Why Sam Zell's Tribune deal went so bad, so fast.

Commentary about business and finance.
Dec. 9 2008 2:06 PM

The Road to Zell

How the Tribune deal went so bad, so fast.

Daniel Gross recently chatted online with readers about this article. Read the transcript.

Sam Zell. Click image to expand.
Sam Zell

What's the difference between Smart Money and Dumb Money? Twelve months, the popping of a credit bubble, and about $800 million.

In the run-up of asset prices, which ended about a year ago, everyone was a genius. Hedge-fund managers felt wise for borrowing large sums of money and buying stocks, commodities, or pretty much anything that went up. Private equity barons bought companies, issued debt to pay themselves dividends, and were hailed as master investors. Heck, even millions of homeowners felt like Einsteins for refinancing at lower rates. And hardly anyone was deemed smarter than Sam Zell.

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The Chicago-based real estate investor, nicknamed the Grave Dancer for his delight in picking up dead businesses and reviving them, built Equity Office Properties, a collection of high-end office buildings. In February 2007, Zell was lauded as a genius for unloading the company in an all-cash transaction valued at about $38 billion (Blackstone put in $6.4 billion in cash and borrowed the rest), after a frenzied bidding process. But Zell wasn't content to take his winnings and stow them under the mattress. Having benefited from the dumb-money culture—people willing to pay high prices for leveraged assets in the hope and expectation that they'd be able to sell them to other debt-fueled buyers at even higher prices—Zell loudly plunged right back into it. (Regular readers of this column should expect to hear more about the culture of dumb money—I've got an electronic book about it in the works with the Free Press.)  In December 2007, Zell closed on the $8.2 billion acquisition of the Tribune Co., putting in $315 million of his own money and borrowing much of the rest. Make no mistake about it, the Tribune Co. was a classic dumb-money play, and not just because its main assets were declining newspapers.

A big part of the dumb-money culture was the rising sense that hedge-fund managers, asset flippers, and financial engineers—because they had made a lot of money from cheap credit—could apply their genius to industries in which they had little expertise. Frequently, however, that strategy didn't go much beyond financial engineering or selling assets—which depended, in other words, on the plentiful availability of cheap credit and credulous buyers. If hedge-fund maestro Eddie Lampert couldn't remake Sears into an effective retailer, investors thought, he could at least bolster shareholder value by buying back shares or by selling the real estate underlying the stores. That hasn't quite worked out. Hedge-fund manager Bill Ackman set up a vehicle to amass a huge stake in retailer Target. * His bright idea: Target should sell its stores and lease them back.

It was plain from the beginning that Zell didn't have much of a strategy for reversing the revenue decline at the newspapers. And the failure to realize that a slowdown in real estate and autos—the credit crunch had started a half year before the deal closed—would reduce revenues sharply was an act of colossal stupidity on Zell's part and on the part of the bankers who made the era of dumb money possible. (Andrew Ross Sorkin has a good rundown of the fees earned by Citigroup, Merrill Lynch, and Morgan Stanley for their roles in this debacle.) Zell loaded up the company with nearly $13 billion in debt, which required interest payments of nearly $500 million in the first half of 2008. The plan, such as it was, was to pay down debt not with operating cash but with asset sales. One problem: Most of the assets were themselves dumb-money assets—trophy properties such as the Chicago Cubs, office buildings, and big-city newspapers that couldn't support a lot of debt on their own and whose purchase would require easy credit. In May 2008, Zell managed to sellNewsday to Cablevision for $650 million. In September, it sold a chunk of CareerBuilder.com for $135 million. In June, Tribune put the company's headquarters buildings in Chicago and Los Angeles on the market. So far, no takers. The hope to stay current on debt payments rested on selling the Chicago Cubs, perhaps the greatest Midwestern trophy property of all. But the credit crunch decimated the net worth of many of the potential buyers, and lenders fell by the wayside. Having failed to find any greater fools, Tribune filed for bankruptcy Tuesday.

Correction, Dec. 12, 2008: The article originally misidentified Bill Ackman as Dan Ackman. ( Return to the corrected sentence.)

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