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Friday, June 23, 2006

Loophole Wizard Is Key to Chandler-Tribune Rift

Los Angeles Times
By Michael A. Hiltzik
June 22, 2006

In 1994, a top executive at Times Mirror Co., then the parent of the Los Angeles Times, crafted a $2.3-billion sale of the company's cable subsidiary that so brilliantly eliminated taxes on the deal that it won him an instant following on Wall Street - and ultimately provoked Congress to close the loophole.

The executive was Chief Financial Officer Thomas Unterman, a wizard at crafting highly complicated corporate transactions that stymied the Internal Revenue Service. A boon for Times Mirror's controlling shareholders - the Chandler family - the 1994 deal also marked the beginning of a long, mutually profitable and controversial bond between the family and the Chicago-trained lawyer.

That relationship has made Unterman perhaps the most important behind-the-scenes figure in the current battle over the future of Tribune Co., which acquired Times Mirror in 2000. As Tribune's second-largest shareholder, the Chandlers have called for a breakup or sale of the company after a bitter conflict with management over some of the financial structures Unterman put in place.

Unterman's financial acumen long has been a byword among investment bankers.

'I've followed his work for more than 20 years,' said Robert Willens, a tax expert and managing director at Lehman Bros.

Willens especially admires the sale of Times Mirror's cable unit to Cox Enterprises Inc. The structure was so widely copied that 'it was deemed a threat to the Treasury, and Congress had to close the loophole,' Willens said. 'That's pretty much the definition of a successful tax-planning technique.'

Unterman, 61, left Times Mirror in 1999 to run Rustic Canyon Partners, a Santa Monica venture capital and private equity firm that mostly invests the Chandlers' money. But before leaving, he played a key role in the sale of Times Mirror to Tribune, acting without the knowledge of many of his executive suite colleagues - including Times Mirror's chairman and chief executive, Mark H. Willes.

Unterman also engineered the creation of two partnerships between the family and Times Mirror that now present obstacles to a Tribune financial restructuring. Two 1998 Times Mirror divestitures that he was behind have since saddled Tribune with a $1-billion tax bill.

Several sources suspect Unterman had a hand in an explosive June 13 letter to the Tribune directors in which the family, which holds three board seats, accused management of 'strategic missteps' and poor execution that had reduced Tribune shares by 40% in the last two years. In the letter, the Chandlers, who own 12% of Tribune, labeled the merger a failure.

Although the Chandlers say the conflict is based on a dispute over corporate strategy, Tribune executives say it's over money and taxes.

In a speech Tuesday in New York, Tribune Chairman Dennis J. FitzSimons complained that the Chandler proposals for restructuring the company could trigger a corporate tax bill that some sources have said could be as much as $70 million. He remarked that the inherited $1-billion tax bill had already 'damaged our stock's performance' and that Tribune 'has no intention of assuming any additional tax liability' attributable to the Chandlers' interests.

The two sides are at a stalemate over how to unwind the partnerships, which include Tribune shares, real estate and venture investments.

Earlier this year, Tribune proposed removing its shares from the partnerships and substituting a new security that would eliminate or reduce the tax consequences, said a source who asked not to be named because the negotiations are confidential. The Chandlers objected, claiming the proposal would reduce their voting and dividend rights and limit their ability to sell Tribune shares for at least a year, leaving them vulnerable to any further downturn in Tribune's fortunes.

The Chandlers proposed terminating the partnerships. But that would require placing a value on the entities' illiquid holdings. FitzSimons said Tuesday that the gap between the sides was 'material.'

The partnerships were designed to enable the Chandlers to diversify their assets - then consisting largely of Times Mirror stock - without selling the shares outright. As the original owners of Times Mirror, the Chandlers' acquisition price for their shares was effectively zero for tax purposes, making virtually their entire holding subject to capital gains taxes in a sale.

The first partnership, dubbed TMCT I for 'Times Mirror Chandler Trust,' was created in 1997. The family and the company each contributed about $475 million. The family contributed Times Mirror common and preferred shares, while the company put in $249 million in cash and eight pieces of real estate valued at $226 million, including the Times' downtown headquarters, as well as properties housing the Baltimore Sun and Newsday.

The company paid about $24 million a year in rent to lease the real estate from the partnership. The family pocketed 80% of the rent and in return gave up dividends on 80% of the shares, saving the company $16.6 million a year. Times Mirror said the deal was a financial plus because the rent, unlike the dividends, was tax-deductible.

The Chandlers, at least initially, received more income from rent than they had from dividends, but they theoretically sacrificed the potential for higher dividends in the future for a steady guaranteed income from rent. The value of the real estate in that partnership is now a bone of contention between Tribune and the Chandlers.

Tribune has appraised the real estate at $325 million based on their use as newspaper facilities, according to a person who requested anonymity because talks are continuing. The family has offered Tribune an option to buy the real estate for $175 million, possibly as compensation for the tax bill Tribune would face from terminating the partnership. Tribune rebuffed the offer for reasons that are unclear.

The second partnership, created in 1999, was similar but larger. This time the Chandlers and the company each contributed $1.24 billion. As before, the Chandlers provided Times Mirror shares. The company provided $635 million in cash and several real estate investment trusts worth $600 million.

The two parties swapped income streams: Times Mirror was relieved of the burden of paying $23.5 million in dividends a year on 80% of the Chandler-contributed shares. The family received 80% of the income from the cash and real estate.

Whether the arrangements financially benefited the Chandlers over time is uncertain. Tribune documents indicate that in 2005, the family collected $79.3 million from the two partnerships while Tribune got $76.5 million, giving the family slightly more than its 50% share.

For Unterman, the 1999 deal marked a turning point in his relationship with the Chandlers. Around that time, he announced he would leave Times Mirror to manage a venture fund stocked with $500 million from the company's contribution to TMCT II.

TMCT Ventures, as the fund was named, allowed Unterman to pursue investments in new media and high technology that he considered crucial to Time Mirror's future but that had been thwarted by Willes.

'Tom was really the most informed and most interested in expanding new media of anyone' at corporate headquarters, Harry Chandler, a former Times executive and a son of Otis Chandler, the last family member to serve as the newspaper's publisher, recalled in 2000.

Even before leaving Times Mirror, Unterman became involved in the Chandlers' next major financial move: The sale of their company to Tribune. Discussions between Tribune executives and Unterman began in late 1999 and continued with the participation of family representatives until a deal was announced the following March.

At first Unterman and Tribune management saw eye to eye. An advocate of new media and high technology, Unterman endorsed Tribune's vision for marrying TV stations and newspapers in the same markets, and using the combination as a way to attract users and advertisers to the Internet and other new media. After the merger, Unterman joined Tribune's board as a Chandler family designee. But the relationship soon soured.

For one thing, the cross-platform strategy proved to be flawed as well as untimely. 'Advertisers couldn't be trained to buy that way,' said a person familiar with events. When Internet stocks crashed, Tribune backed away from new-media investments where Unterman still saw opportunities. He left Tribune's board in 2001.

Not long after, Tribune executives had another reason to resent Unterman: a 1998 deal by Times Mirror that turned into a $1-billion tax liability for Tribune.

The original transaction involved Matthew Bender & Co., Times Mirror's underperforming legal publishing subsidiary. Willes was determined to sell the unit in a tax-advantaged way. Accounting firm Price Waterhouse, possibly working from an Unterman template, came up with a format that broke down the simple sale of a business unit into five complicated parts, obscuring its fundamental nature.

In essence, the seller and buyer pooled their interests into a new entity. The seller contributed the business, and the buyer contributed cash. Although labeled as a tax-free 'corporate reorganization,' the buyer ended up with full control over the business unit and the seller had full control over the cash.

Anglo-Dutch publishing company Reed Elsevier, which won Bender with a $1.35-billion bid, agreed to the format in finalizing the deal. Times Mirror used much of the huge tax-free gain to capitalize the venture fund in TMCT II, giving Unterman a hand in generating the capital that he was later given to invest on the Chandlers' behalf.

Still, Willes and Unterman knew their tax-free claim was vulnerable to an IRS challenge. They lined up opinions as to its legitimacy from Times Mirror's auditing firm, Ernst & Young; its law firm, Gibson, Dunn & Crutcher; and its investment banking firm, Goldman Sachs & Co. The company also created a reserve of $180 million in case the tax-free claim didn't fly.

Tribune executives were aware of the controversial transaction when they bought Times Mirror in 2000. But they decided to accept the certifications of Times Mirror's professional advisors. Their faith was misplaced: In 2001 an IRS audit rejected the claim and billed Tribune, as Times Mirror's successor, for roughly $400 million.

Tribune exacerbated the situation through its own misjudgment, sources said. Rather than pay the tax while it appealed, the company chose to litigate aggressively while interest charges mounted. Last September, a U.S. Tax Court judge ruled against Tribune on grounds that any transaction in which one side starts with a business and ends up with cash while the other side starts with the same cash and ends up with the business is a taxable sale, no matter how the parties label it.

By then, the delinquent bill for Bender and a second nearly identical deal had risen to $1 billion. Tribune forked over $880 million after deductions and said it would appeal.

'It's hard to feel confident that the appeals court will overrule the tax court,' Willens said. 'That was one deal that went over the line.'

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