What-Ifs of a Media Eclipse

This New York Times article is the largest article ever posted to this blog

By KATHARINE Q. SEELYE
WHEN P. Anthony Ridder met with Wall Street analysts in June last year for a routine financial review, he was the chief executive of the nation’s second-largest newspaper company. And he could not have sounded more upbeat about the prospects for his corporate namesake, Knight Ridder

“The newspaper industry generally, and Knight Ridder specifically, are strong, healthy businesses with a bright future,” he told the analysts. What Mr. Ridder did not say was that during the previous three months, an aggressive group of shareholders, headed by Bruce S. Sherman of Private Capital Management, had been urging him behind the scenes to sell the company.

Among other things, Mr. Sherman and his fellow investors were disappointed with Knight Ridder’s faltering stock price. In the months after the analysts’ meeting, Mr. Ridder maneuvered to cut costs and to satisfy Mr. Sherman. He bought back shares, dumped the troubled Detroit Free Press and cut jobs at Knight Ridder papers in Philadelphia and San Jose, Calif. But Mr. Sherman, joined by two other major institutional investors, continued to press for a sale.

Last spring, Mr. Sherman’s wish was granted. Knight Ridder — with 18,000 employees and 32 daily newspapers with a combined circulation of 3.7 million — sold itself to McClatchy Company">the McClatchy Company for $4.5 billion and the assumption of $2 billion in debt. In June, just one year after Mr. Ridder confidently reassured analysts about his company’s future, the deal closed and Knight Ridder ceased to exist.

Today, many people in the newspaper industry are still scratching their heads over how and why a company with relatively high profit margins and a trophy case of 85 Pulitzer Prizes allowed itself to be wiped off the media landscape.

“Could anyone imagine 10 years ago saying that in 10 years, Knight Ridder would not exist?” asked Jay T. Harris, a former publisher for Knight Ridder at The San Jose Mercury News who quit in 2001 rather than make cuts that the company sought. “It was one of the strongest newspaper companies in America. How could you have a hand like that and play it in such a way that you would end up losing everything?”

The dismantling of Knight Ridder is a study of the hurdles facing publicly traded newspaper companies in a time of seismic change in the industry. The migration of readers and advertisers to the Internet, as well as rising costs and falling revenue, are threatening the financial well-being — even the very existence — of some of the industry’s most storied brand names.

A review of the dynamics behind the Knight Ridder sale and the aftermath of its breakup also offers a cautionary tale: that deep cuts in expenses to satisfy Wall Street will not necessarily save a newspaper company, and may not even bring financial gains to shareholders or buyers.

“Financial restructuring is not the answer to what ails the newspaper industry,” said Peter P. Appert, a newspaper industry analyst at Goldman Sachs, which advised Knight Ridder during the sale. “It’s not a panacea that’s going to create value from a shareholder point of view.”

LAST Thursday night, at a dinner in San Francisco, McClatchy celebrated its takeover of Knight Ridder with the bankers and lawyers who had advised the company on the transaction. But from the stock market’s perspective, McClatchy has very little to celebrate so far.

Once a Wall Street darling, McClatchy — like most other newspaper companies, including The New York Times Company — has seen its stock price plunge. McClatchy’s stock closed at $39.03 on June 27, the day it acquired Knight Ridder, well below its 52-week high of $67.23 . The stock has yet to recover; it now trades at $40.19. (Gary Pruitt, the chief executive of McClatchy, said the company’s weak stock performance was “more a reflection of industry trends than a verdict on the deal,” although Wall Street is concerned about the debt McClatchy incurred in the transaction.)

McClatchy quickly sold 12 of the 32 papers picked up in the Knight Ridder acquisition. All 12 ended up in private hands, and at least one has been subject to further cutbacks. Last Tuesday, Black Press Ltd., which bought the ailing Akron Beacon Journal from McClatchy, announced that it was laying off a quarter of the 161 employees in The Beacon Journal’s newsroom.

Mr. Sherman’s own portfolio of newspaper holdings is now worth about 16 percent less than it was just before he forced the Knight Ridder sale. He had a modest gain on his Knight Ridder shares, but that was offset by the downturn in his holdings of McClatchy.

“Our investment in newspaper stocks continues to cause concern for some clients,” Mr. Sherman wrote in a letter to clients earlier this summer. “Given the disappointing returns thus far, we understand their consternation. In some regards, it would be easier for us to abandon the investment theme than to continue to argue the point.”

While Mr. Sherman’s firm has been shedding some of its newspaper stocks, largely at the direction of dissatisfied clients, about 10 percent of his portfolio remains invested in newspapers. (As of June 30 his firm owned 13 percent of the common stock of The New York Times Company.)

Despite the industry’s woes, some in the newspaper industry have sharply criticized Mr. Ridder for not fighting harder to save his company. He had been acquiescing to Wall Street for years, they say, and his sale of the company was only the final, most striking, example.

“The real story of the fall and decline of Knight Ridder is not Bruce Sherman,” said James M. Naughton, once executive editor of The Philadelphia Inquirer, formerly a Knight Ridder paper, and a retired president of the Poynter Institute for Media Studies. “It’s the notion that you can continue whittling and paring and reducing and degrading the quality of your product and not pay any price. Tony’s legacy is that he destroyed a great company.”

Mr. Ridder, whose great-grandfather founded one of Knight Ridder’s predecessor companies in 1892, dismisses such criticism. “I’m very proud of the journalism of Knight Ridder, and I think Jim Naughton is a bitter guy who was passed over for the top editor’s job,” he said in an interview on Friday. “The issue was what’s happened to the newspaper industry over the last couple of years and the growth of revenue. To say that if we had more people in our newsrooms this could have been avoided is incredibly naïve.”

The paradox for Knight Ridder is that it was making good money when it put itself on the auction block. Its profit margin when it was sold was higher than that of many Fortune 500 companies, including ExxonMobil. But Wall Street’s pessimism about the industry’s ability to overcome its problems kept driving down newspaper shares, including Knight Ridder’s. Mr. Ridder’s decision to sell helped persuade Wall Street that the company’s management lacked confidence in the industry’s future. The sale was a sign of defeat.

When the sale was announced in March, Mr. Ridder said that Mr. Sherman had backed him into a corner. He said he was “upset” and “depressed,” and when the sale became final in June, he pronounced the day a sad one.

Nearly three dozen potential buyers were contacted when Knight Ridder went on the block, and 21 responded. All but two took a pass. (In addition to McClatchy, a consortium of private-equity firms stepped forward but never made a final offer.)

Analysts concluded that the paucity of bidders suggested there was no longer a market for big newspaper groups as a whole. But McClatchy’s ability to sell a dozen of the Knight Ridder papers after the sale indicated that individual newspapers had value. “No one would have anticipated that a year ago,” said Lauren Rich Fine, an analyst at Merrill Lynch. “A year ago there was a presumption that Gannett and Tribune were still buyers of groups of newspapers and that private equity would be very interested, too.”

But in the interim, powerful changes in the industry — particularly the accelerating shift of advertisers from print to online and the effect on big-city dailies — changed the equation.

“The business is not as sickly as all the rhetoric would suggest, but a year later the industry is in declining health, with cost pressures galore,” Ms. Fine added.

That leaves bleak options for newspaper companies that lack the financial resources to ride out the current upheaval or do not have the ingenuity to reinvent themselves to remain profitable purveyors of information, analysis and entertainment in the digital age.

Knight Ridder, formed in 1974 by the merger of Knight Newspapers and Ridder Publications, initially defied conventional wisdom that newspaper chains could not produce excellent newspapers; it racked up a large slate of journalism awards. But by the early to mid-1990’s, newsprint costs were spiraling out of control, and revenue at many papers was sagging.

Knight Ridder responded by making deep reductions in its staff and scaling back its offerings. This was years before Mr. Sherman came calling, and it left Knight Ridder walking a narrow line.

“It was trying to promise shareholders improving margins at the same time it was trying to preserve the culture of quality, and in that sense it couldn’t be true to anyone,” Ms. Fine said. “But you can’t cut the journalism and still put out a good paper.”

Still, Knight Ridder’s profit margin hovered at 20 percent until this year, when it slipped to about 16.4 percent largely because of severance packages in Philadelphia and San Jose. That was almost three points below the industry average of 19.2. Historically, the newspaper industry has produced even higher margins, which helped to raise expectations of investors looking for value investments in traditional media stocks despite the industry’s problems.

Mr. Sherman’s Private Capital Management began investing in Knight Ridder in April 2000, and by 2004 it had become the company’s largest shareholder, with a 19 percent stake. Mr. Ridder said Mr. Sherman was optimistically buying newspaper stocks after the Internet bubble burst because he was driven by the belief that “the Internet is not going to be as big a factor for the industry, so we’ll go with newspapers.”

But by mid-2004, newspaper ad revenues had taken a turn for the worse and stocks across the industry started to slide. By the spring of 2005, Mr. Sherman, who, by some accounts, was overextended in newspapers, had fully 14 percent of his portfolio invested in the sector.

Mr. Sherman first approached Mr. Ridder in April 2005 about selling the company, according to proxy statements. Because of their stock structure, Knight Ridder and Gannett, in which Mr. Sherman also held a stake, were vulnerable to unhappy shareholders. According to people who have spoken with Mr. Sherman, he thought that Gannett was probably too big for any other newspaper company to buy, but he was also frustrated with Knight Ridder.

Last November, Mr. Sherman delivered a letter to the Knight Ridder board, saying that the company’s shares were undervalued; he pressed for an “aggressive” effort to sell it. He said Knight Ridder had failed to address four major issues: the consolidation of print advertising; media fragmentation that was diverting newspaper ad dollars to other media; margins that fell below the industry standard, and the lack of a strategy to leverage its content online.

MR. SHERMAN was intent on a sale and planned to carry it out by having his own slate of directors elected to Knight Ridder’s 10-member board, according to proxy statements. Mr. Ridder said the board believed him. “We were convinced that they would get three directors elected in April so they would have three of 10, then seven of 10 in April ’07 and then the game was over,” he said.

Had Mr. Ridder tried to resist, the agitators might have taken over the board and simply thrown Mr. Ridder out. “Wall Street would have sold him down the river in a heartbeat,” said Edward Atorino, a media analyst at the Benchmark Company, a financial research firm.

Once Mr. Ridder decided to sell, he did not discuss his company’s prospects publicly. But behind the scenes, according to several people involved in the talks with prospective buyers, Knight Ridder tried to elevate potential buyers’ interest by saying that there was still room to cut costs and that the company could become more profitable.

That pitch was based in part on a report by Morgan Stanley, which had said that a new owner could save $150 million a year by reducing Knight Ridder’s work force by 5 percent, trimming benefits and streamlining corporate expenses. Knight Ridder also suggested that copy-editing functions could be consolidated, even among far-flung papers. And it said that the physical size of the newspapers could be reduced, something that many papers, including The New York Times, are doing or are planning to do in order to save on newsprint costs.

Mr. Ridder’s public silence fostered a perception that he had no heart for a fight.

“He gave up,” said Brian P. Tierney, the adman who led the group of investors that bought the Philadelphia newspapers, The Inquirer and The Daily News. “I’m sure he could have found investor bankers who, if they saw the fight in your eye, they would have said, ‘You have a chance.’ But it’s like someone getting a bad report from the doctor and not trying to beat the disease.”

At the time of the sale, Ms. Fine recommended to Knight Ridder that it consider other options. “I said, if you have the conviction that the news business and the online are a win, put up a ‘work in progress’ sign and say that margins are going to go down” while the company retrenches, she said.

She said she still thought that Knight Ridder, as well as other newspaper companies, could benefit from fresh management at the top, “an outsider with a healthy respect for journalism but who has no ties to the way business has been done.”

Some thought that Mr. Ridder could have sold off pieces of the company in order to keep it afloat. William Dean Singleton, the chief executive of the MediaNews Group, which eventually bought four of the Knight Ridder papers from McClatchy, was one.

“In retrospect, if Tony had it in him to sell Philadelphia and Akron, as Gary has done, the company he had left would have looked good,” he said, referring to Mr. Pruitt’s sale of the Knight Ridder papers in those markets. Without those papers, Mr. Singleton said, “his financial performance would have been among the best in the industry.”

MR. RIDDER said that none of these options would have worked. Selling off underperforming papers would have produced hefty capital gains taxes. And even as those papers were lagging, they were still generating enormous cash flow, which he said he did not want to give up. Selling the papers, he said, would be a “liquidation” strategy, not a strategy for growth.

But to McClatchy, absorbing such taxes on the 12 papers it sold was worth the short-term hit. “We’ll pay $585 million in taxes as a result of selling those papers,” Mr. Pruitt said. “But long term, it put us in a stronger position. We wouldn’t have done the deal if we hadn’t been able to sell those papers.”

In any case, Mr. Ridder, who said Mr. Sherman had never complained to him about how he ran the company, said he felt he had two choices: “We could have this public battle and eventually lose, or we could have some control over the process.” If the company did not like the bids it received, he said, it could have refused them, although financial analysts said that would have created an uproar on Wall Street.

“Part of me would have loved to have had this fight,” Mr. Ridder said. “But what was the point? To look macho? I would have felt better, but there would be all this turmoil.” He said the chief lesson he had learned was this: “For those who have two classes of stock, don’t ever give them up.”

Knight Ridder had a single-class stock structure that made it vulnerable to restive shareholders in a way that companies with a regular class of common stock paired with a special class of voting stock — The New York Times and The Washington Post, for example — are not. But the lack of interested buyers in Knight Ridder, and broader changes undermining the industry’s financial health, mean that even companies with two-tiered stock structures may not remain insulated from pressures that continue to rock the industry.

Very few in the industry, either on the news side or the business side, seem to believe that public ownership is worth the grief, at least in the current climate.

“There’s a big lesson in terms of the pressures of public stock ownership,” said Larry Jinks, who had been a Knight Ridder senior vice president for news and was a top executive at two of its papers. “Particularly with mature businesses, those pressures can be destructive, and I think they were in the case of Knight Ridder. There’s a tendency over time with public ownership for the editorial presence in the corridors of power to decline.”

Mr. Appert of Goldman Sachs said he expected that the Knight Ridder experience might persuade public newspaper companies to take themselves private.

“You’ll have these financial pressures forever,” he said. “To the extent you want to maintain the same level of quality, maybe you are better off not being subject to the public financial market.”

Mr. Pruitt said McClatchy’s public ownership offered him a leg up: if it were private, he would not have been able to use stock as part of his currency when buying Knight Ridder. He said that going private is not a near-term option for him because his company has too much debt it needs to repay.

For the time being, he said, the lessons from the Knight Ridder sale are these: “The media business is tougher today than it was a generation ago, with a smaller margin for error. And in the age of shareholder activism, the consequences of market underperformance are great.”

Mr. Ridder, despite his sorrow at losing the company, said earlier this year that there was nothing he would have done differently. He said he had not reduced his expenses nearly as deeply as Wall Street sometimes wanted. “I guarantee you we could have had a higher margin if we had been tighter on costs,” he said.

Mr. Ridder said that there was a link between staff size and the quality of newspapers, but that staff reductions had not been a problem at Knight Ridder. “I wouldn’t say you could reduce the staff and it has no impact on the quality,” he said. “But I feel that over all, I don’t feel that any of our newspapers are inadequately staffed.” On Friday, he said, “I’ve not heard of anybody who has bought any of those papers say, ‘We think we need to add more resources.’ ”

Whether the former Knight Ridder papers will be better off, financially and journalistically, under new management remains to be seen. Some may get infusions of energy that had dissipated under Knight Ridder. But they will also continue to grapple with the Internet as they reorient themselves to a media world in which pressmen, truck drivers, reporters and editors are all rethinking how they do their jobs.