Bankers liken a potential acquisition of newspaper publisher Knight Ridder to buying beachfront property: It's a valuable, hard-to-come-by asset, but it's eroding.
The question for private-equity firms, which typically like to exit their investments after about five years, is whether the San Jose, Calif., company's business will suffer more damage before they cash out.
Like most newspaper companies, the publisher has been losing readers and advertisers as the popularity of the Internet surges. Beyond that challenge, its largest newspapers face their own particular headwinds, with the Miami Herald hurt by a changing ethnic mix, the Philadelphia Inquirer struggling amid a loss of manufacturing jobs, and the San Jose Mercury News zapped by a shift to electronic media.
Despite a gloomy outlook, big private-equity firms are mulling bids for Knight Ridder, which put itself on the block in mid-November following pressure from large shareholders unhappy with its weak stock price.
Knight Ridder has warned that its move to explore strategic alternatives might not lead to a deal. In addition to its longtime financial adviser, Goldman Sachs Group, Knight Ridder has hired Morgan Stanley to help it explore its options, which could lead to restructuring instead of a sale.
"It's a very attractive deal to finance with all of the recurring revenue from circulation and advertising, which would argue for a private-equity investment," said Robert Broadwater, head of the newspaper merger practice at New York media investment bank Veronis Suhler Stevenson. "The only issue is its residual value and who would take it off your hands in five years."
With their huge stockpile of investment capital, a big buyout firm consortium could certainly afford to acquire Knight Ridder, the nation's No. 2 newspaper publisher based on circulation.
The "absolute prerequisite" for any potential buyer, whether a rival newspaper company or a buyout firm, "is a view that a significant amount of both cost-cutting and value can be harvested and that some of Knight Ridder's depressed markets can grow again," Doug Arthur, newspaper analyst at Morgan Stanley, wrote in a recent report.
Working in the favor of buyout firms, other media companies may not offer much competition in the bidding. Gannett Co., the nation's largest newspaper publisher, is the only rival considered big enough to make such a big-ticket acquisition.
Gannett, publisher of USA Today and about 100 other daily newspapers in the United States, is a disciplined buyer, bankers say. Despite its deep pockets, the company allowed itself to be defeated in two recent newspaper deals: the January sale of Pulitzer, which went to a rival, and the sale of Freedom Communications, which in 2003 signed a deal with two big private-equity firms that enabled family shareholders to maintain control.
Other newspaper companies might be interested in acquiring certain assets, but the tax hit to Knight Ridder and its investors would make breaking the company up a less appealing option than selling it whole, bankers said.
Whether teaming up with rivals or a smaller newspaper company, the biggest hurdle for buyout firms will probably turn out to be price.
Historically, newspapers have sold at multiples of 11 times to 13.5 times forward cash flow, which would represent a price of about $71 to more than $90 a share. But Knight Ridder may be forced to accept a lower multiple, given the murky outlook for the industry and pressure from its large investors.
The company's biggest shareholder and the first to urge a sale, Private Capital Management, has held shares in the company since April 2000 and currently owns about a 19 percent stake. The Florida money-management firm's average cost basis for the investment is roughly $65 a share. PCM's Chad Atkins said the firm had no comment on what acquisition price it would consider acceptable.
Henry Berghoef, director of research at Harris Associates in Chicago - Knight Ridder's No. 3 shareholder, which also is pushing for a sale - said that investors need "to wait and see what the market says it's worth."
Knight Ridder's shares surged as high as $65 a share after the company agreed to try and sell itself. Although still well above the $53 a share it traded before the investor pressure, the stock has retreated, reflecting concerns that bids may not be robust. Shares traded recently at about $61.
