Hollinger International HLR
December 29, 2004 - 12:19am EST by
2004 2005
Price: 18.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,656 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Hollinger International is a special situation investment with a significant upcoming dividend (30% of market cap) which leaves a stub newspaper business trading at a significant discount to fair value. With the stock at $18.00, a $5.43 per share upcoming special dividend, other identifiable cash and assets of $3.54 per share, and a potential settlement worth $2.17 per share, you create Hollinger’s Chicago Sun Times assets at 5.0 - 6.3x ebitda. The stock is undervalued due to significant legal battles with former management and shareholders, most notably former CEO Conrad Black, which have caused most investors to shy away. Also, financials have not been filed since Q3 of ’03, making analysis of the business difficult. Ultimately, the stock could reach between $21-$23, or 17%-28% upside (23%-41% upside post-dividend).

This is a quick business summary from SEC filings: Hollinger International is a leading publisher of English-language newspapers in the United States, the U.K. and Israel with a smaller presence in Canada. Its 23 paid daily newspapers have a worldwide combined circulation of approximately two million. In addition, the Company owns or has interests in over 250 other publications, including non-daily newspapers and magazines. Included among its 144 paid newspapers are the following premier titles:
• The Chicago Sun-Times, which has the highest daily readership and second highest circulation of any newspaper in the Chicago metropolitan area and has the fifth highest daily readership of any metropolitan daily newspaper in the United States;
• The Daily Telegraph (just sold), which is the leading daily broadsheet newspaper in the U.K. with a 36% share of circulation in its domestic market and approximately 300,000 greater circulation than that of its nearest competitor; and
• The Jerusalem Post (also just recently sold), which is the most widely read English-language daily newspaper published in the Middle East and is highly regarded regionally and internationally.

I’ll give a brief description of the important points of the fraud/court proceedings, if you’re interested in more information, the comprehensive report of the Special Committee can be found at http://www.sec.gov/Archives/edgar/data/868512/000095012304010413/y01437exv99w2.htm . The fraud was perpetuated by the former CEO Conrad Black and other former Hollinger Board members. Black owns Ravelston, a private Canadian holding company, which in turn owns 78% of Hollinger Inc. (HLG). HLG is a publicly traded (Toronto exchange) Canadian holding company whose principal asset is 18.2% of the economic interest and 68% of the voting interest in Hollinger International (HLR). Black was Chairman and CEO of HLR while also controlling Ravelston. The first way that Black allegedly looted money was through egregious management fees paid to himself. Since 1995, Ravelston had entered into management agreements with HLR to provide “strategic, financial and operational consulting services.” Total compensation for these services was $218m. These were not approved by the comp committee, generally undisclosed to the Board and obviously way above market. Secondly, over the years, HLR has sold various publishing assets. Upon sale, Ravelston, HLG, Black and other HLR Board members negotiated payments with sellers to receive direct compensation for non-compete agreements, i.e. remarkably the non-compete compensation went to the individuals not the company. This totaled approximately $90m.

In May 2003, Tweedy Browne (an 18% shareholder at the time) brought attention to the issues by filing a 13D describing their concerns over executive comp and the payments among affiliated parties. In response to Tweedy letter, in June 2003, the Hollinger Board established a special committee to investigate the allegations. In the fall of 2003, the Special Committee notified the SEC of its initial findings, and subsequently the SEC subpoenaed HLR and KPMG (HLR’s auditor). KPMG has been unable to opine on the financials as a result the investigation. Subsequently, practically all senior management and Board members were replaced, and HLR hired Lazard to evaluate strategic alternatives. In May 2004, HLR filed a lawsuit on racketeering charges (under the Racketeering Influenced and Corrupt Organizations Act or “RICO”) against Black and the other executives seeking $1.2b. The report of the Special Committed was released on August 30, detailing in over 500 pages the fraud perpetrated against the company. The RICO suit was dismissed under technical grounds, i.e. the judge ruled that RICO could not be applied to a claim that amounted to securities fraud. In October, HLR filed a second suit seeking $542m in damages. In November, the SEC filed civil charges seeking a) $85m in restitution, b) that the Hollinger Inc. shares to be placed in a voting trust, and c) a ban of Black and others from serving on public company boards. Both of these suits remain outstanding.

HLR price as of 12/28/04 $18.00
Shares outstanding 92.00
Mkt Cap. $1,656

The valuation is composed of an announced special dividend and self-tender, other identifiable cash and assets, and the Chicago Sun Times newspaper group (a collection of 100 papers in the Chicago area).

1) The special dividend was announced on December 16, 2004, for $500m total. Based on conversations with management, this is lower than I thought and frankly somewhat disappointing. I believe Hollinger could/should have applied incremental excess cash of up to $125m in this dividend. Perhaps this is just conservatism and gives management more optionality as they still have to run the business until an ultimate sale. Nonetheless, the structure is to pay $2.50 per share on January 18, 2005, or approximately $227m. The second traunche is to be distributed via a self-tender of $273m or $3.00 per share. To account for options above the 90.8m shares implied in the dividend, let’s call it $5.43 of total per share value to be distributed. The self-tender is contingent on successful filing of the 2003 10K and the 10Qs subsequent to 9/30/03, the filings of which have been delayed by the Special Committee investigation. All filings are now expected to be completed by end of Q105. Effectively, the source of proceeds for the tender are the proceeds from the sale of the Daily Telegraph of $1.02 billion (net of WC adjustments and tax), plus a $30m payment received from Black, minus both the retiring of all company debt of $500m and approximately $50m in prepayment premiums on the debt. Although Black protested the Telegraph sale vigorously in Delaware Court, he lost. The deal is closed, the cash is in the bank, and he is under an injunction which prohibits him from interfering with the distribution of the proceeds. Thus, I view the risk of the completion of the $500m dividend as low.

2) Other cash and assets.
Hollinger still owns Canadian newspaper assets left over from the sale of most of the Canadian assets to CanWest in 2000. These assets include ten daily and 23 non-daily papers, and the Business Information Group, which is a publisher of magazines and tabloids for the construction, transportation, manufacturing, and other industries. These assets have generated roughly $70-$75m in revenue over the past three years, and have been close to breakeven. Court filings from July (when Hollinger accepted bids to sell all its assets), indicate that the Company received 22 offers for the Canada assets with a high bid of $117m. Management believes they can get $120m for these newspapers, but there’s a pension liability attached to them which is valued at $60m. I attribute $60m of net value to these assets.

Hollinger just sold the Jerusalem Post for $13m, and its Chicago office headquarters to Donald Trump for $72m cash. The Company just received approximately $123m from the redemption of seller paper due from CanWest associated with the asset sale in 2000. Other assets include private company investments which management values at $15-$20m, or call it $18m. Management has indicated there is approximately $150m of cash on the balance sheet over and above the aforementioned. Netted from these are approximately $50m Hollinger spent in legal bills, and $60m owed to CanWest for working capital adjustments related to the 2000 asset sale. In total, net other cash and assets are worth $3.54 per share.

Adding in the special dividend of $5.43 to be received, total net cash and assets are worth $8.98. With the stock at $18.00, you’re paying $9.02 for the rest of the business composed of the Chicago Newspaper Group.

To summarize:
UK newspaper sale $1,020 $11.09
Payment received from Black 30 0.33
Debt (550) (5.98)
Total anticipated dividend $500 $5.43

Canadian papers (net of pension) $60 $0.65
Jerusalem Post 13 0.14
Private investments 18 0.19
Sun Times Office cash 72 0.78
Cash 150 1.63
Canwest PIK note 123 1.34
Legal bills (50) (0.54)
Canwest liabilty (60) (0.65)
Subtotal $328 $3.54

Hollinger stock price $18.00
Less: dividend (5.43)
Implied value of Chicago and other assets $12.57
Less: value of cash and other assets (3.54)
Implied value of Chicago stub $9.02

c) So what is the Chicago Group worth?
The Group includes the Chicago Sun-Times (with average daily circulation of 480,000 and readership of approximately 1.7m) and 100 other newspapers serving the greater Chicago area, such as the Post Tribune (northwest Indiana), Daily Southtown (Chicago), Pioneer Newspapers Inc. (56 weeklies in Chicago’s northern suburbs), Midwest Suburban Publishing Inc. (23 biweeklies, 13 weeklies, 4 free in southern suburbs), and Fox Valley Publications Inc. (The Herald News, The Beacon News, The Courier News, The News Sun, and other free papers located in Chicago and Cook counties).

Revenue from 2000-2004 was $401m, $443m, $441m, $451m and $492m (’03 and ’04 are estimated). Ebitda margins ranged between 11-17% from 2000-2003, but most analysts had estimated between $90-$95m of ebitda in ’04, or an 18% margin. This is well below the industry average of approximately 25%. It’s not surprising that while Black was paying himself, flying around on the company’s jet (since sold), and throwing lavish parties he wasn’t focused on running a newspaper efficiently. Conversations with analysts and management indicate that a low 20% Ebitda margin is achievable over the next twelve months, and 25% eventually. One of the first steps to take cost out of the business would be to rationalize the sales force and distribution of the 100 newspapers in the group. The Group is currently run without attention to obvious synergies, i.e. there are duplicative sales force personnel at many of the papers calling on the same customers. With flattish revenue of $500m and 25% margins the business could do $125m of ebitda. The newspaper companies currently trade at 2.8x forward revenue and 10x forward ebitda; 10x ebitda is also the average historical forward multiple. 10x $95m to $125m of Chicago Group ebitda implies an enterprise value range of $950m to $1.25b. Taking this range and adding in the other assets, the value of the stock ranges from $19.30 to $22.56.

Further upside potential exists if the company receives any damages from Black and the other Board members and officers. I think there’s a high likelihood that Black and friends are found guilty given the massive documentation of the alleged improprieties. What remains of Black’s personal assets is unclear as he may have spent/hidden his cash. But we know that he owns 18.2% of HLR valued at $301m. If we assume that of the $542m lawsuit only $200m of stock is recovered, that implies incremental $2.17 per share of upside. Taking the midpoint of the range of Chicago Group values, +/- a potential settlement, I think this stock is worth $21-$23 per share.

Chicago stub Per Implied HLR price
value ($m) Share HLR price with settlement
950 $10.33 $19.30 $21.47
1000 $10.87 $19.85 $22.02
1100 $11.96 $20.93 $23.10
1200 $13.04 $22.02 $24.19
1250 $13.59 $22.56 $24.73

This implies 17-28% upside, however ex-dividend the % upside will be even more attractive to investors, because of the lower stub price of $12.57. Chicago ($11.96) + cash and assets ($3.54) = $15.50 + settlement ($2.17) = $17.67, or 23% pre-settlement to 41% post-settlement upside.

I think the ultimate realization of value comes with a sale of the company to a private equity or strategic buyer. I think that is the new Board’s intention as they are clearly now shareholder friendly given the special dividend, the continuing sale of assets and a recently instituted quarterly $0.05 dividend; management also said that internally “nobody wants to run this business.” The July court filings show that there was significant interest in the Chicago Group when it was marketed; Lazard received 10 initial offers to buy it. The sale will likely be a stock purchase/merger of Hollinger not an asset/stock sale of the Chicago Group given a low basis exists in the Chicago Group assets. Therefore I’d expect the other tangential assets to be sold prior to the sale of the Company. Management may also want to wait for a real recovery in the ad markets. Net/net it seems reasonable a sale could occur in six months to two years.

• The Company hasn’t filed financials since Q3 ’03, so a lot of the analysis is relying on conversations with management and are difficult to confirm.
• Black still owns 68% of the voting interest in Hollinger and could potentially block a sale. I believe he is in an incredibly weak negotiating position however. Given the massive civil and potential criminal liability he faces, the worst case is that he trades his blocking rights in exchange for relief from some of the charges. Best case is that those rights are taken from him via a settlement for his shares, however that outcome may take longer.
• Circulation was overstated at the Chicago Sun Times by 16% and Hollinger took a $27m charge to settle with advertisers. The Company investigated for four months and fired those involved; this should be the end of it although we can’t be sure. Regardless, I think this is a one-time hit and not an ongoing ebitda impact due to the fact that there’s a lack of suitable alternatives for local advertisers and relations with ad reps are generally long and good. When advertisers attempted to sue the Chicago Tribune over its overstatements, the dispute was quickly resolved when the Tribune responded by not printing their ads. Also I think the cash costs are less than the settlement value, because Hollinger will offer free ads the incremental cost of which is simply printing another page. Ironically, Hollinger may actually save money as a result of lower printing and delivery costs incurred generating the phony circulation.
• Canadian tax liability. The company showed a $347 income tax payable on its 9/30/03 balance sheet. The tax payable was from a gain on an asset sale located in a non-recourse, Canadian based subsidiary. There’s approximately one year remaining on the statute of limitations on that tax to the Canadian government after which it’s uncollectable. Canadian tax authorities could potentially get more aggressive in pursuing this claim before expiration.


First traunche of special dividend on January 18, 2005
Filing of financials by end of Q105 for the first time since Q303
Second traunche of special dividend announced on or after Q105
Sale of other assets
Settlement with Black and other former directors
Ultimate sale of business
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