Guest commentary

Knight Ridder in grave jeopardy

By Lou Alexander
Posted Nov. 3, 2005

Lou Alexander

Power brokers on Wall Street have ensured that the relatively comfortable status quo employees and readers of Knight Ridder's newspapers and Web sites enjoyed as recently as Monday is gone.

Things are going to change forever in the 29 markets the company serves with daily newspapers and the 110 markets reached by Knight Ridder Digital. None of the scenarios that can reasonably be anticipated allow Knight Ridder and its newspapers to operate in the future as they have in the past. And I assure you there will be chaos and uncertainty

On Tuesday Bruce S. Sherman from Private Capital Management, L.P., the largest shareholder in the company, wrote Knight Ridder's board of directors urging them to "aggressively pursue the competitive sale of the Company" because of the poor performance of the stock. If the board is not willing to sell the company Sherman threatened what would essentially be an unfriendly takeover. PCM owns about 19% of Knight Ridder Inc.

Situation deteriorating for KRI

Not too surprisingly, the situation, from Knight Ridder's perspective has worsened in the last few hours:

• The second largest owner of KRI stock is Southeastern Asset Management Inc. It holds an 8.9% stake in Knight Ridder, and in a regulatory filing on Thursday said that it wants the flexibility to enter talks with management and other shareholders about the future of the company.
• The third-largest owner of KRI stock is Harris Associates L.P., a Chicago-based money manager. They sent a letter to Knight Ridder's board this morning urging the company to consider offers "immediately" given the wide gap between the company's current share price and its fair value. Harris has an 8.2% stake in Knight Ridder.

These three companies own an aggregate of more than 35% of Knight Ridder stock. Although this is probably enough to force a sale in the arcane world of public companies, they will have little trouble getting the votes of more than 50% of the stockholders if they need it.

Knight Ridder does not control its own stock. About 90% of Knight Ridder stock is owned by institutions rather than individuals. According to Yahoo Finance, about 57% is owned by 10 large institutional investors, including the three listed above. Another 17% is owned by 10 large mutual funds. The details of the numbers have surely changed in the last few days but almost all of the stock is held by people to whom newspapers and quality journalism is secondary to returning maximum shareholder value.

There is no way to know for sure, but it is a reasonable bet that Mr. Sherman knew or had a good idea in advance of his letter to the board on Monday how Southeastern and Harris would react to his move.

I told you so

This is one of those times when the old expression "I hate it when I'm right" really applies. On Sept. 20, Grade the News posted a commentary I had written in which I explained that publicly traded newspaper companies faced terrible dangers if they did not maintain margins high enough to meet the demands of their shareholders.

I assure you I did not have any inside information before the news started breaking Tuesday and I take little pleasure in being prescient. The San Jose Mercury News is still a great newspaper as are the other KRI papers I read on the Web. I have friends on the KRI corporate staff, at the Mercury News and other KRI newspapers. And I am one of a large group of KRI retirees dependent on the company for pensions and medical coverage. I am very sorry we will all have to face the uncertainty and chaos the weeks ahead will entail.

Likely scenarios

Here is my take on some of the likely scenarios:

1. Knight Ridder makes a fight of it. I think this is a real likelihood. Tony Ridder is a proud and purposeful person. He does not want to be the member of the Ridder family blamed for the loss of the company. Unfortunately, Tony and the other insiders at KRI control less than 2% of the stock.
   
   That means to win the fight KRI will have to buy out the dissident shareholders, mostly likely as part of a leveraged buyout. The various financial sites on the Web seem to be settling on a buyout price of $80 a share for KRI stock, which has around 70 million shares outstanding. I do not want to get lost in the math, but if that price holds (I think it is actually a little low) KRI will have to raise billions of dollars.
   
   There are two ways to do this. They sell off one or more newspapers (an investor hinted at the need to sell off the Philadelphia Newspapers during the third quarter financial conference call on Wednesday, Oct. 19), or they borrow the money.
   
   Selling off newspapers starts the breakup of the company. Borrowing money means that instead of being a slave to the stock market, Knight Ridder will be a slave to the interest payments required on the LBO loans. The margin pressure will almost surely go up if Knight Ridder is taken private as part of a leveraged buyout. Any of you who worked for Harte Hanks Newspapers when they went through the LBO in the 1980s will remember how much the need to drive profit went up in that company which was already very margin driven.
   
2. Knight Ridder makes a compromise with Bruce S. Sherman. This would mean that Mr. Sherman and/or others of his choosing get seats on the Knight Ridder board of directors. I also think it would mean changes in the top management at Knight Ridder. Mr. Ridder is 65 years old and has made some noises about retiring. He could bow out now and allow a restructured board to bring in a turnaround specialist.
   
   A turnaround specialist would almost surely be from outside the newspaper industry. About the only skill that counts in a person like this is the ability to increase the stock price.
   
   Maintaining the journalistic traditions of Knight Ridder would be seriously at risk in this scenario.
   
   I think there is at least some chance of this happening. Mr. Sherman would not have acquired about 19% of KRI stock if he did not think there was money to be made. Also, in his letter to the board he said that if Knight Ridder were not sold his company "would strongly consider supporting more aggressive efforts that might be initiated by other parties seeking to change the composition of the Board, install new management, acquire a majority of the Company's voting shares, or take other action to maximize shareholder value."
   
3. The company is sold either to another newspaper company or a private equity company.
   
   I know the financial industry is split on the issue of whether or not anyone would buy Knight Ridder. But from my seat as a former ad sales manager, the sale of Knight Ridder to Gannett or Tribune Company works. A combination of Knight Ridder and either of these companies would create a potent national network for advertisers. A network of this size would have the potential to capture some of the ad buys that now go to the Web and broadcast. And I think the people who would run this combined company would also find new ways to exploit the sales power of the network.
   
   I suspect there are some economies of scale that a company this size could apply to many different parts of the newspapers.
   
   Also, I am pretty certain that Tony would prefer to have the company sold to another newspaper company. He does not want the company where he has spent his entire life broken up.
   
   As for the Justice Department concerns, they are not overwhelming. Cross ownership issues that might crop up are not deal breakers, especially with the current administration.
   
   There might be other suitors -- McClatchy has been mentioned -- but I think it will take somebody the size of Gannett or Tribune to benefit from the sale enough to pay the premium price this deal will require.

So this brings me back to my earlier point. The status quo has changed. We are all in for a period of chaos and uncertainty.

Let me leave you with one more thought. Knight Ridder is not the only company that has lost control of its stock. Several of the public companies have most of their stock in the hands of institutional investors, including Bruce Sherman of Private Capital Management. If institutional investors can generate billions in profit by forcing major changes on Knight Ridder it is reasonable to wonder where they will turn next.

Lou Alexander spent 20 years in the advertising department of the San Jose Mercury News, rising to the top jobs in both display and classified before retiring in 2004. Before turning to the business side, he was a journalist for eight years. He lives in San Jose.

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