers
Tuesday, March 14, 2006

McClatchy Co., a family-controlled chain of mid-size newspapers, agreed yesterday to pay a bargain price of $4.5 billion for Knight Ridder Inc., a move that will dismantle the nation's second-largest newspaper company.

After a four-month auction, McClatchy emerged as the only newspaper company willing to bid on Knight Ridder, publisher of the Philadelphia Inquirer, the San Jose Mercury News, the Miami Herald and 29 other dailies. Knight Ridder, one of the best-known names in the news business, wound up on the auction block after a prolonged stock price decline sparked complaints from a major shareholder. McClatchy, a Sacramento-based publisher with 12 dailies and 17 community newspapers, has bucked many of the industry's trends in recent years with a focus on small and mid-size newspapers in growing markets.

In announcing the deal, McClatchy said it would immediately seek to sell 12 of the largest Knight Ridder daily newspapers in slower-growing areas, including the Inquirer and the Mercury News. The proposed sales sent jitters through newsrooms already familiar with rounds of layoffs.

Other newspaper chains recently sold fetched higher prices than Knight Ridder, measured as a multiple of the annual cash they generate after paying any debts. But analysts said the low price reflected a lack of confidence in Knight Ridder's management more than a statement about the health of the newspaper business. While the industry grapples with declining circulation, job cuts and stagnant advertising revenue, newspapers generally continue to enjoy fat, if flat, profit margins, analysts said.

"I don't think the gloom and doom is at all justified," newspaper analyst John C. Morton said. "Five years from now, this will look like a great deal for McClatchy."

Wall Street was not initially convinced. McClatchy's stock price slid nearly 3 percent yesterday. Gary Pruitt, chairman and chief executive of McClatchy, said in an interview that he was unconcerned about the stock-price movement, noting that when McClatchy bought the News & Observer in Raleigh, N.C., in 1995 and the Minneapolis Star Tribune in 1998, its shares flagged. "When we announced those deals, the market went down, and in the next year, we roared back," he said. "I'll take long-term gain over short-term decline."

The proposal to sell was made last year after Private Capital Management Inc., a major Knight Ridder shareholder, expressed concern about the company's fortunes and its management. Private Capital Management is also a major shareholder of McClatchy, but Pruitt said it supports the deal. "I don't anticipate a problem there," he said. "Of course, we'll have to deliver and we understand that."

Under the deal, Tony Ridder, chairman and chief executive of Knight Ridder, stands to collect $67 million on about 1 million shares of company stock he owns, including options. If he is terminated after the merger, he'll also get three times his annual salary and bonus, or more than $5 million.

Still up in the air are the 12 metropolitan dailies that don't fit with McClatchy's strategy. Larry Grimes, president of W.B. Grimes & Co., a Gaithersburg investment-banking firm that focuses on the media industry, predicted that McClatchy may get higher prices, as a multiple of cash flow, for these newspapers than it paid for all of Knight Ridder's portfolio.

Knight Ridder sold for 9.5 times free cash flow, making the purchase price, on a cash-flow basis, cheaper than any other major newspaper deal of the past five years. Recent deals have priced newspapers at 12 to 14 times their free cash flow.

"It may be the case here that Knight Ridder's parts are more valuable than the sum of the parts," Grimes said.

Besides San Jose and the morning and evening newspapers in Philadelphia, McClatchy plans to sell dailies in Akron, Ohio; Aberdeen, S.D.; Grand Forks, N.D.; Fort Wayne, Ind.; Contra Costa County in California; Monterey, Calif.; Wilkes-Barre, Pa., and Duluth, Minn. McClatchy will also sell, for antitrust reasons, the St. Paul Pioneer Press, which competes directly with McClatchy's Minneapolis Star Tribune.

Gannett Co. of McLean, the country's biggest newspaper publisher, as well as Colorado's MediaNews Group Inc. are the most likely buyers for those newspapers, analysts and investment bankers said. Less likely buyers could be private equity funds, including a group led by Boston funds Bain Capital LLC and Thomas H. Lee Partners LP, which submitted a losing bid for Knight Ridder.

A Gannett spokesman declined to comment and MediaNews Group did not return phone calls. A Bain spokesman also declined to comment.

Another interested buyer is Yucaipa Cos., a buyout fund run by Los Angeles billionaire Ron Burkle that has made similar purchases of grocery store chains and other types of businesses. Newspaper workers represented by the Newspaper Guild-Communications Workers of America have teamed up with Yucaipa to make a bid on eight of the union-shop newspapers McClatchy is selling.

"We certainly have a keen and stated interest in eight properties and [will] take a look at all 12," said Ian Laird of Duff & Phelps Securities, which is advising Yucaipa and the union on a potential bid.

By choosing to keep some of the Knight Ridder newspapers and jettisoning others, McClatchy set off a fresh wave of anxiety in some newsrooms across the country and relief in others. Knight Ridder informed the newspapers of their potential sales only after it had issued its early morning news release yesterday, provoking surprise and anger in some newsrooms. Knight Ridder sent corporate officers to all of the newspapers it was divesting to hold meetings with the staff.

At the Akron Beacon Journal, a newspaper now on the block, reporters and editors began their day contemplating their futures, said the paper's editor, Debra Adams Simmons. "Today is a sad day in the life of the Akron Beacon Journal because the Akron Beacon is the original Knight newspaper," she said.

Mike Antonucci, a writer on popular culture for the San Jose Mercury News, another newspaper to be sold, said some staff members believed the daily, once a star performer in the Knight Ridder stable, would fall into strong journalistic hands while others were doubtful. "There's a sensation of, 'How in the world did we go from being such a robust economic force in Knight Ridder to a paper that McClatchy is immediately going to divest,' " he said.

The mood was different at the Charlotte Observer, one of the newspapers in a growth market that McClatchy will keep. Rick Thames, the Observer's editor, said a McClatchy executive reassured the newsroom of the company's commitment to quality journalism. "There's a great sense of relief in the newsroom today," Thames said. "We've all read about the potential suitors and if you were to go and look of the company most compatible with the values of Knight Ridder you'd go to McClatchy. People felt this was best possible outcome, at least for Charlotte."

Though many newspapers are struggling to maintain circulation, most are enjoying gains in overall readership measured by people who go to the print and online editions. Clark Gilbert, an assistant professor at Harvard Business School, believes the Internet presents vast opportunities for newspapers to tap into new avenues of advertising.

"I'd be the first to say the newspaper industry is under attack -- the core print business is threatened," he said. "But at the same time, the newspaper industry is poised on brink for a growth opportunity."