The market for selling loans was red-hot because of an influx of a new type of buyer — managers of collateralized loan obligations, or CLOs, the corporate lending equivalent of the mortgage-backed securities that were inflating the real estate bubble. This created a huge demand for new loans that fed on itself. As volume rose, the deals got bigger and riskier.
The banks "were climbing over themselves to get into this deal," former Tribune Co. general counsel Crane Kenney said in a deposition.
Tribune Co. had already promised its two investment bankers, Citigroup and Merrill Lynch, that they could provide financing for any deal they drummed up. But since Zell had never worked with Citi, his team reached out to JPMorgan and BofA, where the Chicago billionaire had long and lucrative relationships.
JPMorgan jumped at the chance to get involved, according to court documents. It worked furiously to complete its initial analysis and documentation in five days, a process that often takes weeks.
Petrik, who declined to comment, said in a deposition that Zell's team gave BofA added incentive: If the bank could move quickly, it might be able to unseat Citi, giving it access to as much as one-third of the potential $208 million in lender fees. That ignited a scrap between the two banks; eventually both got a piece of the transaction.
Although the market for corporate deals was raging, there was nothing easy about the Zell transaction. In emails, Merrill Lynch banker Todd Kaplan likened the process of solving its technical problems to "wrestling an octopus."
Documents show that some on the deal teams were alarmed by the company's financial performance and worried that the transaction wouldn't sell to outside investors. It didn't help that the deal was structured to close in two steps, at least six months apart, exposing it to potential changes in the market's appetite for risky deals.
Julie Persily, a leveraged finance specialist at Citigroup who initially called the buyout's complex structure "silly," was convinced that the only reason competitors were so enthusiastic about it was that Zell was a longtime client, emails show. Her boss, Chad Leat, had even complained that friends were "laughing at him" for trying to fund such a precarious transaction, according to one Persily email.
But Wall Street exists to do deals, not dwell on why they can't get done. "As problems got solved, it became clear this could happen," said one banker. "So it's a little like a snowball."
It helped that Zell had powerful allies at JPMorgan, the bank he chose to lead the transaction.
JPMorgan declined to comment for this series, but two of its former bankers said Jamie Dimon, the bank's chairman, and Jimmy Lee, the vice chairman, took a keen interest in making the buyout work. At one point, documents show, Dimon suggested that if the market was worried about Zell's small equity contribution, JPMorgan should invest some of its own money alongside Zell's as a show of confidence. That didn't work, but emails show Dimon's deal team got the message that "Jamie will want to find a way to play."
To solve the equity problem, Tribune Co. and the deal's architects reframed it. In presentations for the rating agencies and, later, for potential investors, they pushed a concept some bankers called "synthetic equity," sources said. This effectively bolstered the equity side of the balance sheet by adding in a number of items including the expected $1 billion in S-Corp tax savings as well as more than $2 billion in Tribune pre-buyout debt that would be pushed down the payout ladder by the new loans.
Under this formulation, the new Tribune Co. would have debt of a little more than 7 times cash flow, rather than a more onerous 9.1 times.
The idea was to make owners of the buyout debt more comfortable: In the event of a default, there appeared to be enough of a cushion in the capital structure for them to get paid back in full. But there was much less certainty for the owners of the pre-buyout debt or the company itself, since that "junior" debt still required interest payments and would eventually have to be paid off, putting strain on the company as a whole.
As the bankers moved ahead on the deal, Tribune Co. management was working through its own ambivalence. Chief Executive Dennis FitzSimons and his team had earlier proposed a smaller restructuring that would pay shareholders less and presumably leave management in control.
Some Tribune Co. executives said they relished the idea of working with Zell and believed he might truly be able to energize the company. But FitzSimons "went hot and cold" on the new proposal, worried that "it was doable but (with) a lot of debt," Citigroup investment banker Christina Mohr said in court papers.
What was clear was that all of Tribune Co.'s top management had powerful incentives to restructure the company, including the potential for a big payday.
Documents show that the company's top 38 managers received almost $150 million in payments triggered by the deal, including various incentive and severance packages, as well as cashed out restricted stock and options. FitzSimons alone walked away with a total of more than $40 million, including proceeds from stock holdings accumulated over his career at Tribune Co.
The Zell proposal created an incentive program intended to give a large group of Tribune Co. managers "phantom stock" worth 5 percent of the company, which tracked the value of the ESOP shares. Those shares ended up valueless, but documents show that a much smaller group of top executives also got phantom shares worth 3 percent of the company that vested earlier than the rest and included cash-out provisions.