It’s no secret that Chicago, and the state of Illinois, are in bad fiscal shape. As a resident of the city’s North Side, I’ve witnessed the demolition and re-construction of the Wrigleyville neighborhood surrounding Wrigley Field. The transformation is largely complete as I write this in September 2018. Much of the money invested into Wrigleyville redevelopment was money committed by the Ricketts Family, the owners of the Chicago Cubs since 2009. The Ricketts family patriarch, Joe Ricketts, made his fortunes my starting an online brokerage firm, named Ameritrade. Today, it’s known as TD Ameritrade, after a merger with Canada’s Toronto Dominion bank. Joe retired from the board of TD Ameritrade back in 2011. He’s doing really well; he’s worth about $2.1 Billion. He saw the future of brokerage, and he turned the industry upside down. First, he undercut the competition on price (Ameritrade was one of the first discount brokerages). Then, he took stock trading electronic. Stock brokers all over the country weren’t too happy about that; online stock trading made individual stock brokers obsolete. Most stock brokers were charging ridiculous fees to off-load shitty stocks to unsuspecting customers. Joe Ricketts got rid of an inefficiency that needed riddance. Ameritrade went public in 1997, with an IPO at $15/share. The late 1990’s were the heyday for Ameritrade. According to stockmarketcrashes.com,
“Between July 6, 1998 and July 6, 1999 TD Ameritrade experienced tremendous stock growth. Its stock had 3 stock splits on August 18, 1998 [2:1], February 23, 1999 [2:1] and July 6, 1999 [3:1] which pushed its share price from $1.95 to $31.60 per share, split adjusted — over 16 times in value in a year, with it reaching a high of $44.24 per share on April 14, 1999 with its non-split adjusted price standing at $173.25 per share.”
Between IPO @ $15, to its high price on April 14, 1999, Ameritrade returned 1055% to shareholders. That’s incredible! And clearly unsustainable, given that it happened in the course of 2 years. Which is why what happened to Ameritrade during the “Dot Com Bubble Burst”, was not a surprise. Again, according to stockmarketcrashes.com,
“When this ‘Dot-Com Bear Market’ finally bottomed, TD Ameritrade was trading at $2.38 per share on July 22, 2002 — up only $0.43 from July 6, 1998.”
I’m sure Joe Ricketts lost a few years of life stressing out about the future of his company in 2002. Fortunately for him, by 2011, when Joe retired from TD Ameritrade’s board, the stock had recovered magnificently. Once more from stockmarketcrashes.com,
“As of April 15, 2011 — TD Ameritrade was trading at $22.50 per share, up 1,153% over the last 13 years which is over 88% per year.”
Being the son of Joe Ricketts has many advantages. One of them is that you have access to a whole lot of money. Which is extremely useful when you want to buy a Major League baseball team. That’s not to say that the Ricketts kids are not successful on their own merit, because all indications are that they are. But there is a difference between being successful, and being a billionaire. Tom Ricketts seems to be the closest to self-made out of the four offspring. He founded a Chicago investment bank named InCapital. They are a brokerage service for corporate bond investors. His company makes a lot of sense to me, being a former bond trader myself. The gist of his business is to give individual investors a more direct avenue to invest in quality corporate debt/bonds. From Futures Magazine,
“Incapital provided innovation to the world of fixed income underwriting by using the Internet and by allowing individual investors and advisors to transact directly on Incapital’s platform instead of having to go into the secondary market.”
The idea is exactly the same idea his father had when he started Ameritrade; it was an intent to make the market for corporate bonds more efficient by giving individual bond investors direct access to the primary market for corporate bonds. Usually, the primary market is reserved for investment banks, commercial banks, and large investors, who buy bonds directly from the issuing companies. Individual, smaller investors would then have to deal with those banks interested in making a profit on the deals they had exclusive access to in the primary market. The primary market is essentially an auction, and InCapital wanted to democratize it. Good on you Tom.
But for all the success of InCapital, Tom and his siblings still needed help in their Cubs purchase. So how much help did they need? Well, let’s get some background on how the whole saga began. What follows is a bit of a digression into another man, a man known as Sam Zell, who put the first gear in motion on the sale of Chicago Cubs.
Sam Zell and Tribune Co.
In 2007, a man named Sam Zell, a self-made real estate mogul billionaire won a bid to buy the Tribune Company. Sam Zell is a finance genius. He is an expert on something called LBO, or leveraged buyouts. He decided to buy Tribune by way of a leveraged buyout. He intended to finance 98% of the purchase, and put only 2% cash down. This was a theme back in 2007; lots of people were buying all sorts of things with little to no money down. The New York Times tells us the deal proceeded in stages. The first stage involved an initial investment by Zell. The following is an excerpt from a New York Times piece written in December of 2008, about 18 months after the deal closed. Andrew Ross Sorkin is the author. He is now a morning anchor on the CNBC financial news channel. I digress. In referring to Mr. Sam Zell, the author states,
“He invested $315 million in the form of subordinated debt in exchange for a warrant to buy 40 percent of Tribune in the future for $500 million. It is unclear how much he’ll lose, but one thing is clear: when creditors get in line, he gets to stand ahead of the employees.”
The key above is that Mr. Zell did not purchase shares in the company. He bought debt. Even though it is subordinated debt, which means it stands a bit lower in the claim hierarchy in event of bankruptcy, it still gives Mr. Zell a claim on assets ahead of common shareholders. Why is that important? It’s important because of the LBO! The LBO financed the actual buying out of shareholders (to take the company private) with debt. Essentially, Sam Zell took control of Tribune by taking out loans in the name of the company, $13 Billion worth of loans to be exact. By owning debt instead of stock, Zell protected his $315 Million in that he would have claim on company assets ahead of shareholders in event of bankruptcy. Ok, but who are these shareholders Mr. Zell wanted to get ahead of? As messed up as it is, they were the Tribune employees. Zell convinced them to participate in the buy-out. They would do so as part of the Tribune’s Employee Purchase Plan. So on the one had, Zell was protecting himself from the employees, but on the other hand, telling them that they were in this together. They were far from in it together. Somehow, Zell used the Tribune Employee Pension Plan future earnings as collateral for part of the $13 Billion of debt! From the New York Times,
“Mr. Zell financed much of his deal’s $13 billion of debt by borrowing against part of the future of his employees’ pension plan and taking a huge tax advantage. Tribune employees ended up with equity, and now they will probably be left with very little.”
The tax advantage the excerpt talks about above is the S Corporation tax status that Tribune company became after the go-private LBO was completed. As Incorporate.com states, an S Corporation is,
“…not subject to double taxation as a c corp is. That means that an s corp’s revenue is not taxed at the corporate level. It’s only taxed when paid out as salaries or dividends to shareholders.”
What this means is that Tribune Company would not pay any taxes! So who would pay those taxes? They would be paid by the shareholders. Who are the shareholders? Once again, they are the employees who participate in the Employee Share Purchase Plan, the equity owners of the company. This was why it was critical for Zell to get the employees on board with the LBO! So Sam Zell was shifting the tax liability onto the employees, thereby freeing up the company to use as much of its income as possible to pay down its massive debt load. He hoped that since the employees would have vested interest in the company, they would trust him on what needed to be done to get the business back on track. With that said, the business wasn’t actually doing all the bad before Mr. Zell placed $13 Billion of debt on it. According to Forbes,
“…the Tribune’s way of business didn’t need to be modified for it to be profitable, strictly speaking. It was profitable at the time he bought it, albeit decreasingly so. The need to service the more than $13 billion of debt* he piled on the company in taking it over had more to do with its abrupt descent into bankruptcy, just one year later, than did its slimming margins.”
With the benefit of hindsight, we know today that the likes of Facebook and Google have taken over the advertising business. Most likely, the declining revenues would have continued to decline, possibly making bankruptcy inevitable. But back in 2007, the most pressing issue for Tribune was not declining revenue; it was debt. The reason why debt is so bad is because it ties up resources; it makes getting loans to operate the business nearly impossible. This is why Tribune went bankrupt; it was a huge miscalculation by Zell. As one analyst put it back then,
“Mr. Zell literally mortgaged the future of Tribune’s employees to pursue what one analyst, Jack Newman, at the time called ‘a childhood fantasy’.”
The above quote implies Sam Zell wanted to own a newspaper just for the hell of it. For some reason, rich guys want to own newspapers. Jeff Bezos, for example, bought the Washington Post. One would like to think these billionaires see themselves as guardians of the free press somehow, but my cynicism makes me doubt that. I doubt that Mr. Zell didn’t know how much of a long shot the Tribune buyout would be. By the time the deal closed in December of 2008, he said,
“I’m here to tell you that the transaction from hell is done.”
I somehow feel that when Mr. Zell made the above statement, it was slowly settling in that he was doomed. Tribune employees had either decided not to participate in Employee Share purchase, or were becoming critical of Zell’s attempts to reform Tribune. It turned out, Sam wanted to fire journalists, slash the number of reporters, and place advertisements on the front page of all the papers. It simply didn’t work. When Tribune filed for bankruptcy shortly thereafter, debt holders took control of the company. That meant that any employee who participated in share ownership was wiped out. Awful. An LA Times columnist, Dan Neil, who now works for the Wall Street Journal, sued Zell on behalf of Tribune employees and,
What about the pension funds that backed the debt that Sam Zell took out in Tribune’s name? Would the debt collectors repossess? Thankfully not.
How did Sam Zell make out in bankruptcy? We know he did everything he needed to do to protect himself. Recall that Sam’s $315 Million investment bought him subordinated debt and a warrant he could exercise at a later date to buy $500 Million of newly issued Tribune stock.
That is important to emphasize.
A warrant is basically an option to buy stock at a set price at some later date. Zell did not have to put skin in the game at all unless the company recovered and equity ownership made sense. Sam Zell is a shrewd businessman, my hat’s off to him, but his shrewdness destroyed an entire company. I will give him credit for giving up when the situation became irrecoverable; before Tribune declared bankruptcy, he called a meeting with the senior secured debt holders. According to the NY Times again (they followed this story like hawks),
“…in fact, the bankruptcy filing last December was in part an attempt to protect the interest of those lenders as Tribune’s cash reserves dwindled. Mr. Zell told senior secured creditors then that, in essence, the company was in their hands, and that making a scheduled payment on junior debt would leave less for them, and asked what they wanted to do. They endorsed bankruptcy.”
Sam Zell was one of those junior debt holders, since his debt was subordinated debt. Senior secured credit is is the best type of debt, because it is backed by assets and senior to all other claims. Sam Zell did the honorable thing, after all had been lost. Sam Zell lost $315 Million. Fortunately, it was hardly a pinch of his vast wealth. As NPR reported,
“He [Sam Zell] was flush with cash after selling his Equity Office Properties Trust, owner and manager of a 590-building chain, to private equity firm Blackstone Group last November  for $36 billion.”
At this point, we haven’t mentioned yet that the Tribune Company owned the Cubs, Wrigley Field, and a 25% stake in Comcast SportsNet Chicago. When the Tribune deal closed, Sam Zell immediately put them up for sale, in addition to some land across from Wrigley. At first, he stumbled quite a bit with the sale. From the New York Times,
“Mr. Zell’s maneuvering also contributed to more than a year of delays in selling the Cubs and, according to some analysts, may have resulted in a lower price than Tribune would have gotten when the economy was stronger. He sought to sell the team and its home, Wrigley Field, separately — the Cubs to a private buyer, the stadium to a government agency and possibly the naming rights to the stadium to a third buyer. But that strategy ran into trouble, and Tribune eventually reverted to an earlier, simpler plan to sell them as a package.”
The above is very interesting, because it gives us some insight into Sam Zell’s thought process. Leveraged buyouts are often used to buy companies with the hope of breaking them apart; the assumption on the part of the buyer (Zell) is that the sum of the pieces is worth more than the unbroken whole. This seems to have been what Sam was thinking for the Cubs. If he could sell each thing separately, he’d make a bigger profit than selling everything together as one. Remember, Sam needed to immediately start chipping away at the loans he had taken out to buy the company. That was essential. Unfortunately, when Tribune filed for bankruptcy, the financial crisis had taken its toll, and that plan was scrapped. This is where the Ricketts family came to be involved. They offered $845 Million for everything (Wrigley Field, the Cubs, 25% CSN Chicago, and the land parcel outside the field), and they won the bid.