Taxing question could blight Hollinger sale

The auction of Hollinger International, the owner of the Daily and Sunday Telegraph, is proving as complex as it is dramatic. Amid accusations of corporate greed and boardroom sackings, the spectre of the American taxman hovers over the newspaper group.

One British bidder for the Telegraph Group estimates the potential tax bill from the break-up of Hollinger International at $300m (£162m). The Chicago-based group has two big assets: the Telegraph Group and the Chicago Group, the latter housing the Chicago Sun-Times and more than 100 local titles. The sale of either would be subject to significant capital gains tax penalties because both were bought for a price far below their current valuations.

The Daily and Sunday Telegraph have attracted bids of more than £500m, for instance, but Lord Black bought control of those titles in 1985 with an initial investment of £10m. A capital gains liability would be due on the difference between the final sale price of the Telegraph Group and the amount the Canadian peer eventually paid for it.

Cardinal Capital Management, a US shareholder in Hollinger International, contacted the company last year with two remedies for the tax issue. The first would involve spinning off the Chicago Sun-Times group, Hollinger's second largest asset, and housing it in a separate entity. That company would then be sold off, probably to a US trade bidder. The plan takes advantage of recent changes in tax law which state that a demerger will be tax free, even if the company is subsequently taken over.

The second proposal involves "partnering", whereby Hollinger International would be sold to a buyer who simultaneously sold on either the Chicago Sun-Times or the Telegraph Group. Cardinal, which owns 2.6% of the newspaper empire, declined to comment on the auction process.

One shareholder, who spoke on condition of anonymity, said Hollinger International would accept a significant tax hit on a break-up only if a bidder paid over the odds for the Telegraph Group or another asset. "If somebody offers a ridiculous price for the Telegraph there is a small chance Hollinger would sell it and then pay the taxes. But that is a low probability event."

Express Newspapers owner Richard Desmond is not expected to launch a joint bid for Hollinger International. His arch-rival, the Daily Mail & General Trust, also remains focused on an individual offer for the Telegraph Group, backed by private equity firm Cinven.

The third and most obvious option is to sell the group to a single bidder. Hollinger International is valued at $1.3bn (£730m), but £250m of debt gives it an enterprise value of closer to £1bn. Suitors for the Telegraph Group, which include private equity groups, are awaiting further instruction from Lazard.

There is an undercurrent of irritation at the new emphasis on bids for the whole group and the muddied lines of communication. "They seem to be spinning it out to smoke out an offer for the whole thing," said one Telegraph bidder.

Lord Black's Hollinger Inc, the largest shareholder in Hollinger International, is also exasperated by the apparent about-turn in the auction process. But a scathing verdict from a Delaware judge last week put a block on any attempt by the company to influence or pre-empt a sale. Hollinger Inc believes Lazard intended to sell the newspaper group in one go, but then pursued a break-up to destabilise the Barclays' bid for Hollinger Inc, which would have given the twins control of Hollinger International. The Delaware ruling forced the brothers to terminate the deal, allowing Lazard to switch back to selling to one bidder.

Lord Black needs a speedy outcome. Hollinger Inc said on Monday it had missed the deadline for a $7.4m interest payment on a $120m bond issue. The bond is secured against Hollinger Inc's 30% shareholding in Hollinger International, which converts into a 73% voting stake. It has a 30-day grace period to meet the payment or the shareholding will be sold by trustees to pay off the bondholders.

Peter White, Hollinger Inc's co-chief operating officer, told the Delaware court that the company was on the verge of a default: "We're broke." The judge dismissed his claims and ordered the company to retrieve the $5.9m owed by Lord Black, its chief executive, and David Radler, the former chief operating officer of Hollinger International. Ravelston, another Lord Black company, must be approached over outstanding payments.

Judge Leo Strine also ordered Hollinger International to provide short-term financing to its parent if the money owed by Lord Black, Mr Radler and Ravelston fails to materialise.

The company denied yesterday that it was close to breaking a covenant stating that Hollinger Inc, which does not have an auditor, must file full-year results by March 15. According to its lawyers, the deadline is mid-May.

Hollinger Inc can take one comfort. It faces a deadline of April 30 for redeeming C$92.7m (£37.3m) worth of preference shares. Under Canadian law, it does not have to make the payment if "the company's liquidity would be unduly impaired". But those shareholders, and the taxman, will be knocking on the door when Lord Black receives the proceeds from the Hollinger International auction.