McClatchy looks perilously close to bankruptcy

An agreement between McClatchy Co. and its banks puts the country’s third-largest newspaper chain at risk of defaulting on its debt by the end of the year, according to credit analysts. If that happens, Bank of America and other creditors could either show leniency and rework the terms of their agreement or push the publisher of 30 daily newspapers, including the Miami Herald and Sacramento Bee, into bankruptcy.

In the current environment, banks are less likely to sustain companies on life support, said Shelly Lombard, an analyst at Gimme Credit. She pointed to the example of Idearc ( IAR - news - people ), a Yellow Pages publisher, which breached debt agreements and filed for bankruptcy in March. “Banks are starting to pull the plug on companies,” she said. “It used to be that banks worked with the clients because they were better alive than dead. Some of them may not be worth it.”

Elaine Lintecum, the company’s treasurer, declined to comment, citing a quiet period before its earnings announcement. Lintecum said McClatchy ( MNI - news - people ) will address its financial health during the earnings call in late July.

Like other newspaper owners, McClatchy, based in Sacramento, Calif., has suffered from declining advertising sales, which dropped 30% in the first quarter from a year earlier. What’s different about McClatchy is that it shoulders $2 billion in debt, much of it a result of the $4.6 billion acquisition of Knight Ridder in 2006.

Gary Pruitt, McClatchy’s chief executive, has slashed costs through laying off about a third of employees, cutting the dividend on its stock and trimming pay (see McClatchy Aims To Have The Last Newspaper Standing).

The newspaper chain’s agreement with the Bank of America ( BAC - news - people )-led group requires it to keep its debt below a ceiling of seven times one measure of its earnings (earnings before interest tax, debt and amortization). With declining revenues and $2.05 billion in debt, McClatchy’s debt ratio will sit at 5.7 after the debt exchange, according to estimates. From there, it’s a short slip to breaking its bank covenants: trailing 12-month EBITDA would only need to drop from $362 million to $294 million.

An analysis by the research firm CreditSights says a 40% drop in EBITDA each quarter--a more optimistic scenario than some estimates--would put McClatchy in violation of its bank agreement by the fourth quarter.

Banks may see little reason to give the newspaper owner more time to raise earnings or trim its debts, especially after its exchange offer failed to sway many bondholders. Its 7.125% notes currently yield 92%. From a bank’s perspective, that cash rewarding bondholders could be better used paying down its loans, Lombard said.

CreditSights estimates that McClatchy's assets are worth $750 million, less than the $950 million in bank loans. Banks may worry that these assets will sink further given more time.

McClatchy's fate looks increasingly out of its hands, Lombard said. “A lot of it depends on the economy.” If Internet advertising and print advertising rebounds before McClatchy manages to avoid tripping its covenants, then maybe it’s one newspaper chain that survives the recession. “It’s certainly within the realm of possibility,” she said.

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