Myths and Realities of
Newspaper Acquisition Costs
The Myths and Realities of
Newspaper Acquisition Costs:
Fiduciary Responsibilities,
Fungibility of Assets, Winners' Penalties & Excess Cash "Problems"
Submitted to the Media Management & Economics Division,
AEJMC Convention,
New Orleans, La., Aug. 4-7, 1999
By Dane S. Claussen
Until May 8, 1999:
Dane S. Claussen, M.S., M.B.A., Teaching Assistant & Doctoral Candidate
Henry W. Grady College of Journalism & Mass Communication
The University of Georgia, PO Box 3028, Athens, GA 30612-1028
[log in to unmask]; 706-208-1198 (H); 706-542-6190 (O)
From May 9, 1999 to Aug. 15, 1999:
Dane S. Claussen, Ph.D., M.B.A.
President & Principal, American Newspaper Consultants, Ltd.
PO Box 3028, Athens, GA 30612-1028; 800-554-3091 (H/O)
Beginning Aug. 16, 1999:
Dane S. Claussen, Ph.D., M.B.A.
Assistant Professor, Department of Communication and Mass Media
Southwest Missouri State University, 901 S. National Ave., Springfield, MO 65804
417-836-5218 (O)
When McClatchy Newspapers announced in late 1997 that it would buy Cowles Media
Company, whose primary holding was the Minneapolis Star Tribune, McClatchy
Newspapers' stock took a beating. It is typical for an acquiring company's
publicly-held stock to drop, whether because the acquirer is borrowing heavily,
diluting earnings per share by issuing more stock, diversifying outside core
markets, spending cash reserves potentially needed for inevitable economic
downturns, growing at the "wrong time" of an economic cycle, or paying too much
for the acquisition. In fact, when The New York Times Co. bought Affiliated
Publications (The Boston Globe), its stock also dropped, as did Knight Ridder's
when it bought four former Capital Cities/ABC papers from Disney. What was
unusual in the McClatchy-Cowles deal was how much McClatchy stock dropped, how
quickly, and how vocal Wall Street analysts were about the deal: Knight-Ridder's
acquisition caused its stock to drop 7% in seven days, and New York Times Co.'s
acquisition prompted its stock to drop 16% over a month, but McClatchy's stock
dropped 17% in two days.
McClatchy Newspapers made defensive statements to the press (for example, see
Gremillion, 1998), and John Morton, a well-paid newspaper management consultant
popular with many chains, devoted his column in the January-February 1998
American Journalism Review to justifying McClatchy's action. His column was
headlined, "Expensive, Yes, But Well Worth It." (Apparently still feeling
defensive, Morton's column in the July-August 1998 AJR used the subject of
high-priced acquisitions as his starting place to affirmatively answer the
question, "Can High Profits and High Quality Coexist?")
Well, was the Cowles purchase worth it? This paper, in addition to answering
this question from a perspective that is surely more objective than Morton's
(who seems to have been a consultant and/or expert witness for almost every
large newspaper company), takes the opportunity of the McClatchy-Cowles deal to
more generally address the question of newspaper acquisition prices, referring
to recent economic and financial research.
Overview of the Issues in this Paper
The three major "stories" in the U.S. newspaper industry during the 20th
century surely have been increased competition from other media; a substantial
decrease in household penetration and stagnation of total circulation numbers;
and the consolidation of the industry through both shutdowns and the growth of
commonly-owned "groups" or "chains." Other phenomena that have been arguably as
important have included the professionalization of journalism, implementation of
new technology and the decline of newspaper unions, and the "corporatization" of
the management and organization of both individual newspapers and newspaper
chains/groups.
It is important to differentiate between the growth of corporations consisting
of numerous newspapers and the corporatization of individual newspapers to
introduce this paper. Individual newspapers' corporatization has received nearly
encyclopedic treatment in the book, The Menace of the Corporate Newspaper: Fact
or Fiction? by David Pearce Demers (Iowa State University Press, 1996). But
Demers discusses newspaper groups often only incidentally to his topic of
"corporate newspapers," and it must be noted that trends, issues and
cause-effect relationships within an individual newspaper as an organization do
not necessarily apply to group of newspapers as an organization, or vice versa.
For the purposes of this paper, the most obvious case of this phenomenon, to
which this paper returns below, concerns economies of scale. Demers cites a
paper by Rosse, Dertouzos, Robinson and Wildman (1978), and a book by Dertouzos
and Thorpe (1985) while discussing economies of scale enjoyed by larger
individual newspapers (Demers, p. 131). But Demers does not cite the Dertouzos
and Thorpe book, nor a Dertouzos article (1982) or Dertouzos and Trautman (1990)
article, when and where these researchers concluded that newspaper chains as
organizations do not enjoy further economies of scale above and beyond those
obtained at individual large newspapers.1
This paper addresses yet another aspect of newspaper chains, frequently
mentioned in trade and professional publications but not by Demers and seldom by
other scholars or the trade press2: are the prices paid by newspaper chains to
acquire additional properties, such as in the McClatchy-Cowles deal, too high,
too low, or about right, and does it or should it matter? It should be noted
here that this question is of more than ephemeral interest: U.S. corporate
boards of directors and executives are legally and ethically bound -- their
"fiduciary duty" -- to prudently manage their corporation to the maximum benefit
of stockholders; doing so means, among other responsibilities, making the right
acquisitions at the right time at the right price.
In other words, despite the "default" rationalization that an acquired company
is worth whatever someone is willing to pay for it, and despite prices of high
technology and some other stocks during the last few years that bear no
relationship (or an inverse one!) to companies' earnings and/or liquidation
value, the fact remains that widely-accepted, long-used formula exist to value
any company that is an acquisition target. And directors and executives who fail
to fulfill their "fiduciary duty" run the risk of being sued by stockholders for
breach of fiduciary duty; this was the rationale for stockholders' suit against
Disney when Michael Eisner gave Michael Ovitz a "golden parachute" worth as much
as $100 million after Ovitz had worked for Disney for only about a year and
accomplished almost nothing. The only reason why more such suits are not filed
is that individual stockholders have little to gain and much to lose (time and
legal costs) from filing such suits; unlike the 1980s "corporate raiders" who
took over allegedly mismanaged companies, average stockholders either hold their
stock and hope the company's error is corrected, or simply sell their stock,
hope to still make a profit on the sale, and invest their money elsewhere. An
excellent example of the latter case recently occurred at A.H. Belo Corp., owner
of The Dallas Morning News, the Providence Journal Bulletin, and a flock of
television stations; in February 1997, Belo paid $1.5 billion for the Providence
newspapers and nine television stations, and by late October 1998, its stock had
dropped 50% from its 52-week high (to about $17 from about $34) because of
declines in newspaper classified advertising revenue and the parent
corporation's staggering debt load -- a direct result, of course, of the 1997
acquisition (Media Bites, 1998).
Modern Period of Newspaper Acquisitions and Its Historical Context
Newspaper chains have existed for about 125 years -- the first one was
assembled by E.W. Scripps and his siblings, and they were followed by William
Randolph Hearst, Joseph Pulitzer, Frank Munsey, Frank Gannett and many others.
Many scholars/observers trace the modern frenzy of newspaper mergers and
acquisitions to the Newspaper Preservation Act of 1970, and certainly that law
has played a key role in several mostly large cities. But for this paper a
better date may be 1976 -- when Advance Publications, Inc., headed by S.I.
Newhouse, bought Booth Newspapers, Inc. Today that deal may appear to be nothing
more than a historical footnote of sorts, but it was the first major newspaper
acquisition whose sheer size prompted widespread comment: Newhouse paid $260
million for a group of "out-state" Michigan newspapers and Parade magazine, a
bigger deal than when Knight merged with Ridder.
It wasn't only the size of acquisition transactions that caused comment, but
also the number of acquisitions -- which became a dizzying parade by the early
1980s. Ghiglione (1984) attempted to put the times into perspective with his
book of case studies of acquired newspapers, and he leaned over backward to be
fair to group owners by picking equal numbers of instances in which
post-acquisition papers improved or deteriorated. In his introduction, he even
wrote (p. xii),
"It's virtually impossible to generalize -- good guys or bad? -- about groups'
im- pact. If you believe the chains are destroying American journalism, read how
Mc- Clatchy Newspapers brought back from death's door (and lost $2 million a
year while doing it) the Anchorage Daily News. And review the impact of
Knight-Rid- der on the Centre Daily Times: tighter writing, better layouts, more
training, and tougher editorials, including political endorsements where before
there were none"
But still, there was no little doubt where Ghiglione's sympathies lay:
"At the current rate, there will be no single, family-owned dailies by the year
2000. And, as groups buy groups, the American press of tomorrow may begin to
look like the Canadian press of today -- two groups, Thomson and Southam,
control about half the nation's circulation, and ten groups control 80
percent... (p. xi).
And Ghiglione called a "more common pattern" the phenomenon of acquiring chains
that were blatantly greedy and unconcerned about local communities:
"First, many groups set high profit goals for their papers -- as much as 40
percent before taxes -- and these goals, in turn, push the companies to operate
tightly budgeted, often miserly, news operations.
"Second, the people running the papers reflect the bottom-line mentality of
the ownership. Some groups replace the old-fashioned editor-owners, who often
wrote their own columns and editorials, with business-side people -- in some
cases, M.B.A.s who worry only about M.B.O.s.
"Third, while virtually every group (except perhaps Freedom) leaves the
editorial-page policies to the local management, more than one de-emphasizes
the importance of a paper's voice by chopping the editorial-page budget and
staff. The editor responsible for editorial writing at the Transcript, North
Adams, Massachu- setts, was fired (and not replaced) within two weeks of
Ingersoll's purchases."
"Fourth, the paper's relationship to the community, as one might expect of
absentee ownership, is more distant. This isn't necessarily all bad (one person
fa- miliar with the Centre Daily Times said that, prior to purchase by
Knight-Ridder, it 'had sort of become slaves of community organizations'). But
some group-owned papers participate less actively in the life of their
communities and make less effort financially to support local projects" (p.
12).
Ironically, as Ghiglione's book tried to make sense of newspaper industry M&As
in 1984, chains' spending spree was just warming up. For in the 1980s, Gannett
Co. alone paid $300 million for the Louisville Courier-Journal, $600 million for
the Detroit News, and $400 million more for the Des Moines Register.
Self-described "S.O.B." Al Neuharth, then chairman of Gannett Co., when asked
how he could justify to stockholders losing $1 billion on USA TODAY's start-up,
said that he would have paid $1 billion to buy a paper like USA TODAY if such a
paper had already existed. Nearly every medium- to large-sized newspaper group
made acquisitions during the 1980s.
And just when observers thought, in the early 1990s, that newspaper M&A
activity had to slow down -- on the theory that most family-owned newspapers
that were ever going to sell to a chain already had done so -- chains were sold
to other chains (such as Stauffer to Morris Communications, or Multimedia to
Gannett Co., or some Disney papers to Knight-Ridder and others to Lee
Enterprises, or Thomson papers to numerous buyers) and chains stepped up the
swapping of newspapers to form advertising sales-oriented "clusters"
(Fitzgerald, 1997). One observer called 1997 the "year of the deal" in the U.S.
newspaper industry, as 162 dailies changed hands in transactions valued at a
total of $6.23 billion. Not surprisingly, prices generally -- not just those of
plums such as Cowles, Affiliated or the former Capital Cities/ABC papers --
continued at jaw-dropping levels. The New York Times Co. paid about $1 billion
for The Boston Globe, and then Knight Ridder paid $1.65 billion to Disney for
four former Capital Cities/ABC papers (Kansas City Star, Fort Worth
Star-Telegram and two others). And in February 1998, Newspaper Media LLC paid
$95 million for the Quincy, Mass., Patriot Ledger -- a newspaper that all
analysts agreed was worth no more than $70-75 million. (The new owner, with the
generic name, immediately cut the newspaper's operating budget by 20%.)
Why Newspaper Chains Can and Should Make Acquisitions
Newspaper groups have numerous motivations to make acquisitions, and
independent publishers have numerous motivations to sell their newspapers to
someone and even at least two major motivations to sell to chains. But what this
paper hopes to suggest is that chain executives have several motivations to pay
"too much" for their acquisitions, and conversely have few binding reasons not
to pay "too much."
Tax Laws
U.S. tax laws have favored mergers and acquisitions for decades, and newspaper
groups have taken advantage of tax laws, anti-trust laws, banking laws, stock
market rules and other forces in the economy as much as other corporations.
(Adams [1995] found that merger and acquisition activity in the newspaper
industry has generally been closely related to M&A activity in the rest of the
U.S. economy throughout the 20th century.) Dertouzos and Thorpe identified five
tax-related motivations for chains to make acqusitions, all five separate from
the motivations that sellers may have for selling: capital gains taxes (the
bigger the difference is between taxes on unearned income [such as dividends]
and capital gains [and it is much smaller than it was in 1982], the more
incentive corporations had to pay small dividends now and use cash for
acquisitions that would make the stock's price go up -- resulting instead in
capital gains taxes later); accuulated earnings provisions (the Interal Revenue
Service forces corporations eventually to do something with accumulating cash);
tax carry-forward provisions (but of course newspaper chains rarely acquire
newspapers that have been losing money); depreciation (historically, the IRS has
allowed acquiring firms to depreciate assets that already have been depreciated
by the acquired company); and tax-free stock exchanges (an independent owner
could swap stock in his firm with stock in the chain's firm, and pay no capital
gains taxes on the sale until he sold the chain's stock). While all five of
these tax-based acquisition motivations may be powerful, and one might think
they were embedded in U.S. tax codes for clearly justifiable economic reasons,
Dertouzos and Thorpe speculated that they do not result in any new economic
activity, and concluded, "If these tax laws do not truly stimulate any real
investment activity and merely encourage mergers, they deserve review" (p. 72).
(Of course U.S. tax laws have been revised in hundreds of ways since 1982, but
one certainly could not argue that that mergers for the sake of mergers have
been discouraged or that mergers and acquisitions create any more fresh economic
activity than they ever did.)
Optimal Use of Capital
A second major reason for media corporations to make acquisitions is that even
rigorous financial analysis may show that making acquisitions will increase the
company's short-term and/or long-term profits more than would investing in
current operations. And to use built up cash from profits to buy stock on the
open market and/or to pay higher dividends would be something of an admission
that management is unable to come up with more strategic uses for the money.
(And we address executives' personal motivations for acquisitions at this
paper's conclusion.) Newspaper executives also are implying, by retaining cash
rather than boosting dividends, that boosting dividends will not increase
interest in the stock on the open market to a sufficient degree to be the cause,
by itself, of the stock's price going up; interestingly, no media company has
yet adopted the model of many public utility stocks, that is, decide that
additional acquisitions are ill-advised; reinvest some profits in current
operations; and pay the rest in high-level, steady dividends.
Non-Fungible Assets
A newspaper chain's executives, compelled by the non-fungibility of some
assets, may believe they have little or no alternative but to make an
acquisition when one presents itself. For example, The Boston Globe had been in
Taylor family hands for more than a century, and when it became known to New
York Times Co. executives that it was for sale, surely Times Co. executives
realized that there is only one Boston Globe, that once sold it was unlikely to
be for sale ever again, and thus a Times-Globe deal literally was a
"now-or-never" situation. Thus, even if the Times Co. paid too much for the
Globe (and this paper does not address that question), Times Co. executives are
unlikely to admit it.
Synergy
Synergy, a concept related to but different from economies of scale, is
sometimes given as a reason why corporations make acquisitions. It is, for
example, a "buzzword" at Chicago-based Tribune Co., as it develops closer
working relationships between its newspapers, television stations and websites,
and at The Gwinnett (Ga.) Daily Post in its partnership with Genesis Cable
Communications (Georgia newspaper, 1997). Exactly how well synergy is working at
Tribune Co. -- primarily because of possible long-term negative effects on its
newspapers -- and at other media firms is not yet unknown or unclear. In fact,
management experts agree that although synergy has occurred at some corporations
and is possible at others, synergy was oversold in corporate America and that it
has failed in most instances (Conniff, 1994; Landro, 1995; Geneen, 1997;
LaFranco, 1997; Sirower, 1998).
Why Newspaper Chains Should Not Make Acquisitions
There are several reasons why corporations do not and/or should not make even
friendly acquisitions when the opportunity presents itself.
Newspaper Chains Do Not Enjoy Additional Economies of Scale
Dertouzos and Thorpe (1982) found, "Economies of scale resulting from
conglomeration appear to be nonexistent" (p. 22), on both the input and demand
sides; in other words, chain newspapers on average are neither more highly
demanded by readers nor by advertisers, nor do they enjoy lower fixed or
marginal costs. Chain newspapers did not have lower newsprint costs (p. 35), or
lower wage and salary costs (p. 35), nor were chain newspapers more likely to
adopt new technology (p. 50)3, than were independently owned newspapers.
Needless to say, Dertouzos and Thorpe's findings, supported by both empirical
evidence and econometric analysis, flies in the face of both a common assumption
made in capitalist economies (and in the U.S. newspaper industry) and earlier
literature. For example, Herbert Lee Williams' classic newspaper management
textbook, Newspaper Organization and Management, 5th Ed. (1978), listed seven
advantages to chain ownership of newspapers, and five of them were economies of
scale. But clearly, in both the newspaper industry and in the economy as a whole
(Miniter, 1998), economies of scale -- like synergy -- have been widely
overestimated.
Newspaper Company Prices are Sometimes Considered Too High
The first reason why an potential acquisition should not be made is when the
price is so high that it cannot be justified to stockholders. Corporations often
make these acquisitions anyway, believing that ultimately the acquisition will
pay off and/or that stockholders will not hold them accountable if it does not.
The second hunch is usually a safe bet, while the first often is not. Gannett's
expenditure of $600 million for The Detroit News has turned out to be such a bad
"investment" that it is charitable to call Gannett's purchase an investment at
all: Gannett has not even earned back the purchase price let alone profits on
its purchase. Moreover, because of inflation and capital costs, Gannett now will
never be able to make back in profits the inflation-adjusted purchase price and
required profits. For a second example, Ralph Ingersoll II paid too much for
everything or nearly everything that he bought and ended up essentially losing
his company, although he partially saved face by emerging with a few newspapers
in the British Isles; as The Wall Street Journal reported when Ingersoll bought
the New Haven (Conn.) Register, "The price...about four times annual revenue --
stunned some on Wall Street. 'I just find the price breathtaking,' said John
Morton....'I'll be interested to see how Ingersoll gets a return on that
investment'" (Landro, 1986, p. 7).
Prices asked for newspapers for sale are often too high for the reasons one
would guess: the potential seller has an inflated view of the newspaper's value;
the owner is not really interested in selling, but simply wants to test the
market; the owner is willing to sell, but not unless the property commands a
premium price; the seller is using an old valuation for a newspaper whose value
actually has declined due to competition (such as the smaller of two metro
dailies in the same market) or lack of buyers (this author believes that many
small town weeklies currently face this problem); or the owner does not demand a
premium price, but the supply-demand environment for newspaper properties allows
the owner to ask for it. Morton (1998c), for instance, attributed high
acquisition prices to, "big demand and short supply drives up prices, as it
always does," as if newspaper chains can make acquisitions like an individual
makes short-term liquid investments in stock rather what newspaper chains really
are doing in acquisitions: making long-term, capital investments.
And of course even when a potential seller doesn't ask for a premium price,
potential buyers may engage in a bidding war, sometimes significantly jacking up
the price. This is the point at which the "winner's penalty" (which has been
discussed in scholarly literature [see, for example, Varaiya, 1988] on corporate
finance but apparently never before mentioned in mass communication literature)
comes into play: let's say that two newspaper chains each believe that a
newspaper company for sale is worth $100 million -- but no more. Each are
willing to bid the company's value to buy it, but one must be willing to bid
more than the company's value -- say $110 million -- to complete the deal.
Anyone who has ever participated in an active auction has witnessed this
phenomenon. Obviously, the question is whether stockholders and executives
should take the position that any newspaper that is worth $100 million must be
worth $110 million (and, after all, what's $10 million between friends?), or
should they reject the deal because it would cause them to "waste" $10 million?
To complete this picture, it must be noted that some media companies have
refused to make bids when asked and, even if they have done so, refused to
overpay for newspaper acquisitions. Thomas Murphy, the highly-respected,
long-time former chairman of Capital Cities/ABC, Inc., was quoted in 1976 as
saying, "Newspapers are the best unregulated business and television is the best
regulated business to be in" ("Capital Cities predicts healthy second quarter").
The Capital Cities annual report for 1977 informed stockholders,
"With properties available for acquisition being extremely high price/earnings
multiples, and with our stock trading at a low price/earnings multiple, we
believed that the repurchase of our stock was one of the better opportunities
to deploy our assets. During 1977, your company acquired 321,000 shares of its
common stock at an aggregate price of $17,111,000...."
The 1980 annual report added, "It is increasingly difficult for the Company to
invest prudently in broadcasting and publishing acquisitions at the multiples
being asked for the properties." Indeed, Capital Cities acquired no daily
newspapers after the Wilkes-Barre (Pa.) Times Leader in 1978, and its
acquisition of magazines was almost limited to those owned by ABC, which Capital
Cities bought in 1986. In 1986, at the height of one newspaper M&A frenzy,
Forbes magazine asked,
"Isn't this a business in which people, seemingly smart people, are paying 20
times cash flow and more -- not earnings, cash flow -- for distinctly ordinary
newspapers and other media properties? Indeed it is, but where others see
glamour, Don Reynolds [founder of Donrey Media] recognizes that newspapers are
a busi- ness like any other -- you make the money a dollar at a time -- and
nobody has yet repealed the basic laws of economics.
"'I look at each new property as if it was my only,' says Reynolds....His
statement is a dig at the media moguls who blithely buy properties at prices so
high that their cash flow cannot yet support the interest on the debt incurred
in buying them. Says Reynolds, 'If you're going to obligate yourself for a
fantastic payoff, I feel you shouldn't look to another property to carry
it'....
"Not long ago Reynolds eyed the 104,000-circulation Tacoma News Tri- bune, but
dropped out when the bidding got too rich. He says to pay about 20 times cash
flow for Tacoma -- as McClatchy Newspapers did when it paid $112 million --
would have required a 30%-to-35% profit margin, no easy trick in Tacoma, with
eight strong labor unions and a small operating margin" (Behar, 1986, p. 144).
It should be noted here that Reynolds was not known for his commitment to
editorial quality. It was mostly likely Reynolds's company (or perhaps Thomson)
that was being referred to when a newspaper publisher wrote that a friend of his
at a group-owned daily "was required to return 40 percent net on sales. That
lasted, I believe, only two or three years. Yet I cannot conceive the
impossibility of the task or the wretchedness of the product he was forced to
deliver" (Udell, 1978, p. 75).
In the 1980s and 1990s, many newspaper chains have repeatedly made bids or
considered making bids on newspapers for sale, and ultimately made few if any
acquisitions. These included Capital Cities/ABC prior to its sale to Disney, The
Washington Post Co., Tribune Co., Scripps Howard, Newhouse and others.
Spending Too Much of Cash Reserve and/or Borrowing "Too Much"
As noted above, average stockholders -- after sensing that their company has
made a blunder -- have three options: either hold their stock and hope the
company's error is corrected; sue their company for breach of fiduciary duty; or
simply sell their stock, hope to still make a profit on the sale, and invest
their money elsewhere. An excellent example of the latter case recently occurred
at A.H. Belo Corp., owner of The Dallas Morning News, the Providence Journal
Bulletin, and a flock of television stations; in February 1997, Belo paid $1.5
billion for the Providence newspapers and nine television stations, and by late
October 1998, its stock had dropped 50% from its 52-week high (to about $17 from
about $34) because of declines in newspaper classified advertising revenue and
the parent corporation's staggering debt load -- a direct result, of course, of
the 1997 acquisition (Media Bites, 1998).
Acquiring Chain is Diluting Ownership (and Earnings Per Share)
Particularly in family-controlled companies, such as The Washington Post Co.,
Dow Jones & Co., The New York Times Co., or companies with individual outside
stockholders who own large percentages (such as Warren Buffett after the Capital
Cities/ABC merger), stockholders may object to a potential merger or acquisition
if it would dilute their control through the issuance of new or treasury stock,
enlargement of the board of directors and other mechanisms. Likewise, average
stockholders are not likely to balk at having less control after mergers and
acquisitions, but they may balk at dilution of earnings and/or the decrease in
dividends that may result -- particularly if they think that the seller got the
better end of the deal.
Acquiring Chain is Diversifying Outside Its Areas of Expertise
Historically, newspaper chains have grown horizontally -- by getting into
magazine publishing, book publishing, broadcast TV and radio, cable TV,
shoppers, wire services, feature syndicates, and more lately into the internet,
databases, and so on -- or vertically -- by buying paper manufacturers, forest
land, printing plants independent of their newspaper and magazine production
plants, parts of newspaper technology companies, and so on. And IRS regulations
historically have encouraged, if not required, that U.S. corporations use
built-up cash to start or acquire businesses that can reasonably be said to be
closely related to corporations' core business(es); moreover, some broadcasters
originally got into publishing because of FCC rules limiting the number of
television and radio stations they could own. The decision about how a newspaper
chain should expand is, of course, based on much more than what the IRS allows
it to do (and in fact, given the growth of diversified conglomerates in the
mid-20th century, newspaper chains arguably could have expanded outside the
spheres of news, advertising and entertainment): another crucial factor is
management expertise. And management talent -- or the lack thereof -- has had
all kinds of "interesting" results.
For example, Capital Cities/ABC (as it was known prior to its purchase by
Disney), was -- first, last and always -- primarily a broadcasting company, but
its ownership and management of a group of daily newspapers and a huge group of
magazines was, overall, spectacularly successful. Capital Cities Communications'
excellent management allowed it to borrow enough money from Buffett to buy ABC,
and Capital Cities/ABC's continued excellent management allowed it to command a
premium price from Disney. Those who have followed the former Capital Cities
Communications' operations for 20 years, as has this writer, are tempted to
speculate that the company would have performed well almost regardless of what
new businesses it entered. But other chains have been much more successful with
TV stations than with newspapers or vice versa; just because both TV stations
and newspapers are mass media doesn't mean that they can be managed similarly.
To use a particularly graphic example, McClatchy Newspapers in the early 1990s
shut down a chain of senior citizens' publications all over the western U.S.
with the ex-planation that McClatchy couldn't make them profitable; incredibly,
this happened at the same time at which profitable senior citizens' publications
were popping up all over the United States and senior citizens were finally
recognized as both one of the wealthiest and fastest-growing segments of the
U.S. population. Other chains primarily in the business of publishing daily,
general interest, mass circulation newspapers, have had similar failures with
suburban weeklies, urban neighborhood weeklies, shoppers, alternative
newsweek-lies (Wilburn, 1995), and other specialty or niche publications.
Clearly, such chains should stick to their daily newspapers -- or, at the least,
acquire a company with excellent manage-ment and keep those managers in place.
In short, while Morton (1998c) claims that news-papers' "professional
management" has resulted in the industry "getting ahead of the curve with
initiatives that prevent threats" and not relying on "seat-of-the-pants
expertise," a more objective view of this usually reactive, rarely proactive,
industry suggests otherwise.
Finally, it must be noted that some daily newspaper chains aren't even very
talented at managing daily newspapers. In particular, the histories of the
Hearst Corp. and Scripps-Howard Co. during the 20th century display a continuing
series of shutdowns, forced sales of newspapers, disastrous strikes,
persistently poor quality news products, missed opportunities and in many cases,
of course, low profits. Likewise, many observers who associate the Tribune Co.
with the Chicago Tribune don't know or forget that Tribune Co. now owns only
four newspapers; over the past 20 years, the corporation has sold off or shut
down several other newspapers and passed on the opportunity to buy dozens of
others. Yet for all of Tribune Co.'s de facto efforts to almost exit newspaper
publishing (implied but not stated by Auletta, 1998), its frequent mismanagement
of the newspapers it no longer owns, and its less-than-optimal management of the
four papers that remain, it is noteworthy that Tribune Co.'s much-touted
broadcasting division is only very slightly more profitable than its publishing
division.
The moral of these stories is that newspaper chains need to be extremely
careful in making judgments about their ability to manage potential acquisitions
-- in part because they must be realistic about how well they are managing what
they already have. The best use of capital in some situations is for the
corporation to boost its share price and dividends by buying up its own stock as
Capital Cities/ABC did; the only downside to this is that the IRS may
investigate whether the repurchase is a "disguised dividend payment."
Corporation has Better Alternative Uses of Capital
All of the above may suggest that when a newspaper chain has built up tens of
millions or hundreds of millions of dollars of cash, the best use of its capital
may be to buy its own stock and/or increase its dividends, hold the cash until
it is questioned by the IRS (assuming this will occur at all), buy companies
outside the media and entertainment industries, invest in current operations, or
buy companies inside the media and entertainment industries. All of these
options should be periodically reviewed. A general argument for corporations
buying their stock is that when corporations build up cash rather than buying
their own stock and/or increasing their dividends, they are assuming that
unknown future acquisitions or internal investments will benefit their
stockholders more than paying cash to stockholders who are willing to sell now.
As we already have seen with post-acquisition stock price declines and a new
study on corporate mergers (reported in Hiday, 1998), this assumption is highly
questionable.
Valuing Acquisitions
One of the strengths -- and weaknesses -- of many corporate finance theories is
the difficulty of taking into consideration aspects of corporation management
such as management expertise, executive egos, possible synergies resulting from
the acquisition, irrational demands or reactions by stockholders, and so on. The
prestige value of a particular acquisition -- which, if high enough, may warrant
increased interest from potential stockholders that the corporation otherwise
would not receive -- must be reflected (if at all) in the goodwill value
assigned to a potential acquisition (if one allocates part of the purchase to
goodwill at all anywhere other than public financial statements and tax
returns). Obviously, the prestige value of a particular acquisition -- such as
when The New York Times Co. bought The Boston Globe -- can be potentially huge;
the more significant such unique and often intangible benefits are, the more
likely that acquisition can be called "non-fungible" -- in other words, it is
not simply interchangeable with another, similar potential investment, because
no other potential investment is very similar.
Such questions as whether the acquiring corporation will need to spend "too
much" cash and/or stock -- in reserve, from borrowing cash, and/or issuing
additional stock -- or whether the corporation has more profitable and/or more
strategic uses of capital, must be answered as a separate question before or
after conducting rigorous, traditional financial analysis of a potential
acquisition's effect on profitability and cash flow. In sum, the tradi-tional
method of valuing a potential acquisition is relatively simple, but important
because that method cannot be directly influenced or clouded by other
acquisition considerations.
The first of Dertouzos and Thorpe (1982, p. 65) two models for valuing an
acquisition is:
"P = (1/r) n + T
"where P is the observed purchase price, $ million; r is the relevant discount
rate; n is the level of expected gross annual profits of the newspaper, $
millions, and T is the tax benefit associated with the purchase of the
property." And because profit figures for various newspapers included in
Dertouzos and Thorpe's empirical analysis were usually not known to those
researchers, they calculated estimated revenues based on "firm circulation,
media competition, publishing schedules, input prices, and aggregate advertising
activity" (p. 67).
Dertouzos and Thorpe used actual acquisition prices, estimated profits, a
discount rate (cost of capital) of 12% (standard in corporate finance
equations), and then -- assuming on average that acquisition prices accurately
reflected acquired companies' true financial value -- assigned the rest of the
purchase price to tax benefits. As asserted above and discussed below, to assume
that on average acquiring companies did not pay too much (which, by the way,
assumes that for every acquiring company that paid too much, another company
paid too little) was a big assumption for Dertouzos and Thorpe to make. This is
especially true after they already had admitted that, "it is not uncommon for
firms to sell for amounts far in excess of what is justified on the basis of
annual earning" (p. 57) and their reminder later that, "Reported price-earnings
ratios [of acquisitions] often exceed 20 to one and have been known to climb as
high as 60 times annual pretax profits!" (p. 77).
And having already assigned significant value to tax benefits, Dertouzos and
Thorpe go on to state that if the 12% discount rate is too low, "the predicted
profit measures may overstate expectations and understate the magnitude of the
tax factor" (p. 72); they leave it for their footnote #28 to remind us that "the
wedge between the actual selling price and the value which is justified by the
predicted future profit stream is presumed to be due to tax laws" (p. 81). In
other words, again, Dertouzos and Thorpe had no empirical evidence of
acquisitions' tax benefits.
Their second model, developed to take into account exogenous variables, was:
P = B0 + B1n + E Bi n Zi
The regression analysis indicated three statistically significant variables,
which were:
"Growth = The difference between the percentage change in the number of
households in the local county and the United States between 1967 and 1975. The
U.S. growth was 24.0 percent for this period while county changes ranged from
3.0 to 40.7.
"Dom = A dichotomous variable equal to one if the newspaper was dominated by
competitors (as indicated by having lower circulation levels) in the local
county subscription market.
"Weekly = A dichotomous variable equal to one if the sold newspaper was
competing directly with a weekly newspaper located in the same town.
Based on 22 mergers and acquisitions, no one of which (according to Dertouzos
and Thorpe) was large enough or small enough to skew estimated coefficients,
Dertouzos and Thorpe found that:
P = 5.32 + 11.17n + .26Growth - 3.39Dom - .68Weekly.
While this equation makes some intuitive sense (a daily paper's acquisition
price is highly correllated with its profitability, a fact tempered
significantly if the daily paper is dominated by its competitors and temperedly
very slightly if the daily paper's city also has a weekly newspaper), Dertouzos
and Thorpe do not discuss their findings and instead immediately launch into a
discussion of whether 12% is the most appropriate discount rate (cost of
capital). Thus it is difficult to make substantial comments on the model.
Claussen (1986), then unaware of the Dertouzos and Thorpe study, proposed a
different model -- the traditional net present value (NPV) model used in
corporate finance -- of valuing newspaper publishing companies that are
potential acquisitions:
NPV = -P + A + n/r-G
where NPV = net present value of making the acquisition; -P is the observed
purchase price, $ million; A is the value of hard assets obtained in the
purchase; n is the level of expected gross annual profits of the newspaper, $
millions; r is the relevant discount rate, and G is the real growth rate.
Claussen applied his equation to McClatchy Newspapers' purchase of the Tacoma
News Tribune for $112 million. Liberally assigning a $2 million liquidation
value to the News Tribune's hard assets, assuming the standard 12% discount
rate, assuming the standard 3% real growth rate, he concluded that the News
Tribune would need to net about $9.8 million per year for the net present value
of McClatchy's purchase to be zero. (Remember that net present values should be
significantly positive in order for an acquisition to be advisable; a zero NPV
means the deal is worth the price but no more.) Assuming that the
then-104,000-circulation News Tribune was annually grossing about $28 million,
Claussen concluded that the required $9.8 million annual profit represented
McClatchy's need to net about 35% per year, in perpetuity, for the acquisition
to have been even justifiable to stockholders; he implied that this was
unlikely. Claussen's equation was even more telling about Gannett Co.'s
acquisition of the Louisville Courier-Journal for $300 million. Here, Claussen
plugged in the purchase price, an assumption of $6 million in hard assets
(liquidation value), the 12% discount rate, the 3% real growth rate, a liberal
estimate of 21% profit in perpetuity (about $7.6 million in 1986), and found a
hugely negative net present value: -$209.5 million.
In sum, the Dertouzos and Thorpe models assumed acquisition prices to be
rational, assigned value otherwise accounted for to tax benefits, and neglected
to include the liquidation value of an acquisition's hard assets; their models
would be immediately disproved, if -- after asking newspaper executives what
financial basis they had for making acquisitions -- newspaper acquisition prices
could not be financially justified; the quickest way to discover that would be
checking Dertouzos and Thorpe estimates of acquisitions' tax benefits with
actual tax benefits. In contrast, Claussen's equation sought to discover if
acquisition prices were rational -- a question that challenges assumptions and
doesn't make any. The only flaw in Claussen's equation was that it omitted tax
benefits above and beyond what would be reflected in the acquisition's profits
in perpetuity. In short, after including tax benefits in an analysis of
McClatchy's News Tribune acquisition, that deal may have been more likely to
have a significantly positive NPV, but it still is obvious that Gannett's
purchase of the Courier-Journal (and the Detroit News, for that matter), was
fiscally irresponsible; under no possible scenario could Gannett have obtained
$210 million in tax benefits in a $300 million acquisition of a profitable
publishing company.
Moving forward in time to McClatchy's recent acquisition of Cowles Media, let's
restate Claussen's equation, with a new variable added for tax benefits. The
suggested new equation is suggested: NPV = -P + T+ A + n/r-G
where NPV = net present value of making the acquisition; -P is the observed
purchase price, $ million; T is the tax benefit associated with the purchase of
the property; A is the liquidation value of hard assets obtained in the
purchase; n is the level of expected gross annual profits of the newspaper, $
millions; r is the relevant discount rate; and G is the real growth rate.
Applying this amended equation to the McClatchy-Cowles deal, the mathematics
(after deducting $200 million from the acquisition price for Cowles operations
that McClatchy immediately sold off; using purchase price, hard assets and
profitability figures from Morton, 1998a; a tax benefit estimate from Dertouzos
& Thorpe, 1982; and standard assumed discount and growth [Claussen, 1998]) are
as follows:
$471.5 million = -$1.45 billion + $366.5 million + $200 million + $122
million/.12-.03
Assuming the figures used are correct, the McClatchy-Cowles deal was a good buy.
But if the tax benefits -- which this paper concludes were significantly
overestimated by Dertouzos and Thorpe -- were substantially less than $366.5
million, and/or if Cowles' hard assets were not realistically worth $200
million, and/or if the Minneapolis Star Tribune cannot annually net, in
perpetuity, an inflation-adjusted $122 million, and/or if McClat-chy's cost of
capital was more than 12% (which is possible considering both McClatchy's
acquisition alternatives and the beating its stock took), then one can easily
see how the acquisition's net present value would be much smaller. In other
words, if, for example, the tax benefits and hard assets were worth only 50% of
these estimates and profits only slight-ly less, the net present value quickly
moves toward zero. Time will tell.
Conclusion: Why Chains Make Acquisitions When They Are Irresponsible
Assuming for the moment that newspaper executives work with financial formula
of their own in making acquisitions, and -- using conservative rather than
wildly optimistic numbers -- can tell for themselves that some acquisitions
(such as Detroit or Louisville) don't make sense financially,4 why do executives
make such acquisitions anyway?
Fortunately, scholarly research into corporate finance has finally caught up to
journalists5 and other observers to largely give up the naive assumption that
corporate executives act only in the best interests of their stockholders
(Singh, 1991, detailed what was known and unknown at that time about takeover
behavior). Caves (1989) concluded that contrary to the impression given by the
"corporate raiders" in the 1980s (T. Boone Pickens, Carl Icahn, etc.), the
performance of target firms' managers (whether particularly good or particularly
poor) usually is an "inefficient deterrent to mergers"; on the other hand, some
acquiring firms' executives make so many acquisitions so often that it results
in "excessive mergers," which inevitably are followed by "selloffs and
spinoffs."
More specifically, a three-pronged theory of motivations for acquisitions has
been developed and successfully tested. Corporate executives -- and there is no
reason to believe, especially in the 1990s, that media executives are different
from any other -- make acquisitions for reasons of corporate synergy, agency
(executives increasing their own income and/or net worth, also known as
utility), and hubris (the dictionary definition of this word, of course, is
pride, self-confidence and arrogance, but I call it simply "ego" for short).
Gupta, LeCompte and Misra (1997) found evidence for all three motivations.
The agency/utility motive was clearly supported by Firth (1991), who found that
an acquiring firm's "senior management remuneration increases substantially
after an acquisition" regardless of whether their corporation's stock goes up or
down; Berkovitch and Narayanan (1993), who found that "agency is the primary
motive in takeovers with negative total gains"; Zantout and O'Reilly-Allen
(1996) found circumstantial evidence that when a corporation's CEO is also its
board chairperson, acquisitions were less likely to benefit stockholders (the
chairperson/CEO still would benefit from increased salary, bonuses and/or stock
options); and Loderer and Martin (1997), who found circumstantial evidence that
executives benefit from acquisitions even when they own little stock in their
companies because, of course, they have other ways to benefit besides increases
in stock value and/or stock ownership. (One wonders if newspaper chain executive
compensation will go down now that several chains are selling or closing down
less profitable -- not to say unprofitable -- newspapers. [Morton, 1998b])
Roll (1986) was the first to suggest the hubris hypothesis, but the first
empirical evidence of hubris was offered by Berkovitch and Narayanan (1993), who
surprisingly found evidence of synergy indistinguishable from evidence of
synergy. No research has refuted the hubris hypothesis.
In sum, in contrast to the traditional assumption that newspaper executives
formed chains primarily because of chains' economies of scale, research
conclusively proves that newspaper chains do not enjoy economies of scale above
and beyond individual large newspapers. It then become necessary to understand
that newspaper executives have numerous personal, corporate tax related, and
fiduciary motivations for making acquisitions, and further, that while some of
those motivations benefit stockholders or do not noticeably affect stockholders
at all, other motivations have been shown in research on other industries to
benefit primarily executives and to be contrary to stockholders' interests (if
only in lost opportunities). In assessing mergers and acquisitions in the
newspaper industry, each transaction needs to be examined individually, and no
assumptions should be made as to why a particular transaction was made or
whether it was in stockholders' best interests. Fortunately, models developed by
Dertouzos and Thorpe (1982), and Claussen (1986) can serve as the basis for
further refined models -- such as the revised equation offered by this paper --
that can soberly and objectively begin to analyze acquisitions' financial value.
Notes
1. That individual newspapers enjoy economies of scale, and/or the extent to
which economies of scale are or are not related to most newspapers'
quasi-monopolistic status has been well-documented by Primeaux (1975, 1977);
Sherman (1976); Bogart (1977); Ferguson (1983); Thompson (1988) Bucklin, Caves
and Lo (1989); Reimer (1992); and Blair and Romano (1993), among others.
2. These questions are neither asked nor answered in a recent American
Journalism Review cover story on remaining independent papers (Risser, 1998), an
entire "Media Mergers" issue of Media Studies Journal (1996), such articles as
Neiva's history (1996), and almost all other sources consulted for this paper.
3. "The empirical evidence presented suggests that the changing structure of
the newspaper industry is not due to differential abilities to adapt to rapid
technological change. Econometric analysis of two distinct data sets with
disparate statistical models yield quite similar conclusions. First, individual
newspaper size does enhance the probability of diffusion of VDTs. However, an
examination of residuals and estimation of separate slopes by circulation
category indicate that size matters only to a point. Evidence suggests that the
higher probability of VDT diffusion does not stem from efficiencies or capital
market advantages but rather from the fixed-cost nature of certain production
processes. In addition, group newspapers, in general, have not adopted
electronic technology at a faster pace. There is some evidence that small,
regional groups began using VDT input equipment in classified departments
earlier, but this phenomenon is probably a result of the higher benefits of
computerization for such firms. In fact, the regressions for display VDTs
indicate no apparent advantage for group newspapers.
"The dramatic growth in newspaper chains can not be explained in terms of more
efficient adaptation to technological change. In some cases, chain-owned
establishments exhibit inferior levels of development. They appear to enjoy no
apparent capital market advantages nor is the purported sequential adaptation of
technology or "learning by doing" very important. Also, there are no strong
economies of scale in technological innovation. There is a pronounced threshold
for the adoption of computer technology, but it occurs at a level which is much
lower than the size of most firms" (pp. 50-51).
4. Simply making this assertion is contrary to Seyhun's conclusion (1990) that
no evidence exists that "bidder managers knowingly pay too much for target
firms." Is even the most cynical observer ready to allege that newspaper
executives are so sloppy in their due diligence and/or financial analysis that
they "unknowingly pay too much for target firms"? In other words, this paper
concludes that bidder managers must knowingly pay too much for target firms, and
that numerous explanations exist for that behavior.
5. For example, journalist Jenkins (1998) has written that the diversification
of stockholders means that the "stock barometer can humble our corporate leaders
and make them better. The risk of persistent folly has all but disappeared from
large-cap stocks, making the S&P 500 a consistently safe bet. Management noses
are held to the grindstone by continuous, direct and searching accountability."
I am not as optimistic as Jenkins that "persistent folly" is now almost
impossible, but obviously I agree that in the past there has been "folly" and a
lack of "continuous, direct and searching accountability."
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