ADVANCED FINANCIAL MANAGEMENT MODULE 9: RISK ANALYSIS IN INVESTMENT DECISIONS COMPANY CHOSEN: Tribune Corporation Current Event Assignment

#4: Find an example of how a company overcame or was overcome by investment risk. Describe what happened. Could any of the concepts contained in this course have helped the company? What human factors were involved in the companys situation? Answer A Businessweek article titled Selling Out for Buybacks published in September 7, 2006, points out that many companies in difficulties are being pushed by shareholders to incur debts in order to finance stock buybacks. Tribune Co., a media giant, is quoted as an example. Early in 2006, Tribune was forced to borrow as much as $2bn to repurchase 25% of its shares. This move was intended to boost the companys regressing return caused by its stagnant stock price and weak revenue environment at both its newspapers and TV stations. Tribune Co.s announcement of the buyback, expected to come from bank loans and publicly traded bonds, did not produce the intended effect; that of enhancing the companys value. The companys share dropped by eight cents, to $31.14 on September 7, and well below the 52-week high of $39.06. S&P cut Tribunes rating from A/Stable-A-2 to BBB/Negative/A-3. What happened? An earlier Jun 20, 2006 Businessweek article captioned The Trouble at Tribune (www.businessweek.com/investor/content/jun2006/pi20060620_579681 .htm) explains disagreements between Tribunes executives and a key shareholder, the Chandlers family, over the cost-cutting 1

Boniface Naoussi Zoua, MBA #999-01-079. Advanced Financial Management, FA6160

plans proposed by the corporation. The shareholder forcefully objected tribunes decision to contract the $2bn debt. In a letter filed against the company, the shareholder cited numerous strategic flaws committed by Tribunes management and requested the company separate its newspaper and TV and explore other options. Damaged Performance Theres no doubt that the above-mentioned dissent created tension in house. Remarks made by Dennis FitzSimonss, chair CEO of Tribune Co., there was evidence of a bone of contention between Tribune executives and the Chandlers over the two trusts that they jointly owned (separate from the two trusts through which the chandlers own their Tribune stock) which the two parties have never agreed to restructure despite several discussions held. Throwing more light on the Tribune/Chandlers saga over the trusts, FitzSimons declared, A tax liability could recur if these trusts are restructured. Tribune had absorbed a $1billion tax bill inherited, he added. This tax bill, FitzSimons further stressed, certainly damaged our performance relative to its peers. From what precedes, what are the risks faced by Tribune Co.? (a) Buybacks can be a source of trouble and companies that can fund them with cash reserves or manageable amounts of debt often find that they do not necessarily boost a companys stock price. (b) Companies with poor profit growth such as Tribune must not take on a lot of debt to fund a buyback only to appease investors since such measures can worsen the companys situation (please see table below for selected three-year financial data on Tribune Co.)

Boniface Naoussi Zoua, MBA #999-01-079. Advanced Financial Management, FA6160

2006 2005 2004 Revenues (million $) for Fiscal Year ending Decembre Quarter 1 1299.08 1315.74 1332.32 Quarter 2 21431.85 1462.07 1495.93 Quarter 3 NA 1402.81 1413.85 Earnings Per Share ($) for FY ending December Quarter 1 0.33 0.44 0.35 Quarter 2 0.28 0.73 0.29 Quarter 3 NA 0.07 0.37 Income Statement (Million $) Revenues NA 5,595 5,726 PEff. Tax Rate NA 51.84% 39.08% Net Income NA 5534 573 Other Financial Data (Million $) Current Asset N/A 1,492 1,52 Current Liability N/A 1,446 1.370 LT Debt N/A 2,959 2,350 Cash Flow N/A 770 798 Current Ratio N/A 1.03 1.05 %LT Debt of Cap N/A 24.58 20.27 %Net income of Revenues N/A 9.5 10.0 % Return on Assets N/A 3.7 4.0 % Return on Equity N/A 7.8 8.2 Dividends 0.54 0.72 0.48
Source: http://research.businessweek.com/company_financials.asp?

The following last eight calendar quarterly earnings graph further illustrates Tribunes underperformance.
0.8 0.7 0.6 Earnings 0.5 0.4 0.3 0.2 0.1 0 Q3 04 Q4 04 Q1 05 Earnings

Q2 05

Q3 05 Quarters

Q4 05

Q1 06

Q2 06

Boniface Naoussi Zoua, MBA #999-01-079. Advanced Financial Management, FA6160

Source: From data collected on October 9, 2006 from http://host.businessweek.com/businessweek/Quarterly_Earnings.html?

Buybacks can limit the financial flexibility needed for strategic acquisitions or investments. In extreme case, it can raise the risk of default or even bankruptcy. Analysts say such buybacks are on the rise while S&P report warns, the increasing influence of private equity groups, hedge funds, mutual funds and other big investors make it appear more and more likely that shareholder-friendly deals will be done whether the impact on credit quality is positive or not. Many companies that announce large buybacks also take on lots of debt, and in many cases, earnings growth is difficult, meaning that companies cant afford to pay for the buybacks out of their pockets. Steve quoted three examples to illustrate this: Could any of the concepts contained in this course have helped the company? Among others, the following discounted cash flow techniques could have helped Tribune CO. in determining the success of its investment. Payback period calculation: It is the time an investor must wait to recoup his or her initial investment. Assessing this earlier could have helped Tribune to determine the merit of its investment risk (the longer it takes to recoup an original investment, the greater the risk incurred). It is calculated thus: Payback period = Investment/Annual Cash Flow Accounting Rate of Return: This the average annual cash inflow divided by total cash outflow. Annual average cash inflow Total cash outflow

Boniface Naoussi Zoua, MBA #999-01-079. Advanced Financial Management, FA6160

Net Present Value (NPV): It is the present value of cash inflows less present value of cash outflows. It reveals the increase of wealth accruing to an investor when he or she undertakes an investment. NPV could tell Tribunes management what equivalent value the cash flows had in todays currency. Management could then compare alternative investment strategies. An NPV > 0 means the investment will add value to the company. Benefit-Cost ratio (BCR): This is a profitability index, similar to NPV, which helps to compare the discounted value of cash flows in with the discounted value of cash flows out. A BCR > 1 indicates an investment will be beneficial to the company. Internet Rate of Return (IRR): It is the discount rate at which the net present value is equal to zero. The investment is considered favorable if the IRR is greater than the companys present cost of investment capital. In addition to the above approaches to mitigating investment risk, Tribune could have also applied the following techniques: Sensitivity Analysis, Scenario analysis and Simulation. What human factors were involved in the companys situation? In another business week article
(www.businessweek.com/printmagazine/content/06/_25/3989024.htm)

on related

issue published on June 19, 2006 titled Dog-Bites-Man Thinking, Jon Fine affirms that Tribune has been beset by problems, some self-afflicted, some not. Self-afflicted problems relate to management shortfall and are three-fold: Reluctance of Tribunes management to invest when necessary (risk-aversive). Poor union strategies, such as the one with Time Mirror

Boniface Naoussi Zoua, MBA #999-01-079. Advanced Financial Management, FA6160

 Inadequate risk analysis prior to investment decision (the article states that Tribune bets on shaky strategies).

Boniface Naoussi Zoua, MBA #999-01-079. Advanced Financial Management, FA6160