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It is a fair assumption that for Lord Black of Crossharbour, chairman of Hollinger, the newspaper empire stretching from the Chicago Sun-Times to the Jerusalem Post, the penny dropped in June 2002.
The Tory peer's opulence - the houses in London, Miami, New York and Toronto, the casual use of corporate jets, the whole money's-no-object corporate lifestyle - was under sustained attack.
Dennis Kozlowski, chairman and chief of the sprawling Tyco conglomerate, where Lord Ashcroft, Black's House of Lords colleague, was a director, had just resigned and was being charged with tax evasion. It was the most telling sign yet that the new fascination with corporate governance which was sweeping America was more than a passing fad.
The regulatory clampdown, led by the likes of New York deputy district attorney Eliot Spitzer, was for real. Company shareholders were up in arms, furious at the way corporate executives had milked millions of dollars during the boom years, before the stock market crashed and exposed the crass and often fraudulent way so much of big business had been run.
Black must have realised that as far has Hollinger and the outside world was concerned, a second front had been established. An authority on Napoleon, the owner of the Daily Telegraph would have seen that this latest development exposed him to just the strategic weakness which ultimately led to the downfall of his historical hero.
Conrad Black was already fighting a bitter war on a financial front which had subjected his newspaper publishing empire to enormous pressure. Half way through last year, the deepest advertising recession in a generation was taking a severe toll on his finances.
Yet while the numbers at Hollinger were not pretty, Black knew about balance sheets. He knew how to stretch and bend his firepower and he probably believed that with a bit of crimping and a fair commercial wind going forward, he would be able to deal with his adversaries. The emergence of corporate governance as a new potent enemy, however, changed all that. The newspaper baron's perspective of his longer term prospects will have shifted, fundamentally, because as has now become clear, those "corporate finance zealots", as Black was to describe this new threat, were going to ask questions the peer could not answer. He did not want to fight enemies on two fronts.
Kozlowski's arrest at Tyco was preceded by six months of momentum for the governance movement. The Enron collapse had rocked Wall Street and shattered the confidence of ordinary Americans in the ability of US executives to run the businesses they were charged with managing. On Capitol Hill, politicians were baying for blood. The Sarbanes-Oxley legislation, setting out tougher rules for business conduct was poised to secure overwhelming cross party support, and in New York, Spitzer, the district attorney-in-waiting, was securing a high profile with his vigorous assault on Wall Street. In Mississippi, WorldCom had revealed it had overstated profits by $3.8bn (£2.3bn).
Meanwhile, in Delaware, the state where Hollinger is incorporated, investors in the Walt Disney Corporation were pursuing a lawsuit against the company alleging that directors had failed to fulfil their responsibilities to shareholders over a former director's pay-off. That case would ultimately give investors the right to seek redress through the courts if they felt that their interests had not been properly served by the board.
Only days earlier at the annual meeting of Hollinger International, the US quoted company which directly owns Lord Black's newspapers, the peer had gained first-hand experience of the new mood among investors. Tweedy Browne, the US fund manager which was holding a stake of around 18% in Hollinger International, had asked a series of awkward questions about the company's business practices. The New York investor was unhappy with the management fees being paid by Hollinger to Ravelston, Lord Black's private company, based in Toronto. In the last seven years those fees had topped $200m (£120m). The firm had first raised the thorny question of governance in October 2001 but Lord Black, who was poised to be introduced to the Lords later that month, was not going to allow shareholders to sour his transition to the position of a genuine press baron.
Contempt
By June 2002, however, Tweedy Browne's overtures were becoming more difficult to resist. Lord Black was now fighting on two fronts and he did not like it. There were aspects of Hollinger's arrangements with its senior executives which had not yet captured the public's imagination. For the last two years the company had been selling newspaper titles. As part of those deals new owners had often insisted on non-compete clauses preventing Lord Black, Hollinger and other executives from setting up rival publications.
The clauses were accepted in return for generous fees which found their way to individual directors and their private holding company, Ravelston, rather than into the coffers of Hollinger. Lord Black was to denounce those asking questions but his contempt does not seem to have prevented him from taking the threat seriously. Over the next 16 months he appears to have pursued a strategy of trying to justify the existence of what looked like indefensible management fees by linking them directly to the financial health of the whole group. The management fees were needed, it would be claimed, to keep Hollinger solvent. In June 2002, however, Black knew he needed to reinforce his empire's other front, namely its finances.
The global economy, which had been weak before terrorists struck in New York, was deteriorating. After three years of good profitability, in 2001 Hollinger Inc, Lord Black's quoted Toronto holding company which gave him control of Hollinger International, had recorded a $102m loss. Further losses were anticipated in 2002.
At the time, Black's internal estimates for New York-based Hollinger International pointed to a cash flow deficit of $80m in the current year and then a deficit of $22m for 2003. To make matters worse, Black knew that when these forecasts became actual figures and were consolidated into his Canadian Hollinger Inc holding company, the financial pressures would increase. The complex structure of Hollinger Inc, set up as a tax-efficient investment trust, meant the company could be forced to buy back shares from its ordinary investors. In April 2004 Hollinger Inc would also be forced to repurchase $72m worth of preference shares.
What Lord Black required was a mechanism which could close down one or both of the fronts on which he was fighting. He needed something which could somehow put the financial difficulties on hold and simultaneously remove the issue of management fees from the corporate governance arena.
It was time for a meeting of the inner circle. Lord Black was not a believer in exorbitant fees for investment bankers and corporate lawyers. He preferred loyal friends to hired hands. Not only did Lord Black's circle provide some sharp business minds, they also understood Hollinger's complex dynamic. In David Radler and Peter White, his closest confidants, Lord Black knew he had brilliant advisers.
But he will have missed the counsel of Montegu, his elder brother, who had died of cancer in January. Years earlier, the two had taken the Canadian business scene by storm, with Conrad's deep knowledge of so many military campaigns providing the vision, while Montegu brought business acumen to the partnership.
The brothers went into partnership with Radler and White in 1969 to acquire the Sherbrooke Record, and while Monte had become a banker rather than concentrate on the media industry, he continued to advise on some novel financing methods as his brother expanded his publishing empire. Black, Radler and White had a tremendous affinity. In a joint submission to Canada's special senate committee, investigating the mass media at the time, they declared: "The profession is heavily cluttered with aged hacks toiling through a miasma of mounting decrepitude and often alcoholism, and even more so with arrogant and abrasive youngsters who substitute 'commitment' for insight. The product of their impassioned intervention in public affairs is more often confusion than lucidity."
While White subsequently acted more as a silent partner, Radler, who became known as the "human chainsaw" for his cost cutting abilities, and Black have worked together as the prime driving force behind the newspaper empire. Thirty four years on, "costs" were not the issue. Black needed an imaginative way to secure the financing and corporate governance fronts, and this would not be a "drowning the kittens" solution - a favoured phrase of the Hollinger elite.
Black was convinced the corporate governance issue was a fad. But he had to make sure that he was not completely out of step with the times and possibly unprepared for some sort of disastrous cascade of events. Radler knew better than most that corporate governance was a priority. He is president and chief operating officer of Hollinger. He is also president and majority shareholder in a company called Horizon Publications. Lord Black is also an investor in Horizon.
In 1999 Hollinger International sold 33 US titles to Horizon. The purchase price was $44m, but Hollinger lent money to Horizon to finance the purchase. During 2001, Hollinger also transferred two publications to Horizon in exchange for what is described in official documentation as "net working capital".
The transactions gave rise to a string of governance questions, such as whether it could ever have been appropriate for Hollinger to sell an asset to a company which at the time was controlled by officers and members of the Hollinger board and then have Hollinger finance at least a portion of the purchase price. The company had given no information on which individuals negotiated the purchase price on behalf of Horizon and Hollinger, nor was there detail on how the Hollinger audit committee had ensured that the purchase price was fair for the shareholders.
The deal was typical of so many Hollinger transactions - opaque, overly complex and riddled with potential conflicts of interest between a publicly listed company and a private counterpart. Between the management fees, the non-compete fees and the so-called related party transactions, there was a danger that the corporate governance brigade would find something that would stick.
Hollinger appears to have devised a plan which lent much to Napoleon's philosophy to use an "indirect approach and outflank the enemy". If the management fees were to be the focus of any corporate governance backlash then Hollinger's case could be assisted by establishing an economic link between Hollinger International, which paid the fees, and Ravelston which received them.
Until late 2002, Ravelston was an understated and private vehicle for Lord Black and his Hollinger colleagues. Now was the time to demonstrate its essential involvement in the corporate circle which represented Lord Black's empire.
Last autumn, the publishing group began a series of financial manouevres which would change the way the management fees were perceived and simultaneously create the impression that Hollinger Inc, the Canadian holding company, had been placed in an economic straitjacket. Crucial to this was the appearance of a $120m debt issue on the Hollinger Inc balance sheet in March this year. It is a loan costing more than double the rate of interest on the debt it replaced and one that carries extraordinarily onerous banking covenants, limiting the way Black can run his business. It is also secured with almost all the holding company's shares in Hollinger International, the company owning the newspapers.
Regulatory filings by Hollinger do not adequately explain why this loan was taken out. For a start, Hollinger had already made great strides in reducing its long-term debt, which had fallen from $1.4bn at the end of 2002 to $770m at the end of June this year. The most recent half yearly accounts reveal an increase in cash and a fall in short term bank debt. Yet the same interim report points out that Hollinger Inc is dependent upon the continuing financial support of Ravelston, the private holding company, in order for Hollinger to "pay its liabilities as they fall due."
Conventional wisdom would dictate that Black was forced to accept such harsh terms (an interest rate of nearly 12%) because he was a distressed borrower who was so desperate for the cash to keep his empire afloat that he would accept any conditions. The $120m loan replaced a revolving bank credit facility - effectively an overdraft, which stood at $70m. This "revolver," as such banking facilities are known, was in default, but Hollinger's bankers waived the breach of terms and only wanted $34m repaid.
Black could have eased this pressure by selling down a little of Hollinger Inc's stake in the Hollinger International division, which at the time was worth around $215m. Instead Hollinger Inc chose to raise $120m through the new loan, expose itself to severe restrictions and put virtually its entire investment in Hollinger International up as collateral for the debt. The money raised was used to make not just the mandatory $34m payment but to pay off the entire overdraft. A further $38m was repaid to Ravelston and, bizarrely, another $12m was handed to Ravelston specifically to cover the interest due on the Hollinger loan for the first year. In essence Hollinger Inc had swapped a $70m loan with an interest rate of 5.5% and flexible covenants and collateral for a $120m loan paying interest at nearly 12% and bearing extremely harsh covenants and generous collateral.
Importantly, from a corporate governance perspective, a committee of independent directors was formed to scrutinise and approve all aspects of the $120m debt issue. At a stroke the debt issue created a clear economic relationship between Hollinger Inc, Hollinger International and Ravelston. The guarantees which Ravelston gave to support Hollinger Inc and help fund the interest payments on the bond remain dependent on it receiving sufficient management fees from Hollinger International. Any examination of the management fees enjoyed by Ravelston would be made against a backdrop which makes it clear that Hollinger Inc will face severe financial difficulties if the fees are cut.
Importantly, the debt issue also restricted Hollinger Inc's ability to repay money falling due to shareholders.
In particular, Black faced a $20m repayment of one set of preference shares in August this year and then the looming liability of $72m on a series of preferences shares due to be redeemed on April 30 next year. Also, $92m was due to ordinary shareholders who had exercised their right to have their stock repurchased by the company. The ugly $120m bond issue allowed Black to tell all these creditors that they would just have to wait for their money, since by paying them now would impair Hollinger's liquidity.
Finally, the debt issue locked up almost all Lord Black's investment in Hollinger International because it was pledged as collateral for the debt. Any prospect of those shares being sold to refinance Hollinger Inc had been removed, since those shares are now held in trust on behalf of the bondholders in the event of a default. Although Hollinger Inc has said in earlier regulatory filings it could sell shares in Hollinger International to pay down debt, that option is no longer available. If investors were to demand that Black scale back his investment in Hollinger Inc to resolve outstanding financial problems he can legitimately argue that the shares are no longer his to sell.
Black and his lieutenants seem to have been gambling that so long as the situation looked dense enough, the issues over corporate governance and the need for a stream of management fees to Ravelston from Hollinger International would remain out of focus. If so, the strategy has now backfired, in spectacular fashion.
This summer, under yet more pressure from Tweedy Browne, Black set up a committee of independent directors to investigate the allegations of corporate governance shortcomings. Chaired by Richard Breeden, a former head of the Securities and Exchange Commission and the man chosen to oversee the investigation into the collapse of WorldCom, the independent committee was seen as a robust proxy for a more formal inquiry which could have been launched at any time by the US authorities. Sceptics naturally suggested the committee's report would be a professional whitewash. Yet the opposite has now proved to be the case.
Radler has gone and Black has been stripped of his executive duties. As he faces the inevitable formal enquiry from the SEC over corporate governance, the peer's shareholding has been frozen while the new board takes a decision on how it might fix Hollinger's ghastly finances.
In 1812 Napoleon ultimately won the Battle of Borodino, but at such mortal cost that he was eventually forced to retreat from Russia. Black also fought on two fronts. But he seems to have lost on both.
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