Times' spending: good business or a setup for a loss?

Early last year, Frank Blethen, chief executive officer of The Seattle Times Co., convened a meeting of his four first cousins. The company had weathered a 49-day strike, a plunge in the economy, and even a chilling ultimatum from Citibank, its lead lender: Find $40 million to get back into compliance with its loan terms or face the prospect of selling assets — possibly including the flagship Seattle Times.

Although The Times had cut $40 million out of its budget to regain compliance, it had lost about $5.1 million in 2001, its second straight year of losses, and Blethen was worried. But interest rates had sunk so low, he told his cousins, that refinancing the debt now would give the company a $20 million cushion.

It was a perilously thin cushion with the economy still staggering and no end in sight. Recounting the situation in an interview early this year, Blethen said the choice the fourth-generation of Times owners debated that day, in the conference room just outside his office, was this:

Sit pat, keep cutting back at The Times, and hope the slump would end before the money ran dry and they had to sell the paper. Or refinance and go deeper in debt, spending the cash that would come with that transaction to rebuild the newspaper's badly depleted resources and reverse its fortunes.

In the stock market, the strategy is called "doubling down" — increasing your investment in a sinking stock and hoping the tide will turn and you will make it all back.

Blethen denied the cousins were gambling the future of their company. Instead, he called their decision to refinance and spend "the most noble and responsible act my generation (of Blethens) has ever taken."

"We said we'd forgo further liquidity and dividends to grow The Times circulation," he said.

Last year's spending decision, and the Blethens' motivation for making it, is a key element in a legal battle shaping up between The Times Co. and The Hearst Corp., owner of the Post-Intelligencer. It could also determine which paper may be left when the fight is over.

In its lawsuit against The Times Co., filed Monday in King County Superior Court, the privately owned Hearst maintains the Blethens' spending decision was carefully calibrated to do away with the P-I.

At issue is the joint-operating agreement (JOA) that governs the partnership between the two companies. Under the JOA, after The Times is paid for handling all non-news operations of the two papers, it receives 60 percent of the papers' remaining joint revenue; the P-I gets 40 percent. The papers use this "remainder" to pay their separate news and editorial expenses, and the result constitutes a profit or loss for the year.

A "loss operations" clause in the JOA gives either paper the right to demand negotiations to shut down the other paper within 18 months after it serves notice it lost money for three straight years.

Details of Times audit

Tuesday, The Times presented Hearst with an audited statement indicating it lost money from 2000 to 2002. According to the statement, whose details were made available by a source close to the situation, The Times' share from the JOA was $27.1 million in 2000, while it spent $29.2 million on news and editorial expenses.

In 2001 it received $22.8 million and spent about $28 million on news. Last year, after the Blethens' decision, The Times' editorial spending rose about 17 percent from 2001, to $32.7 million. Its cut from the JOA remainder rose 31 percent to nearly $30 million, for a loss of $2.7 million.

The Times hired dozens of full- and part-time news employees in 2002. The cost has not been disclosed, but the hiring helped restore the staff size after it had been reduced by about 20 percent as a result of the strike and economic downturn. Times spokeswoman Kerry Coughlin said that at the end of 2002 the paper had 366 full and part-time news staffers, compared with 374 in the prestrike period.

In addition, it established a wine page, boosted sports, arts and suburban coverage, and made other expenditures.

Coughlin said last night that Blethen would have no comment on the audit or other JOA matters while the litigation is pending.

But in the interview earlier this year, he said the moves were "absolutely critical" to hold up the paper's "core readership." According to Audit Bureau of Circulations figures, the number of Times readers grew 2 percent to 224,140 in the year ended Sept. 30. During the same period, the P-I's circulation dropped 7 percent to 157,558. Figures as of the end of March, which have not been announced yet, are expected to show a wider gap.

Blethen insisted the prospect that heavy spending could put The Times news operations in the red for the third straight year — triggering the possibility of invoking the loss clause — was not behind the cousins' decisions last year.

But there is little doubt, industry experts say, that shutting down the P-I would financially benefit the Blethens, who own 50.5 percent of The Seattle Times Co., and San Jose, Calif.-based Knight Ridder, which owns 49.5 percent.

In a 1999 revision to the JOA, if Hearst agrees to voluntarily close the P-I under the "loss operation" clause, it would receive 32 percent of the remainder revenue — after both news and nonnews expenses — until 2083. If no agreement is reached, the JOA is dissolved and Hearst is free to publish the P-I on its own. That could be prohibitively expensive, requiring Hearst to build or acquire a printing operation among other things.

How business could change

In any case, getting rid of the P-I would give The Times' owners a lock on the largest ad market in the Northwest. The paper's 25-cent newsstand price could go up. Home subscription rates, now among the lowest in the industry, could also rise. Ad rates, set by The Times Co. for both papers under the JOA, would probably stay about the same, industry watchers say.

In addition, though overall revenues would likely decline should the P-I close, The Times would no longer incur many expenses associated with printing, delivering, promoting and other tasks related to publishing the 157,000-circulation paper.

"There is no question that the survivor would begin making money again," says Peter Horvitz, owner and publisher of the Bellevue-based King County Journal.

Horvitz, who owns other papers in Washington and in Tennessee, says the Blethens' spending clearly added to their financial squeeze.

"Metro dailies like The Times should be making $50 million to $60 million a year in pre-tax cash flow," Horvitz says. Cash flow, or earnings plus depreciation allowances, is a common accounting measurement of a company's financial health.

Times' spending strategy

Hearst's figures, taken from JOA records, indicate The Times' annual pre-tax cash flow between 1983, when the Seattle JOA began, and 1999 averaged slightly more than $31 million annually.

From 2000 to 2002, Hearst says, cash flow at The Times sank to an average of about $17 million a year.

In the past, Times officials have said their cash flow is a third to a half lower than publicly traded companies because the Blethens could pour revenue into operations instead of rewarding shareholders.

"Blethen is one of the few people willing to spend money on staff for news product in the last 10 years," says Doug Underwood, an associate professor at the University of Washington Department of Communication and a former Seattle Times reporter.

Horvitz says Blethen's strategy works during flush times. More spending makes a more appealing product, which pays off by drawing more readers and more advertising revenue.

But when the economy turns sour, the strategy can backfire.

"What happened was they could make a lot of money at a certain level of spending in the economy," Horvitz says. But continuing to spend when the economy collapsed inevitably led to losses, he says.

Horvitz calls the Blethens' spending decision "inexcusable" in a down year like 2002. The only way to fix the imbalance, he says, "is to adjust expenses to the reality of revenue."

'A creeping merger'

Horvitz, whose paper stands to gain readers and advertising if Seattle becomes a one-paper town, is not a disinterested party. In 1999, he petitioned the U.S. Justice Department officials overseeing the revision of Seattle's JOA to reject the JOA, calling it "a creeping merger."

He also has had an acrimonious relationship with Frank Blethen, especially during the 2000 strike, when Horvitz's company briefly printed a paper produced by striking workers.

But these days Horvitz agrees with Blethen that the JOA concept is a failure. One well-run city daily can make a profit, but two cannot, he says. The most logical way to reduce expenses now, he says, "is to produce one newspaper instead of two."

Whether the Blethen cousins intended to use the JOA's loss-operations clause to achieve that end is the heart of the current fight.

The Seattle Times Co., which is private, guards its decision-making carefully. "We've got people out there who would love to take this company away from the Blethen family," Frank Blethen said in the interview. "We have no interest in helping them harass us."

The family business

The company's decisions are controlled by the Blethen Corp., a family corporation that is, in turn, controlled by Blethen and his cousins. The five cousins hold voting proxies for 16 Blethen family members, or their trusts, which hold shares in the Blethen Corp. The structure was set up in the late 1940s to manage Blethen interests and pays dividends that Blethen called "very modest by corporate standards."

Blethen declined to say how much of a dividend is paid out by the corporation, and he refuses to let any of his kin speak to the media. But he said the dividend hasn't grown in more than a decade.

The cousins control a bicoastal company with substantial newspaper and land assets, including seven papers in Washington and Maine. The Maine papers, bought by Blethen in part because of the family's roots in that state, carry a bank loan. But King County real-estate records show some of the company-owned land is worth millions and carries no mortgages. The company recently put a parcel in Renton up for sale for $12 million.

Industry experts estimate the market worth of the flagship Seattle Times alone could be $900 million — rising to $1.4 billion if the P-I is eliminated from the market. But selling The Times would not be easy, requiring the approval of all 16 Blethen family shareholders.

"It would be incredibly difficult for this family to sell this newspaper," Blethen said. He also said the corporation is structured so family members cannot even borrow against their ownership equity.

"The financial rewards (for family members) are really quite modest," Blethen said. "The expectation is you'll get a modest dividend and if you have a professional career, you'll get a professionally based salary."

The Blethen board also includes financial, legal and business advisers.

Several members, such as Gary Reed, a former CEO of Simpson Timber and member of Safeco's board, also sit on The Seattle Times Co. board.

Somewhat ignored in all this is Knight Ridder. The media giant holds six seats on The Seattle Times Co. board, although not all are always filled. Shortly before the 2000 strike, Knight Ridder CEO Tony Ridder offered to buy out the Blethens stake for $750 million, including the assumption of $250 million in debt. The cousins turned him down.

Neither Blethen nor Ridder makes any secret of their mutual dislike. Ridder did not reply to a request for comment, but in the past he has vented his frustration with the Blethens spending habits.

"For a guy who's been coming to board meetings telling everybody I was running the company into the ground," Blethen said, "it was kind of a compliment to be offered $750 million for the company."

Blethen broke into a grin at the recollection.

"Tony's got a problem," he said. "He's got a stock where he can't acquire control. He can't even control the dividends, or sell it for the dividends."

A Knight Ridder spokesman describes the relationship between the two executives as "rancorous" and declines further comment. But in a recent note Ridder said he would be willing to sell his company's stake to The Times, if the Blethens made the right offer.

"I don't know what the Times Co. is worth today," he said.

Earlier this year, however, Ridder told analysts it is unlikely that the awkward ownership situation would change.

"He's got that right," Blethen said.

Bill Richards is a free-lance writer hired on a special contract by The Seattle Times to cover events involving the joint operating agreement with the Seattle Post-Intelligencer. He can be reached at brichards@seattletimes.com.