Strategic Report for Tribune Co

STRATEGIC REPORT FOR TRIBUNE CO.

PATRICK FLEMMING SAMUEL MEEHAN BENJAMIN KRAUS

April 18, 2007

TABLE OF CONTENTS

EXECUTIVE SUMMARY ...... 3

COMPANY BACKGROUND...... 5

COMPETITIVE ANALYSIS ...... 9

INTERNAL RIVALRY...... 9 SUPPLIER POWER ...... 11 BUYER POWER ...... 13 ENTRY...... 14 SUBSTITUTES AND COMPLEMENTS...... 15

SWOT ANALYSIS...... 17

FINANCIAL ISSUES ...... 22

STRATEGIC ISSUES AND RECOMMENDATIONS...... 28

EXECUTIVE SUMMARY Tribune Company is a media, entertainment, and broadcasting company which operates in the publishing, radio, television, and sports industries. Its primary revenues are in the newspaper industry, where it owns such powerhouses as the Chicago Tribune and The Los Angeles Times. Tribune’s varied and unique holdings also include television stations (23 major market TV stations, including a 31% equity stake in the Food Network) and radio stations (most importantly its WGN radio station) as well as the Chicago Cubs Major League Baseball team. In 2006, 73% of Tribune’s revenues came from publishing and 27% came from broadcasting and entertainment. Of the revenues from publishing, about 79% came from sales of advertising in print and online, about 15% came from circulation, and the remaining 6% from various other sources.

Tribune truly is a giant among its peers in media, entertainment, and broadcasting. Its national reach is almost unparalleled among its competitors: eight million people read its newspapers daily and eleven million read on Sunday. Unlike its competitors, its internet portfolio is strong and growing with 50 newspaper websites attracting an audience of at least 13 million visitors per month. Tribune’s broadcasting portfolio is also quite strong, with 23 stations reaching nine of the top ten media markets, including the top three markets where it has a strong presence (Chicago, Los Angeles, and New York). The company’s national flagship WGN Superstation (which broadcasts Cubs games nationally) reaches 67 million viewers.

Tribune currently faces several pressing strategic issues. First, the entire publishing industry is mired in one of the worst deteriorations of print advertising spending in years. Print ad sales fell 3.7% in the fourth quarter of 2007 after falling 2.6% in the third quarter and .2% in the second quarter. Classified ad revenues have been hit particularly hard; historically, classified sales compose about half of revenues from advertisers for publishers like Tribune. In addition to a slowdown in print advertising, paid circulation has

3 been trending down since the mid-1980s, and the trend has accelerated in the last several years. Since 2002, Tribune’s shares have fallen almost 40%. Disappointed with the company’s lagging share price, the company’s largest shareholders, the Chandler Family trusts, agitated the board to put the company up for sale in the fall of 2006 in order to return value to shareholders.

The auction languished for months with only tepid interest from private equity groups and other suitors. In April 2007, after six months of boardroom warfare over the failing auction, the board accepted a buyout offer of $34/share from Chicago real estate magnate Sam Zell. If the deal is approved by shareholders in the fourth quarter of 2007 as is expected, ownership of the company will transfer to Mr. Zell and an Employee Stock Ownership Plan, which is being used in the deal for tax purposes. The buyout is highly leveraged and will leave Tribune with expected annual interest payments of over $1 billion (about four times its debt service in 2006) compared with expected net income of $1.2 billion. In the face of such a razor thin margin for error, Tribune’s new owners will quickly need to decide how to restructure or repackage and sell parts of the company.

COMPANY BACKGROUND Tribune Company, founded in 1847, is a leading worldwide media company based in Chicago, Illinois. Its operations include newspaper publishing, television and radio broadcasting, as well as interactive businesses. With unique properties reaching more than 80 percent of household in America, Tribune is the only media company with newspapers, TV stations, and websites in the top three U.S. markets, New York, Los Angeles, and Chicago.

Tribune’s notable newspaper holdings include the Los Angeles Times, Chicago Tribune, Newsday, Baltimore Sun, South Florida Sun-Sentinel, Orlando Sentinel, and Hartford Courant. The company’s diversified entertainment holdings include Superstation WGN on national cable, WGN-AM radio in Chicago, as well as the Chicago Cubs Major League Baseball team.

The company printed its first copy of the Chicago Tribune in June, 1847, with all 400 copies of the first-ever edition printed on a hand press in a one-room headquarters in Chicago. Though the Chicago Fire of 1871 destroyed the original headquarters in downtown Chicago, the Tribune was back in just two days claiming in an editorial, “Chicago Shall Rise Again.” Then-editor and part owner Joseph Medill was elected mayor and led the city’s reconstruction, illustrating Tribune’s connection with the city.

Tribune’s WGN radio station was born in in 1924. Its call letters stand for “World’s Greatest Newspaper,” the Tribune’s slogan. WGN was an innovator in radio for the time and was the first radio station to broadcast the World Series, the Indianapolis 500, and the Kentucky Derby. In an effort to expand its media presence, the company entered the television industry in 1948, founding WGN- TV in Chicago and, later, WPIX-TV in New York. Both stations are now affiliates of The CW Television Network, the result of the merger of The WB and UPN Networks. In 1981, Tribune Broadcasting Company was formed. The company also acquired the Chicago Cubs baseball team in 1981 from the Wrigley family for

$20.5 million. The company’s WGN radio and television stations had covered the Cubs since the stations first started many years earlier. (Cubs games have aired nationally since 1978.) Tribune’s television networks have tremendous national reach; through cable and broadcast satellite, Superstation WGN reaches about 60 million U.S. homes outside Chicago.

Based in Hollywood, California, and founded in 1982, subsidiary Tribune Entertainment Company develops, produces and distributes television programming for Tribune and non-Tribune stations nationwide. Tribune Entertainment currently hold the distribution rights to over 15 series including, notably, Comedy Central’s popular animated hit South Park, as well as some film packages from DreamWorks SKG, the production house responsible for Shrek, Anchorman, and Flags of Our Fathers, among others.

After 136 years of private ownership, Tribune became publicly owned (NYSE: TRB) in 1983 with an initial offering of 7.7 million shares valued at $206 million. The opening price per share was $26.75. In the heady M&A environment of the mid-1980s, strategic acquisitions helped propel significant growth at Tribune after the IPO. In 1985, Tribune purchased KTLA-TV in Los Angeles for $510 million. The acquisition made Tribune the only non-network company to own VHF stations in the country’s top three markets; this was a key step towards its strong positioning in the country’s top three markets today. Television stations in Atlanta and New Orleans were acquired shortly before KTLA, and the Daily Press (Newport News, Va.) joined Tribune’s newspaper group in 1986. The dramatic growth fueled by acquisitions in the 1980s continued in the 1990s after the Federal Communications Commission (FCC) relaxed crossover media ownership rules. Mirroring industry consolidation, Tribune expanded its holdings in the top 40 markets. The company emerged from this period of consolidation as one of the major media powerhouses in the country.

In 1995, the company acquired an equity stake in thenascent WB Television Network. The WB’s target market of teens and young adults is one of the most

6 important to advertisers trying to reach consumers in the formative years when consumers develop brand loyalty. Tribune continued its acquisitive streak in 1997, adding seven more television stations to the portfolio by purchasing Renaissance Communications. In addition, the company divested its legal publishers, selling to Reed Elsevier for $1.1 billion. In 1999, the company formed Tribune Interactive. The new branch of the company was designed to handle the growing online presence of the company’s newspaper, television, and publishing businesses.

In June, 2000, Tribune acquired Time Mirror Co., publisher of the Los Angeles Times, for $8.3 billion. The acquisition of Times Mirror Co. made the Los Angeles Times-founding Chandler family Tribune Company’s largest shareholders. By most accounts the merger has been largely a disappointment. A significant fall in print ad revenue nationwide, particularly in Tribune’s biggest markets (Chicago, Los Angeles, and New York), made it difficult to realize the goal of finding synergies in combining the ad businesses of TV stations and newspapers in the nation’s big markets. The Chandlers, upset with a lagging share price over the last several years, instigated the auction of the company that officially began in September 2006 with the board’s formation of a special committee of independent directors.

Late in 2001, in an effort to refocus on its core media and entertainment businesses, Tribune sold Tribune Education to McGraw-Hill, Times Mirror Magazines (part of the Times Mirror acquisition) to Time Inc., and its flight information services provider to Boeing. In an effort to offset declining classified ad sales, Tribune and Knight Ridder joined in a venture to merge CarrerBuilder.com and CareerPath into CareerBuilder.com, a job site that would a year later acquire rival HeadHunter.net—Tribune has continued to increase its online classified ad presence, and management hopes that online ads will account for 12-15% of advertising revenues by 2010.

Due to a precipitous decline in print advertising revenue during the economic slowdown in 2001—then-CEO John Madigan called it, “the worst advertising environment since the depression”i—major cost-cutting was announced and executed with wages being renegotiated. A year later, however, the company bought Chicago magazine for $35 million and also added to its television station portfolio, buying two Indiana stations for $125 million. Madigan handed over the title of CEO to executive Dennis FitzSimmons in 2003 (he remains CEO currently and will remain on board for the immediate future if Sam Zell’s proposal to take the company private for $34 per share is approved by shareholders later this year, as is expected). FitzSimmons continued to grow Tribune’s already sizeable television portfolio by spearheading the purchases of stations in St. Louis and Portland, Oregon for $275 million.

The company moved the majority of its television stations in 2006 to a new network called The CW (a joint venture between CBS Corp. and Warner Bros. Entertainment which was formed when The WB and UPN Networks folded last year). In addition to the company’s 15 CW Network affiliates, Tribune also has one Fox affiliate and several ABC affiliates.

COMPETITIVE ANALYSIS Tribune Company is a media, entertainment, and broadcasting company which operates in the publishing, radio, television, and sports industries (primarily SIC codes 2711, 4832-3, and 7941). Its primary revenues are in the newspaper industry, where it owns such powerhouses as the Chicago Tribune and The Los Angeles Times. As we have discussed, Tribune’s varied and unique holdings also include television (23 major market TV stations, including a 31% equity stake in the Food Network) and radio stations (most importantly its WGN radio station) as well as the Chicago Cubs Major League Baseball team. There exists no pure play to compare to Tribune, so we will broadly consider Tribune’s competitors in newspaper publishing as well as the broadcast and entertainment industries.

INTERNAL RIVALRY There are few publicly traded (or private) firms that compare perfectly with Tribune because the firm is composed of such a varied selection of businesses. Tribune’s main competitors in the publishing industry, however, include Dow Jones & Company, Inc., publisher of The Wall Street Journal; Gannett Co., Inc., publisher of USA Today and the nation’s largest newspaper publisher by circulation; and The New York Times Company, publisher of The New York Times, The Boston Globe, and the International Herald Tribune. Other competitors include Time Warner Inc., Hearst Corp., CBS Corp., ABC, NBC, and News Corp.

We will focus much of our analysis of the competitive landscape on publishers and media and entertainment companies that operate in Los Angeles, Chicago, and New York, the nation’s three largest markets and those in which Tribune primarily operates. In 2005, 73% of Tribune’s revenues came from publishing and 27% came from broadcasting and entertainment. Of the revenues from publishing, about 79% came from sales of advertising in print and online, about 15% came from circulation, and the remaining 6% from various other sources.ii

This is on par for the newspaper industry as a whole, where newspapers expect to earn about 80% of revenues from advertising and 20% from circulation.iii

To put Tribune’s power as a publisher in perspective, the Tribune and the Los Angeles Times are the eighth- and fourth-ranked newspapers by circulation respectively (see Table 1 below). USA Today is ranked number one, with an average weekday circulation of over 2.2 million compared only about 840,000 copies for the Los Angeles Times.iv Despite its size, Tribune has failed to outperform its rivals in recent years (see the Financial Issues section) and its tendency to acquire has not always yielded the best results. Most recently, the Times Mirror merger failed to create synergies and cost-savings that managers and analysts expected.

TABLE 1: The Top 15 American Newspapers (by Circulation)

NEWSPAPER OWNER 1. USA Today Gannett Co. 2. The Wall Street Journal Dow Jones & Co. 3. The New York Times New York Times Co. 4. Los Angeles Times Tribune Co. 5. New York Post News Corp. 6. New York Daily News Daily News LP 7. The Washington Post Washington Post Co. 8. Chicago Tribune Tribune Co. 9. Houston Chronicle Hearst Corp. 10. Newsday (Long Island, N.Y.) Tribune Co. 11. Arizona Republic (Phoenix) Gannett Co. 12. The Boston Globe New York Times Co. 13. Newark Star-Ledger Advance Publications 14. San Francisco Chronicle Hearst Corp. 15. Minneapolis Star Tribune Avisa Capital Partners Source: Audit Bureau of Circulations, The Wall Street Journal The entire publishing industry is mired in one of the worst deteriorations of print advertising spending in years. Print ad sales fell 3.7% in the fourth quarter of

2007 after falling 2.6% in the third quarter and .2% in the second quarter. Classified ad revenues have been hit particularly hard; historically, classified sales compose about half of revenues from advertisers for publishers like Tribune. Classified ad revenue was down 9% in December alone and this slide is expected to continue through the first half of 2007.v Many of the classified listings that would once have automatically gone to newspapers are now listed online at sites like Craigslist for free. This migration from print to online classified ads is expected to continue into the future. Tribune hopes that its strong positioning in the internet classifieds arena will offset the industry-wide flee from print advertising.

SUPPLIER POWER Newsprint is traditionally one of the most major (and unpredictable) cost components in the publishing industry. As consolidation of newsprint mills in North America has increased, suppliers have been able to wield considerably more pricing power. As one of the largest publishers in the United States, Tribune has historically been able to keep newsprint costs relatively low by purchasing in volume and engaging in long-term contracts. This year’s annual report warns, however, that “[f]ailure to maintain our current consumption levels, further supplier consolidation or the inability to maintain our existing relationships with our newsprint suppliers could adversely impact newsprint prices in the future.”vi

Newsprint consumption is down nearly 10% this year and prices have fallen about 5% from their highest levels in 2006. In an illustration of the great lengths publishers have had to go to cut costs, The Wall Street Journal in January cut its pages down from 15 inches to 12 inches in width. Continued declines in consumption by publishers may push newsprint prices further down in 2007. In January alone, newsprint prices slid more than 1% after falling 2-3% in the preceding months. If the newspaper industry and print advertising continue to decline as they have over the last several years, those newspapers that do weather

the storm will benefit from lower newsprint prices caused by reduced demand for the commodity.vii

Tribune’s 23 television stations get the majority of their content from outside sources, though Tribune Entertainment Company does supply some content in- house. Costs of syndicated programming are significant and often involve multi- year contracts—last summer, for example, Tribune acquired the syndication rights for the hit animated comedy Family Guy to begin airing in Fall 2007. Tribune currently has the syndication rights to Sex in the City through 2009, According to Jim through 2010, Friends through 2012 and Everybody Loves

Raymond through 2013 (excluding Raymond’s major markets).viii

TABLE 2: Tribune’s Formidable Television Station Portfolio

Source: Tribune Co. Form 10-K (2007)

The Chicago Cubs have a unique supply: Major League Baseball players. In the era of free agency, player salaries have skyrocketed. The Cubs, often affectionately referred to as lovable losers, have resorted this season to spending big in an effort to win. In a $300 million spending spree, the Cubs signed outfielder Alfonso Soriano, re-signed third baseman Aramis Ramirez, and added two competent above-average starting pitchers. Though market forces should in theory bring player salaries in line with the value they bring to their team, in practice players (and their agents) wield a significant amount of bargaining power in contract negotiations. Given Mr. Zell’s intention to sell the Cubs after the 2007 season, we do not expect the Cubs to spend any more money on player acquisitions this season.

BUYER POWER The two main buyers that publishers face are readers (viewers in the case of television) and advertisers. Both groups are facing more options at lower prices than ever before. This increased competition for both consumers’ and advertisers’ dollars gives buyers significant power and requires publishers like Tribune to either enhance offerings, lower prices, cut costs, or exit unsuccessful and declining businesses.

In addition to dwindling ad sales, newspaper circulation is steadily falling. Circulation of Tribune’s dailies was down 4.5% in 2006 from 2005 levels; Sunday circulation was down 4.4%. Revenue growth has been flat and earnings have been declining since 2004 for Tribune’s three largest newspapers in the three largest markets (Chicago Tribune, Los Angeles Times, and Newsday in New York). Tribune’s revenue summary for the period ended March 4, 2007 indicated advertising revenues were down 5.1% and circulation was down 7% year-over-year. This troubling negative trend in readership and circulation revenues is pervasive throughout the newspaper industry and is expected to continue.

ENTRY The publishing industry is fragmented and always in a state of flux. There are more than 65,000 publishers in the United States, according to Standard & Poors.ix Entry is always possible, especially as we expand the definition of the industry to wherever the printed word exists. Anyone can start their own blog this second and compete for eyeballs with Tribune, McClatchy, McGraw-Hill, and Dow Jones—but to become popular and one of the biggest publishers in the world is no small feat. Newspapers have high fixed costs tied up in printing facilities and national networks; indeed, it is prohibitively expensive to enter the national newspaper publishing industry. Entry most often comes via acquisition.

As advertising dollars continue to migrate away from traditional print media to the internet and the degree of competition from internet news destinations continues to increase, entry becomes cheaper and easier. A printing press is no longer required equipment. Indeed, all that is necessary is internet access. Thus, although traditionally threat of entry has been quite low, today’s connected world makes entry into publishing, media, and entertainment easier than ever. Instead of turning on the TV, consumers turn to YouTube to watch news and entertainment clips and publish their own videos. They read blogs and Salon.com to catch up on the world. Though the threat has been here for years, it is now more imminent than ever.

In television, the threat of entry is extremely low. There are high fixed costs associated with operating television stations and the right to broadcast is allowed on a license basis governed by the FCC. This gives incumbents an advantage because newcomers must jump through significant regulatory hurdles even before they can begin to attempt to steal market share from entrenched broadcasters.

SUBSTITUTES AND COMPLEMENTS Readers of the news are increasingly moving to the internet to get their daily fix of headlines. For savvy internet users—and, increasingly, even comparatively less savvy users—it is quite easy to aggregate news from many different sources into a one-stop homepage of all the information you need. Many such news aggregators cull RSS (Real Simple Syndication) feeds from popular and unpopular sources alike; most of these “reader” programs are free and their use is growing. Google and Yahoo!, for example, each offer their own customized homepages where users can choose what syndicated content they want to see and how they want it displayed. One can personalize a My Yahoo! page with news headlines and analysis from such varied sources as the San Francisco Chronicle Sports Section, political blogs like Daily Kos, as well as the popular blog of Harvard economics professor Greg Mankiw.

Amid already sagging circulation, the ease with which consumers can go to Google’s or Yahoo’s news sites instead of traditional sources is quite worrying to the old guard media giants like Tribune and Dow Jones. Warren Buffett writes in this year’s Berkshire Hathaway annual report, “The economic potential of a newspaper Internet site—given the many alternative sources of information and entertainment that are free and only a click away—is at best a small fraction of that existing in the past for a print newspaper facing no competition.”x In short, traditional newspapers are quickly losing ground to bloggers and newer media in cyberspace.

In the television industry, the two main substitutes for live network television programming are time-shifted watching via digital video recorders (DVR) like TiVo and, as with print media, the internet. Although DVRs still only penetrate 16% of the United States market,xi they present a significant challenge to television networks whose advertisers cry fowl when consumers can fast-forward through the commercial spots they pay dearly for. (Notably, ratings company Nielsen is developing an improved ratings system in concert with broadcasters to

track if commercials are being skipped over by DVR users.) As DVRs penetrate deeper into the national market and consumers can more easily substitute away from live television to time-shifted viewing, thereby avoiding commercial breaks, advertisers will demand rate cuts or broadcasting companies like Tribune will have to come up with an alternative rate structure. In addition to the DVR problem, consumers are also moving out of the living room to watch video content. YouTube’s popularity has grown immensely over the past year and is the place where many people catch up on popular news clips and interviews and even entire episodes (albeit illegally) of hit shows like Comedy Central’s The Daily Show that they would otherwise watch on television with advertisements (the ads are usually cut out of illegally uploaded TV episodes). The popularity of YouTube and TiVo is only a symptom of a greater trend by consumers to wrest control of programming schedules from the broadcasters. Nowadays, it is just as easy to watch this week’s episode of ABC’s hit show LOST on Apple’s iTunes (for a fee) or on ABC’s website (free with commercials) as it is to watch live on television. This trend is an important one for broadcasters and will continue to shake up the advertising revenue streams as dollars move from traditional 30-second television spots to the internet.

SWOT ANALYSIS Strengths Tribune truly is a giant among its peers in media, entertainment, and broadcasting. Its national reach is almost unparalleled among its competitors. Eight million people read its newspapers daily and eleven million read on Sunday. As we have discussed, its internet presence is strong and growing with 50 newspaper websites attracting an audience of at least 13 million visitors per month. Tribune’s broadcasting portfolio is also quite strong, with 23 stations in nine of the top ten media markets, including a strong presence in the nation’s top three markets (Chicago, Los Angeles, and New York). The company’s flagship WGN Superstation (which broadcasts Cubs games nationally) reaches 67 million viewers.

In addition to an ability to leverage its size via economies of scale, Tribune has a formidable internet presence. Revenue at Tribune Interactive was up 31% in the fourth quarter of 2006, up 28% in the third quarter, up 27% in the second quarter, and up 30% in the first quarter. Online classified revenue was up 26% in the fourth quarter. These results are very encouraging and indicate that Tribune’s online strategy is bearing fruit. The company has a 42% equity stake in CareerBuilder.com through a strategic partnership with rivals Gannett and Knight Ridder. The job-search website is the market leader in both job postings and site traffic; revenue at CareerBuilder was up 29% in the fourth quarter of 2006 while rival Monster.com has recently predicted an expected slowdown in growth in the first half of 2007, good news for Tribune. In the face of declining sales of traditional print classified ads, Tribune owns a 28% equity stake in Classified Ventures, operator of cars.com and apartments.com. In a separate joint venture with Knight Ridder (since acquired by McClatchy in 2006) and Gannett, the three publishers own 75% of Topix.net, a service that monitors the news.

The company’s goal in increasing its internet presence has been to offset declines in advertising revenue, particularly in classified ads. To that end, it continues to seek out the dollars that have steadily been fleeing from print to the internet. In late 2006, Tribune announced intentions to purchase real estate listing website ForSaleByOwner.com and will continue to expand online in an effort to meet the goal of 12% to 15% online revenue exposure by 2010.

Weaknesses For better or worse, Tribune is a conglomerate and thus its overall valuation could be subject to a “conglomerate discount.” The company’s holdings across the board in media, publishing, and entertainment make it difficult to convince shareholders and outsiders alike that the company has a focused vision among so many disparate companies, divisions, and managers competing for executives’ attention. This could be one great benefit of Mr. Zell’s taking the company private—the opportunity to focus, reorganize, and sell various parts at retail prices after acquiring them in a package at wholesale.xii

Tribune is currently operating in one of the worst print advertising environments in years. Advertising revenues were down 5.1% in February 2007 year-over-year. Classified ad revenues, already in a downward trend, were hit particularly hard over the past year. Classified revenue was down 13.3% with real estate down 14%, help wanted down 17%, and automotive down 14%. Meanwhile, interactive revenues, primarily composed of online classifieds, were up 17%, evidence of Tribune’s growing online presence.xiii It is unlikely that Tribune can stop the bleeding completely by increasing online classified sales only, but it is at least encouraging that its recent internet ventures are showing growth.

Paid circulation has been declining at a more rapid rate in the last two years. the negative trend is not a new phenomenon, however. Newspaper circulation has been steadily declining since the mid-1980s—circulation reached its peak in 1984

18 with 1,600 morning and evening dailies with paid circulation of 63 million. By 2003, there were only 1,450 dailies with paid circulation of 53 million.xiv

FIGURE 1: Paid Circulation for Morning/Evening Daily Newspapers and Sunday Editions, 1990-2003

Morn / Eve and Sunday Circ Both Declining

64,000,000

62,000,000

60,000,000

58,000,000 M&E Sunday 56,000,000 Paid Circulation

54,000,000

52,000,000

50,000,000 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Year

Source: Newspaper Association of Americaxv

Increasing popularity of cable television through the late-1980s initially helped to spur the decline in popularity of dailies. In the 1990s, the Internet further helped to aid in the negative trend in circulation as people turned to the web for instant news updates.

Opportunities Tribune owns some of the most unique publishing, media, and entertainment assets in the world. If it can time sales right and find the highest bidder, Mr. Zell and Tribune employees can benefit immensely from a strategy of buying wholesale and selling retail. While we do not recommend an immediate break-up

and fire-sale of Tribune, the company will find itself needing to service a high level of debt over the next several years after the company goes private later this year. One way to find cash to cover the interest payments will be to sell assets.

Under the leadership of CEO Dennis FitzSimmons, Tribune expects to book more than $100 million of a planned $200 million in cost cuts over 2007. If costs can be cut more than expected or newsprint consumption by the publisher falls more than expected (or newsprint prices continue to slide), then Tribune will benefit.

Threats If the negative blip in advertising and circulation revenues over the last year does not rebound and continues to trend downward, Tribune’s main sources of revenue are greatly threatened. Advertising spending is Tribune’s main source of revenue and should industry conditions continue to weaken, Tribune’s strength in the industry will be compromised.

Macroeconomic factors play a key role in determining advertising spending, particularly spending on classified ads. Industry insiders have blamed the precipitous decline in real estate classified advertising on the overall slowdown of the housing market in the United States over the last year. California and Florida were hit particularly hard by the slowdown in real estate classified spending. In Tampa, Florida, for example, real estate classified ad revenue fell 44% compared to February 2006, and overall classified ad revenue was down 27% in the city.xvi

Tribune is also more exposed than its peers to downturns in the retail sector which can lead to declines in help wanted advertising. When department stores in particular cut ad spending, publishers like Tribune feel the heat. A February, 2007, report from Deutsche Bank warns that the Federated/May merger may have a significant impact on ad revenues at Tribune as together the two department stores would be the single largest advertiser with Tribune.xvii

Tribune’s crossover broadcast, entertainment, and newspaper holdings are concentrated highly in top-30 markets and thus make the company more susceptible to the risk of re-regulation and stricter enforcement of crossover ownership rules by the FCC. For the Zell-led deal to be finalized, the FCC must allow the transfer of broadcast licenses to new ownership. FCC rules state that one company is not allowed to own both a newspaper and a television station or radio station in the same market. Currently, Tribune has waivers from the FCC to do so in five markets: Chicago; Fort Lauderdale, Florida; Hartford, Connecticut; Los Angeles; and New York. News reports indicate that there is little reason why the FCC would disallow the transfer of the licenses and waivers.

FINANCIAL ISSUES Tribune’s Ballooning Debt Load Tribune’s most pressing concern going forward is the level of debt it will be carrying when Mr. Zell’s go-private transaction is approved by shareholders later this year. Mr. Zell’s offer of $34/share values Tribune at roughly $8.2 billion. If the deal is completed on schedule by the end of 2007, Tribune will be saddled with more than $12 billion in debt, about 10 times annual cash flow, a higher multiple carried by most businesses in the media industry. Shortly after the deal was announced, one analyst at Barclays wrote, “We think it is possible that Source: The Wall Street Journal Tribune is leveraged higher than the total assets of the company after taxes.”xviii

Mr. Zell will contribute only $315 million in equity, leaving Tribune with a debt- to-2007-expected-profits (E-EBITDA) ratio of 10x, “far too high for secularly declining businesses,” Lehman Brothers analyst Craig Huber wrote in early April 2007.xix A Goldman Sachs reportxx notes that the new debt load of over $12 billion will leave Tribune with estimated annual interest payments of over $1 billion (compared with $260 million in 2006) and expected net income of just $1.3 billion, leaving only the smallest margin for error if the deal is completed as planned.

The details of the two-step take-private transaction are relatively complex, and thus merit a summary review. In the first stage in the second quarter of 2007, the company will accept a $4.3 billion tender offer at $34/share for 126 million shares. Concurrently, an Employee Stock Ownership Plan (ESOP) will buy 9 million new shares and Mr. Zell will buy 1.5 million new shares. The first stage of the buyout will be financed by $250 million in equity from Mr. Zell and newly issued debt.

Source: The Wall Street Journal

In the second stage, another tender offer for the remaining shares will be made at $34/share and Tribune will merge with the ESOP. At this point, Mr. Zell will invest another $65 million, bringing his total initial equity stake to $315 million. In the future, Mr. Zell will have the right to acquire 40% of the company and, should the deal turn out well, Mr. Zell will reap outsize gains. Tribune will issue $8.4 billion in new debt to complete the transaction.

Mr. Zell’s offer of $34/share values the company at roughly $8.2 billion, or 9.1x 2006 EBITDA. A year ago, Knight Ridder was acquired by McClatchy for 9.6x trailing EBITDA—in the 2 months following the announcement of the deal, Knight Ridder stock sold off 9%. Since then, the acquisition has not gone well for McClatchy: since the deal was completed in June 2006, McClatchy’s shares have fallen from highs in the mid-40s to current lows in the low-30s. This does not bode well for current Tribune shareholders and seems to indicate why the Tribune’s own auction languished for months with only tepid interest.

On the upside, between 1995 and 2005 historical newspaper transactions were completed at between 11x and 13.5x EBITDA, meaning that if the industry does rebound from its current slump, Mr. Zell and Tribune’s future employee-owners could see significant value creation in the newspaper portfolio. This could be false hope, however, considering that the newspaper sector is currently publicly valued at 8.4x 2006 EBITDA and prospects for an immediate rebound in earnings in 2007 and 2008 not strong, according to analysts at Deutsche Bank, Goldman Sachs, and Lehman Brothers. The future owners of Tribune may find

value in selling off assets in the television portfolio, however. Historically, television station transactions were completed for ratios of around 15x EBITDA over the last decade.xxi

TRB’s Share Price Lags the Market and the Industry Tribune’s stock price has underperformed the market (as tracked by the S&P 500) since the summer of 2004. This underperformance is one of the main reasons why the Chandler Family Trust demanded the board begin exploring strategic alternatives for creating value for shareholders.

FIGURE 2: TRB Performance Relative to the S&P 500, 2002-2007

Source: Yahoo! Finance

Though the declines in advertising spending and circulation have been widespread throughout the newspaper industry, Tribune’s diversification in television and broadcasting has failed to save it from the same fate as its peers in publishing. As we can see from Figure 3 below, without the recent pop in its share price due to acquisition speculation, Tribune would have performed as

24 poorly as Dow Jones and Co. over the last 5 years, whose stock has seen a 40% slide over the period. Only The McClatchy Co., whose stock has plummeted following its acquisition of Knight Ridder last year, and New York Times Co., have performed worse than both Tribune and Dow Jones and Co.

FIGURE 3: STOCK PERFORMANCE RELATIVE TO PEERS, 2002-2007

WPO: Washington Post SSP: E.W. Scripps Co. MNI: The McClatchy Co. GCI: Gannett Co., Inc. DJ: Dow Jones and Co., NYT: The New York Times Co.

Source: Yahoo! Finance Tribune has been unable to increase revenues significantly over the last three years due to the declining advertising and circulation environment in the newspaper industry. Investors have responded to the poor results by selling off TRB nearly 40% over the last three years. Table 3 shows Tribune’s growth over the last three years as compared to both the publishing industry and to the overall market. Compared to both the industry and the overall market, Tribune has faired terribly, logging negative growth of revenue, net income, and earnings per share (EPS).

TABLE 3: Growth Compared to Industry and Market (last 36 months)

Tribune Industry Market Growth Co. Median Median 36-Month Revenue Growth -1.40% 15.20% 38.90% 36-Month Net Income Growth -33.40% 21.70% 50.50% 36-Month EPS Growth -22.30% 24.80% 45.80% Source: Hoover’s Tribune’s poor share performance may be the result of the market pricing in a “conglomerate discount” because of the company’s disparate holdings across the publishing, media, and broadcast industries. Are the synergies really great enough to justify a publishing and media company owning a Major League Baseball team? The market seems unconvinced. Tribune’s share performance is particularly disappointing considering its relatively robust margin comparisons with the industry and the overall market. Double-digit profit margins have historically been typical of the publishing industry. Tribune’s 10.8% net profit margin is on par with the industry and above the market median (see Table 4 below).

TABLE 4: Profitability Compared to Industry and Market Tribune Industry Market Profitability Co. Median Median Gross Profit Margin 50.40% 49.60% 51.60% Pre-Tax Profit Margin 18.30% 7.50% 6.60% Net Profit Margin 10.80% 5.20% 5.10% Return on Equity 10.80% 11.20% 9.60% Return on Assets 4.30% 3.60% 1.60% Return on Invested Capital 4.60% 6.20% 4.20% Source: Hoover’s Tribune’s valuation ratios support the conglomerate discount hypothesis. Tribune’s shares are trade at lower price-to-earnings, price-to-book, and price- cash-flow ratios than both the industry and market medians (see Table 5 below).

TABLE 5: Valuation Compared to Industry and Market

Valuation Ratio Tribune Industry Market Co. Median Median Price/Sales 1.43x 1.24x 2.26x Price/Earnings 15.18x 19.48x 19.35x Price/Book 1.82x 2.19x 2.21x Price/Cash Flow 10.01x 11.15x 13.54x Source: Hoover’s Again, Gotham Global would like to emphasize that Mr. Zell and the future employee-owners can potentially take advantage of this discount by selling off parts of the company at “retail” prices in the years following the take-private transaction.

STRATEGIC ISSUES AND RECOMMENDATIONS The Chicago Cubs Because Sam Zell is an owner of the cross-town Chicago White Sox, Major League Baseball rules require that he divest his ownership interest in at least one of the teams. We strongly recommend that Tribune do as much as possible to get out of this potential “must-sell” position in order to avoid depressed offers for the Cubs (expected in the range of $600-$700 million). Though news reports around Mr. Zell’s recent take-private offer for Tribune Co. have indicated his intention to sell the Cubs, we recommend that Mr. Zell and Tribune’s current management initiate a focused but subtle public relations campaign to reverse what has now become assumed by the popular press. If Tribune is in a must-sell position, the likelihood of receiving low-ball offers is much higher. If, however, Tribune’s management can credibly say that the Cubs will not necessarily be sold (i.e., under the new ownership, Mr. Zell may choose instead to divest his stake in the White Sox), then Tribune will be in a much stronger bargaining position after the 2007 baseball season (the most likely time the team will be sold).

The Cubs have an uphill battle this year in their quest to win the National League Central, where the reigning World Series Champ St. Louis Cardinals are picked to win. This off-season, the Cubs spent $300 million in an effort to bolster a roster that year after year is affectionately full of media-adorned lovable losers. Management signed outfielder Alfonso Soriano for $136 million for eight years, gave third baseman Aramis Ramirez a $75 million extension for five years, and added two more above-average starters for another roughly $60 million. This off-season’s free agent market was more sellers’ market than it has been in several years, so the Cubs were probably the victim of the winner’s curse with their bids (particularly for Soriano, who, though extremely talented, tends to strike out often and can be inconsistent). Mark Prior, Kerry Wood, and Carlos Zambrano were the best one-two-three starting pitchers in baseball three or four years ago; this is no longer the case (Wood will be making relief appearances only for at least the foreseeable future). Prior and Wood show no ability to stay

healthy. Zambrano is an ace in his own right, but the Cubs did not sign him to an extension this off-season past the 2007 season. We strongly believe that lovable winners will sell for a higher price after the 2007 season. Under the most favorable conditions, if the Cubs can win the NL Central—or, at the least, make a good run—Tribune will be in a strong position to sell the team after the 2007 season.

It bears noting, however, that even in losing seasons the Cubs are one of the most popular shows in town. Last season the Cubs had the worst record in the National League, yet still managed to fill Wrigley Field to 95% capacity, second only to the Boston Red Sox (another club that is as much cult icon as baseball team). Already just the prospect of a sale of the Cubs in the late 2007 is generating buzz among prospective buyers. Mark Cuban, owner of the NBA’s Dallas Mavericks, Jerry Colangelo, owner of the Phoenix Suns, and Donald Trump have all expressed interest in the past and recently. In Chicago, Don Levin, the owner of a minor-league hockey team, and Michael Heisley, owner of the NBA’s Memphis Grizzlies have also expressed interest. The Wall Street Journal notes that “sales of sports teams can be contentious and don’t necessarily go to the highest bidder.” The Red Sox, for example, were sold in 2002 for $660 million to John Henry when another bid for $750 million was still outstanding.xxii

The off-season spending spree that Tribune engaged in does somewhat complicate any deal. New owners may want to re-shape the team and undo some of the $300 million in signings that Tribune made over the last six months. This could certainly play a role in any negotiations.

The Los Angeles Times Southern California’s flagship newspaper has been a thorn in the side of Tribune since the acquisition of Times Mirror Co. in 2000. In a dispute that has played out very publicly over the last year, Times executives and editorial staff have made it clear that Tribune’s cost-cutting from Chicago is not well-received in Los Angeles. Amid disputes with Tribune over cost-cutting at the Los Angeles

newspaper, publisher Jeff Johnson stepped down in October, 2006, and long- time editor Dean Bacquet followed suit in November, 2006. Both publicly refused to further cut costs at the newspaper despite the fact that newspaper circulation had fallen 2.8% nationally and the Times itself had fared much worse, with circulation falling 8% over the preceding six-month period ending in September, 2006. Two Chicago Tribune executives replaced Johnson and Bacquet.xxiii

The decision about whether to sell the Los Angeles Times is a difficult one for several reasons. The newspaper alone brings in more than $1 billion in revenue annually for Tribune, about as much as all of Tribune’s television stations combined; this cash flow is going to be especially important as Tribune’s debt level skyrockets after the company is taken private. The tax implications of a sale of the Times are also important to consider. Though Tribune will benefit from significant tax breaks under the planned ESOP that Mr. Zell’s offer includes, the company will still be liable for capital-gains taxes on asset sales for the next ten years. At an estimated tax rate of 35%, a direct sale of the newspaper would come at a high cost. Los Angeles entertainment mogul David Geffen has indicated he would be willing to pay around $2 billion for the newspaper; in addition, Eli Broad and Ron Burkle showed considerable interest in buying the paper during the six-month Tribune auction process. The Washington Post reported in early April that Mr. Geffen and Mr. Zell have met to discuss a sale of the Times since Mr. Zell’s buyout offer was accepted by Tribune’s board.

We believe that the Los Angeles Times does not fit in Tribune’s newspaper portfolio. The merger with Times Mirror has never yielded the synergies that were expected and the public cross-country discord is further evidence that it is time for a change. We recommend that Tribune continue to thoroughly explore a sale of the Times to an altruistic (and, hopefully, overpaying) bidder like David Geffen, who seems to be showing interest in the paper more as a trophy than as profitable enterprise. Because of the costly capital-gains tax that would come

along with a sale, some sort of tax-efficient structure would need to be worked out in the details of any sale.

Other Newspaper Holdings By all accounts, the newspaper industry is in a steady downturn for at least the near future. Analysts do not expect a rebound anytime soon, writes the Financial Times:

Merrill Lynch, for example, expects a 2.6 per cent gain in overall US advertising spending this year but anticipates that newspaper advertising revenues will be down 1.5 per cent. Analysts at Lehman Brothers are even more pessimistic: newspaper revenues are forecast to fall 4 per cent this year, partly due to a migration of property advertising to the web. ‘The movement out of print media continues and has lately been sharper than expected,’ says Peter Winkler, managing director of the entertainment and media practice at PwC.xxiv

This is the main reason why Tribune’s own auction languished on for six months. Lukewarm interest from private equity firms and lackluster bids from others forced Tribune to allow prospective buyers to bid for parts of the company. The Financial Times wrote, “[The auction] drew no significant bid from private- equity investors, who concluded there was no hidden pot of gold in the newspaper industry and little certainty about future earnings amid internet- fuelled declines in circulation and advertising revenue.” Comparing Tribune’s prospective auction process to Knight Ridder’s sale process last year, the head of the media practice at one New York based consulting firm said, “We all had a lot of work on Knight Ridder. Not for Tribune, however. Potential buyers already know the story—and it is not a good one." We believe that though the story is not a good one yet, given Tribune’s unique mix of internet and television holdings— Tribune is significantly more diversified than Knight Ridder, the most recent comparable transaction—the company can weather the current storm cloud over the publishing industry and emerge in future years with a newspaper portfolio that has appreciated in value. That being said, it seems the best course of action

31 is to hold the portfolio unless offers are made at more than 9.1x EBITDA, since this is what Mr. Zell paid for the entire company.

i Hoover’s: Tribune Company History, http://premium.hoovers.com/subscribe/co/history.xhtml?ID=ffffrrhfxffhrjrhct ii Standard & Poors Stock Report: Tribune Co., 3 Mar 2007. iii Standard & Poors Stock Report: Tribune Co., 3 Mar 2007. iv Standard & Poors Publishing Industry Profile, 2005, http://www.netadvantage.standardpoor.com/NASApp/NetAdvantage/simpleSearchRun.do?ControlName= HomePageSearch v Deutsche Bank Company Research, Tribune Company, “Cost control raises our ’07 EPS,” 8 Feb 2007. vi Tribune Co. Form 10-K, 2007, p. 22. vii Deutsche Bank Company Research, Tribune Company. See also, Debra Garcia, “U.S. Newsprint Prices Continue to Erode,” Editor & Publisher, 28 Feb 2007, http://www.editorandpublisher.com/eandp/columns/forestwebs_display.jsp?vnu_content_id=1003551728 viii Louis Hau, “Who Will Tune in Tribune’s TV,” Forbes.com, http://www.forbes.com/digitalentertainment/2006/11/15/tribune-tv-sitcom-tech-media- cx_lh_1116tribunetv.html ix S&P Publishing Industry Profile, 2005. x Alan Murrary, “Is Zell Just Joining Ranks of Poor Newspaper Fans?,” The Wall Street Journal, 4 Apr 2007, p. A11. xi David Goetzl, “Tampa Leads With Highest DVR Penetration, Miami Is Lowest,” MediaDailyNews, 13 Apr 2007, http://publications.mediapost.com/index.cfm?fuseaction=Articles.showArticleHomePage&art_aid=58696 xii Guidance from Jeff Parks, Kohlberg Kravis Roberts & Co. xiii “Tribune Revenues Down 3.4% in February; Publishing Advertising Revenues Decline 5.1%; Television Revenues Up 1.0%,” PR Newswire US, 21 Mar 2007. xiv Katherine Q. Seelye, “Drop in Ad Revenue Raises Tough Question for Newspapers,” The New York Times, 26 Mar 2007, p. C1. xv “U.S. Daily Newspaper Circulation,” Newspaper Association of America, http://www.naa.org/info/facts04/circulation-daily.html xvi Seelye, p. C1. xvii Deutsche Bank Company Research. xviii Sarah Ellison, “How Will Tribune Pay Its Debts,” The Wall Street Journal, 4 Apr 2007, p. A10. xix Craig A. Huber, Lehman Brothers, Tribune Co. Equity Research, 2 April 2007. xx Goldman Sachs Company Update: Tribune Company (TRB), “Thoughts on a go-private transaction,” 3 April 2007. xxi Huber, Lehman Brothers. xxii Darren Everson, “For Sale: Chicago Cubs; Losers, Lovable, but Pricey,” The Wall Street Journal, 3 Apr 2007, p. B1. xxiii Gary Gentile, “Los Angeles Times editor Dean Baquet is forced to resign over cost-cutting dispute,” Associated Press Financial Wire, 8 Nov 2006. xxiv Aline Van Duyn, “Digital deficit: how media groups are grappling with a drift of revenue to the web,” Financial Times, 2 Jan 2007, p. 11.