Last week, Kohlberg, Kravis & Roberts, the ur-leveraged buyout firm, ousted Tom Rogers, the high-profile CEO of Primedia, the magazine company KKR controls. Primedia is a huge but minor-league media player. It has a few glamour properties, like New York and Seventeen, the school television network Channel One, and once-glorious Web portal About.com. It also owns a menagerie of profitable but sexless niche magazines—from Dressage Today to McCall's Quilts.
The reason for Rogers' defenestration was, as KKR éminence grise Henry Kravis put it, "real differences in the strategic direction of the company." In other words, Rogers was either unwilling or unable to execute the cost cutting and debt reduction KKR required. Too protective of his own empire, and too inattentive to controlling shareholders, Rogers may have been acting precisely like the old-time CEOs who made the 1980s such a target-rich environment for KKR and its LBO imitators. But KKR's struggles with its own executive show just how hard it is for any company—even ruthless KKR—to maintain the toughness that running leveraged firms requires.
Over the course of the 20th century, government regulation essentially divorced the tight marriage ofowners (or "principals") and management ("agents") at publicly held companies. Consequently, executives, who didn't receive returns via dividends or stock appreciation—because they didn't own much stock—too frequently ignored the concerns of shareholders.
LBOs aimed to solve the principal-agent problem. By taking companies private, loading them up with debt, and giving managers equity, KKR gave managers incentives galore to run businesses efficiently. If the company failed to meet its debt payments, all management's stock would be worthless. To manage debt, executives were forced consistently to cut unnecessary costs, husband cash, and make tough budget decisions.
With Primedia, KKR tried to build a leveraged company from scratch.Founded in 1989 as K-III Communications, it went public in 1995, changed its name to the more jazzy Primedia in 1997, and assembled a large portfolio of media properties. In the late '90s, Kravis and his colleagues—who had invested primarily in industrial and consumer products companies—saw Primedia as a way to muscle in on the New Economy boom.
So in 1999 they brought in Rogers, a Jack Welch disciple who had run NBC's highly successful cable operations and its Internet investments. But Rogers was late to the party. In the fall of 2000, after the dot-com bubble had burst, he used $690 million of Primedia's stock to buy About.com. Then, in August 2001, Primedia spent $515 million in precious cash to acquire EMAP, whose 60 magazines included Motor Trend, Teen, and Stereophile.
The media business sank into depression even before the EMAP deal closed. It quickly became apparent that Primedia couldn't service its mammoth debt and provide returns to shareholders. The stock plummeted to the low single digits. In 2002, the company posted a significant operating loss, then had to pay another $140 million in interest on its $1.7 billion debt. Primedia closed the year with just $18 million in cash.
The solution was obvious to any LBO veteran: Shutter the units that are draining cash, sell others, and, if that doesn't do the trick, break up the company. Rogers did start a divestment program. Seventeen has been on the block since last February. In 2002, he sold American Baby for $115 million, Chicago for $35 million, and Modern Bride for $50 million. But evidently his pace wasn't fast enough for KKR, which owns about 60 percent of Primedia. In the words of the New York Times, KKR would like to"pare the business back to a profitable set of hobbyist magazines like Guns & Ammo and Truckin' and their associated Web sites." KKR even brought in an outside consultant to advise on how Primedia should cut costs—exactly the draconian management activity that executives at leveraged companies are supposed to do on their own. (According to the Wall Street Journal, Kravis says that Capstone Consulting "found $85 million of cost reductions that management would never have done by themselves.")
It's easy to understand why Rogers did not respond to the incentives designed to goad leveraged executives. It's true that he would benefit financially if Primedia recovered, but many of his 5 million options are so far underwater that even a doubling or tripling of the stock wouldn't help him. More important, Rogers had little psychological incentive to follow the bloodless dictates of KKR. It makes great business sense to sell off New Yorkand Seventeen, but it also takes the fun out of his job. For a big-shot media executive, the notion of jettisoning New Yorkto focus on the likes of Volleyball must be humiliating. What self-respecting media tycoon wants to spend his days chatting up potential advertisers for National Hog Farmer?
Primedia's experience may prove, in fact, that LBO principles are inimical to the culture of media companies. Magazines and publishing are dominated either by family-controlled businesses (like Condé Nast or the New York Times Co.) or by vast media conglomerates. Huge options grants and massive bonuses are not part of the scenery for managers at these companies, so media executives have grown accustomed to taking compensation in the form of prestige. They get the glamour of running marginally profitable but cool businesses (think The New Yorker or Farrar, Straus & Giroux), work half-days on Fridays, and indulge in small luxuries like car services and lunch at the Four Seasons. For Rogers, the incentive of prestige may have been enough to resist holding the sort of media garage sale that KKR demanded.