For Lord Conrad Black of Crossharbour, chairperson of Hollinger — the newspaper empire stretching from the Chicago Sun-Times to The Daily Telegraph and The Jerusalem Post — the penny dropped in June last year.
The Tory peer’s opulence — houses in London, Miami, New York and Toronto, the casual use of corporate jets, the whole money’s-no-object corporate lifestyle — was under sustained attack.
Dennis Kozlowski, chief of the sprawling Tyco conglomerate, resigned, facing tax evasion charges. It was a telling sign that the new fascination with corporate governance sweeping the United States was more than a passing fad.
The regulatory clampdown, led by New York Deputy District Attorney Eliot Spitzer, was for real. Shareholders were furious about how corporate executives had milked millions of dollars during the boom years and exposed the often fraudulent way so much of big business was run.
An authority on Napoleon, Black would have seen that this development exposed him to the same strategic weakness — fighting on two fronts — that led to the downfall of his historical hero.
He was already fighting a bitter war on a financial front.
Halfway through last year the deepest advertising recession in a generation was taking a severe toll.
But Black knew about balance sheets. He probably believed that with a bit of crimping and a fair commercial wind going forward, he could counter his adversaries. The emergence of corporate governance as a potent new enemy changed all that.
Kozlowski’s arrest was preceded by six months of momentum for the governance movement. The Enron collapse had rocked Wall Street and shattered the confidence of ordinary Americans. On Capitol Hill, politicians were baying for blood. The Sarbanes-Oxley legislation, setting out tougher business rules, was poised to secure overwhelming cross-party support, and in New York, Spitzer was vigorously assaulting Wall Street.
At the annual meeting of Hollinger International, the US-quoted company that owns his newspapers, Black encountered the new mood among investors. Tweedy Browne, the US fund manager with 18% in Hollinger, asked awkward questions, particularly about the management fees paid by Hollinger to Ravelston, Black’s Toronto-based private company.
In seven years those fees had topped $200-million. The company had been selling newspaper titles, and new owners often insisted on non-compete clauses, preventing Black, Hollinger and other executives from setting up rival publications. The clauses were traded for generous fees that found their way to individual directors and their private holding company, Ravelston, rather than to Hollinger’s coffers.
Black denounced his interrogators, but took the threat seriously. Over the next 16 months he pursued a strategy of trying to justify management fees by linking them to the health of the whole group. The fees were needed, it would be claimed, to keep Hollinger solvent.
By June 2002 he knew he had to reinforce his empire’s other front — its finances. The global economy was deteriorating. After three years of good profits in 2001, Hollinger, the Toronto holding company, which gave Black control of Hollinger International, had recorded a $102-million loss.
At the time, Black’s internal estimates for New York-based HollingerInternational pointed to a cash flow deficit of $80-million in the current year and $22-million deficit for 2003.
The complex structure of Hollinger, set up as a tax-efficient investment trust, meant the company could be forced to buy back shares from its ordinary investors. In April 2004 Hollinger would also have to repurchase $72-million of preference shares.
What Black required was a mechanism that could close down one or both of the fronts, putting the financial difficulties on hold while removing the management fee issue from the corporate governance arena.
It was time for a meeting of the inner circle — David Radler and Peter White. Black, Radler and White, partners in the empire’s first newspaper acquisition in 1969, saw things alike. In a joint submission to Canada’s Senate inquiry on the mass media, they declared: ”The profession is heavily cluttered with aged hacks toiling through a miasma of mounting decrepitude and often alcoholism, and even more so with arrogant and abrasive youngsters who substitute commitment for insight.” Radler, who became known as the ”human chainsaw” for his cost-cutting, and Black became the prime driving force behind the newspaper empire.
Thirty-four years on, Black needed an imaginative way to secure the financing and corporate governance fronts. As president and chief operating officer of Hollinger, and president and majority shareholder in a company called Horizon Publications, in which Black is also an investor, Radler knew corporate governance was a priority.
In 1999 Hollinger International sold 33 US titles to Horizon for $44-million, with Hollinger lending money to finance the purchase. During 2001, Hollinger also transferred two publications to Horizon in exchange for ”net working capital”.
The transactions prompted major governance questions. Was it appropriate for Hollinger to sell an asset to a company controlled by officers and members of the Hollinger board, and then have Hollinger finance some of the purchase price?
The company had given no information on who negotiated the purchase price on behalf of Horizon and Hollinger, nor on how the Hollinger audit committee had ensured a fair price for shareholders.
The deal was typical of so many Hollinger transactions — opaque, and riddled with potential conflicts of interest between a public company and a private counterpart. Between the management fees, the non-compete fees and ”related party transactions”, there was a danger that what Black called ”the corporate governance brigade” would make something stick.
His plan was based on Napoleon’s philosophy: use an ”indirect approach and outflank the enemy”. If the management fees were to be the focus of a corporate governance backlash, Hollinger’s case could be assisted by establishing an economic link between Hollinger International, which paid the fees, and Ravelston, which received them.
About a year ago the publishing group began a series of financial manoeuvres to change perceptions of management fees and create the impression that Hollinger, the Canadian holding company, had been placed in an economic straitjacket.
Crucial to this was the appearance of a $120-million debt issue on the Hollinger balance sheet last March. The loan cost more than double the interest rate on the debt it replaced and carried extraordinarily onerous banking covenants, limiting the way Black could run his business. It was also secured with almost all the holding company’s shares in Hollinger International, which owns the newspapers.
Regulatory filings by Hollinger do not explain this loan. Hollinger had already made great strides in cutting long-term debt from $1,4-billion last year to $770-million by end-June this year. The most recent accounts reveal an increase in cash and a fall in short-term bank debt.
Yet the same interim report says Hollinger depends on the continuing financial support of Ravelston, the private holding company, to ”pay its liabilities as they fall due”.
Conventional wisdom would suggest Black was forced to accept a punitive interest rate of nearly 12% because he was a distressed borrower desperate for cash to keep his empire afloat.
The $120-million loan replaced a revolving bank credit facility — effectively an overdraft, of $70-million. This ”revolver” was in default, but Hollinger’s bankers only wanted $34-million repaid.
And Black could have eased the pressure by selling some of Hollinger’s stake in the Hollinger International division, worth $215-million. Instead Hollinger chose to raise $120-million through the new loan, expose itself to severe restrictions and put virtually its entire investment in Hollinger International up as collateral.
The money raised was used to make not just the mandatory $34-million payment, but to pay off the entire overdraft. A further $38-million was repaid to Ravelston and, bizarrely, another $2-million was handed to Ravelston specifically to cover the interest due on the Hollinger loan for the first year. Hollinger had swapped a $70-million loan at 5,5% interest and flexible covenants and collateral for a $20-million loan at nearly 12% and bearing extremely harsh covenants and generous collateral.
Importantly, from a corporate governance perspective, a committee of independent directors was formed to scrutinise and approve all aspects of the $120-million debt issue.
At a stroke, the debt issue created a clear economic relationship between Hollinger, Hollinger International and Ravelston. The guarantees Ravelston gave to support Hollinger and help fund the interest payments on the bond depended on it receiving sufficient management fees from Hollinger International. Any examination of the management fees enjoyed by Ravelston would be made against a backdrop highlighting that Hollinger would face severe financial difficulties if the fees were cut.
Importantly, the debt issue also restricted Hollinger’s ability to repay money due to shareholders. In particular, Black faced a $20-million repayment of one set of preference shares in August this year, and the looming liability of $72-million pref shares due to be redeemed on April 30 next year. Also, $92-million was due to ordinary shareholders who had exercised their right to have the company repurchase their stock. The ugly $120-million bond issue allowed Black to tell creditors they would have to wait for their money, as paying them now would impair Hollinger’s liquidity.
Finally, the debt issue locked up almost all of Black’s investment in Hollinger International, as it was pledged as collateral. Any prospect of those shares being sold to refinance Hollinger had been removed.
Black and his lieutenants gambled that as long as the situation looked dense enough, the corporate governance issues and the need for a stream of management fees to Ravelston from Hollinger International would remain out of focus. The strategy backfired spectacularly.
This year, under more Tweedy Browne pressure, Black set up a committee of independent directors to probe the corporate governance complaints. This was seen as a proxy for a more formal inquiry that could have been launched by the US authorities, and sceptics expected a whitewash. The opposite has now proved to be the case.
Radler has gone and Black has been stripped of his executive duties. As he faces the inevitable formal inquiry over corporate governance, the peer’s shareholding has been frozen while the new board decides on how to fix Hollinger’s ghastly finances.
In 1812 Napoleon ultimately won the Battle of Borodino, but at such mortal cost that he was eventually forced to retreat from Russia. Black also fought on two fronts. He seems to have lost on both. — Â