Advanced Distressed Debt Lesson - Tribune (TRB)

Three days ago, the distressed bank debt of Tribune traded as such:

• TLB (Initial): 61.5-62.5
• Incremental: 59.75 - 60.75

Yesterday:

• TLB (Initial): 63.75-64.5
• Incremental: 52.25-54.25

Going out today, here was the same market:

• TLB (Initial): 64.25-64.75
• Incremental: 56.25-57.25

Talk about volatile. Net/Net the TLB has gone up a couple and the incremental down a couple. I.E. the spread between the two securities has increased (quite dramatically I might add). In addition, the bonds were up a couple of points. What happened?

Well, unless you were living under a rock, you would know that Tribune examiner report was released. I have embedded it below (Warning: This document is highly technical, but an incredible read for the distressed debt professional)

Tribune Examiner Summary

Here is what Steven Church from Bloomberg news reported:

The biggest piece of Tribune Co.’s 2007 buyout is likely to survive a court challenge, even though managers used an improper solvency test to justify part of the $8.3 billion deal, an independent examiner said.

Creditors who blame the buyout for the newspaper publisher’s bankruptcy are “somewhat likely” to win a lawsuit based on the smaller piece of the two-part deal, attorney Kenneth N. Klee found in a report issued yesterday.

Unidentified Tribune managers required consulting company Valuation Research Corp. to use an ‘improper” method to calculate the Chicago-based company’s value, Klee said. When VRC issued its flawed solvency opinion favoring the buyout, Tribune managers claimed the opinion was supported by financial adviser Morgan Stanley.

The process of hiring VRC “was marred by dishonesty and lack of candor about the role played by Morgan Stanley in connection with VRC’s solvency opinion and on the question of Tribune’s solvency generally,” Klee wrote.

In a letter today, Tribune Chief Executive Officer Randy Michaels and Chief Operating Officer Gerald Spector urged the company’s employees, who include reporters, editors and television producers, “not to be distracted by the media attention.”

‘Disagree With Others’

“We agree with some of his assessments and disagree with others,” Michaels and Spector wrote of Klee’s report.

The judge overseeing Tribune’s bankruptcy case appointed Klee in April to evaluate allegations that the buyout violated bankruptcy law. A summary of Klee’s report provides support for both backers and critics of Tribune’s exit plan.

Tribune filed for bankruptcy in December 2008, a year after the buyout led by real-estate billionaire Sam Zell. Some lower- ranking creditors alleged the buyout was a fraudulent transfer because it added more than $8 billion in debt to the company while benefiting only Zell and shareholders.

Tribune’s buyout took place in two parts. The $8 billion in primary financing closed in June 2007 and is “reasonably likely” to withstand a court challenge, Klee wrote, a finding in favor of Tribune and lenders including JPMorgan Chase & Co.

By the time the second part closed in December, Tribune’s financial situation had changed, making VRC’s solvency opinion more important, Klee wrote. Tribune managers should have known that the second phase of the buyout would leave the publisher insolvent, he said.

Approval Opposed

“Fiduciaries charged with the responsibility for overseeing management’s actions and determining whether the Step Two Transactions would render Tribune insolvent did not adequately discharge their duties,” Klee wrote.

The lower-ranking creditors, who would be paid nothing under Tribune’s reorganization plan, have said they plan to oppose approval when it comes before U.S. Bankruptcy Judge Kevin J. Carey in Wilmington, Delaware, on Aug. 30.

Those creditors, who are owed $1.2 billion, have sued JPMorgan and the other lenders. They want the loans that funded the buyout to lose their payment priority.

In step two of the transaction, Tribune borrowed $3.6 billion and paid fees to its lenders, according to court documents.

Klee concluded that New York-based JPMorgan was likely to be exonerated from any allegations of bad faith for the first part of the buyout. The bank wasn’t likely to be cleared regarding the second part, he said.

Creditors Divided

Creditors in similar bankruptcy cases filed since 2007 will look at the report carefully, said Harold Kaplan, an attorney in Chicago with Foley & Lardner. The findings may influence creditors of companies that went through leveraged buyouts when values peaked and were forced into bankruptcy by the recession, he said.

“Everyone is now asking, ‘Did the buyout overpay and saddle the entity with more debt than was justified?’” Kaplan, who isn’t involved in the Tribune case, said in an interview before the report was filed.

The buyout has divided creditors. The lenders behind the deal are split over whether to fight the allegations of lower- ranking creditors or settle with some of them, according to court documents.

Creditors have said that Klee’s conclusions may affect how they vote on Tribune’s reorganization plan. Carey must take that vote into consideration before he decides whether to approve the plan and allow the company to leave bankruptcy.

Right to Sue

Tribune’s plan asks creditors to give up their right to sue insiders, including Zell, and the lenders who financed the buyout over claims they left the company insolvent.

Tribune owns the Los Angeles Times, the Chicago Tribune and broadcasting stations in Los Angeles and other U.S. markets, as well as stakes in cable channels.

Tribune complained in court papers earlier yesterday about Klee’s decision to withhold certain details of the report from the company and other parties in the case until after an Aug. 9 court hearing.

The case is In re Tribune Co., 08-13141, U.S. Bankruptcy Court, District of Delaware (Wilmington).

I had always wondered why the market had put such a small spread between the incremental and TLB. Why risk the incremental's downside for 1/2-1 point. Many market participants did not expect this coming and it shows that even in bankruptcy's nearly 18 months old, new information can really swing the needle one way or the other.