AJR  Features
From AJR,   February/March 2006

Sherman’s March   

How Naples, Florida, money manager Bruce S. Sherman muscled Knight Ridder—the nation’s second-largest newspaper company—into putting itself up for sale

By Charles Layton
Charles Layton (charlesmary@hotmail.com) is a former editor and reporter at the Philadelphia Inquirer and a former AJR senior contributing writer.     

On July 19, the board of directors of Knight Ridder, the country's second-largest newspaper chain, held a most unusual meeting. It was at the Ritz-Carlton Hotel near the top of San Francisco's Nob Hill, and it was unusual because, as the 10 board members convened, representatives of Knight Ridder's three biggest shareholders were camped outside the door, waiting to air their gripes about the company's stock performance.

This meeting would mark the start of an insurrection that ultimately would force the board to put Knight Ridder up for sale, threatening the future quality of its journalism and causing tremors throughout the newspaper industry. One restive shareholder in particular, Bruce S. Sherman of Naples, Florida, was the instigator and ringleader.

Sherman (or rather, the institutions and rich individuals whose wealth he manages) owned about 19 percent of Knight Ridder – a huge stake, far larger than anyone else's. He had been accumulating it for five years, starting with less than a million shares and adding more as his investment group attracted new clients.

When Sherman first began buying the stock in 2000, it was selling in the low to mid $50s. As it rose into the $60s and then the $70s, he kept buying. On April 23, 2004, it peaked at just under $80 a share. Then it faltered and fell.

On the day of the board of directors meeting, Knight Ridder shares were selling at $62. Sherman owned 13 million of those shares, for which he had paid, in the aggregate, about $65 a share. He was under water on the stock.

Sherman was also into other newspaper companies. In fact, he had committed more money to newspapers (about 14 percent of his entire wad) than any other institutional investor in America. And eight of the nine newspaper stocks he owned were falling in value, some precipitously. Tribune Co. had plunged from $42 to $35 in a year's time. Gannett had gone from $80 to $72. And the mighty New York Times Co. was at $32, down from $42 a year earlier.

Not only was Sherman losing his shirt on these stocks, they were a drag on his whole enterprise. He had built a reputation for producing returns of 20 percent and even 25 percent a year for his investors, but now he wasn't even outperforming the market indexes, which themselves were sluggish. (Sherman had once bragged, in an interview with author Peter J. Tanous published in Tanous' 1997 book, "Investment Gurus," "If I don't outperform that index..fire me, and maybe I'll put my money with you.")

He needed a way to rescue his investment. Simply selling the Knight Ridder stock would likely depress its price, sinking him even deeper in the hole. However, he and his fellow mutineers believed that Knight Ridder in its entirety could be sold outright, just auctioned off, for more money – and maybe a lot more – than they could get by selling their shares on the stock market. So Sherman had decided to bully the company into putting itself up for sale.

This sale, if it happens, will constitute the first big-time hostile takeover of a U.S. newspaper company. But maybe not the last. Some on Wall Street are hoping it could trigger a broader wave of consolidation, with all of the investment banking deals, lawyers' and consultants' fees and stock windfalls that this implies. Many who work at newspapers – especially those belonging to Knight Ridder – worry now about their careers and the future of their profession. The assumption is that whoever buys Knight Ridder will make drastic cost cuts, to the detriment of good journalism and the company's long-term strength – a sad end for an organization whose 32 daily papers, including the Philadelphia Inquirer, Miami Herald and San Jose Mercury News, have won 60 Pulitzers over three decades. But for Sherman, the sale is an exit strategy. It could bail him out of a tough spot, maybe with a decent profit.

Sherman has never been widely known on Wall Street. And since becoming the scourge of Knight Ridder, he has refused practically all interview requests, including mine. This has led writers to call him "secretive," "shy" and "publicity-averse," although Phil Lewis, the editor of Sherman's hometown paper, the Naples Daily News, laughs at that.

"He's not a hermit, and he doesn't hide behind trees or anything," says Lewis. In fact, "He's been rather active in the community. The largest charity fundraiser in South Florida is the Naples Winter Wine Festival. He's a director of that." He is also a director of the Philharmonic Center for the Arts, an important cultural institution in Naples, and his wife, Cynthia, a lawyer, is active in local organizations.

Physically, Sherman resembles a fleshier version of the TV personality Regis Philbin. His curly hair is going gray. In photographs, his thin smile, slightly lopsided to the left, conveys a trace of repressed irony. He is 57.

The son of an aviation-engineer father and schoolteacher mother, Sherman grew up in Queens, in a neighborhood called Little Neck. He earned a bachelor's degree from the University of Rhode Island, majoring in accounting, and later an MBA from New York's Bernard Baruch College.

Had he steered a different course in life, he might have made a pretty good investigative reporter. He has the smarts and determination, plus the suspicious turn of mind. His business partner, Gregg J. Powers, told author Tanous: "One way I describe Bruce is, there are people who think the glass is half full, others, like me, who tend to think the glass is half empty, and then there's Bruce, who wants to know who is going to steal the damn glass."

He is especially skeptical of the research of Wall Street analysts, which he called "short-term oriented and superficial" in a 2004 interview in Money Manager Review, and of the financial claims made by companies in their public filings.

As a young CPA, Sherman worked for the accounting firm of Arthur Young and Co. (now Ernst & Young) in New York City, doing company audits. His job involved reading annual reports, proxies and Securities and Exchange Commission filings, asking tough technical questions of the companies' executives and checking to see that the statements and figures all reconciled. He learned about deferred tax liabilities, diluted earnings per share calculations and various ways in which a company can hide financial weaknesses.

"Sometimes the partner would come down and say, we're going to take a reserve of $100 million," Sherman told Tanous. "And I'd say, well, what's it for? He'd say, well, we have a list but we can't show it to you. And then, over the next five years, I saw how the company would live off the reserve by charges against the reserve, thereby inflating earnings."

Sherman takes obvious pride in being able to spot such corporate snow jobs.

When he was 29, he got a call from a search firm that was looking for someone to manage the investments of a family in the Gulf Coast city of Naples, a playground community of palm trees and beaches, golf courses and marinas for the very wealthy. The family turned out to be the Colliers, whose paterfamilias, Barron G. Collier, made his millions in the early 20th century selling advertising franchises to trolley, train and subway lines. At his death in 1939, Collier was Florida's largest landowner, with more than a million acres sprawling from the coast into the Everglades.

Sherman did well managing this family's wealth, and in 1986 he launched his own firm, Private Capital Management, with initial assets of $25 million. He did well at this also, and attracted some notice. Tanous spent an entire chapter praising Sherman, and Nelson MarketPlace recently calculated PCM's earnings on investments at an annualized average of almost 21 percent over a 10-year period ending in September of last year. This put PCM in the very top tier of wealth management firms, based on percentage of earnings.

Sherman's reputation as a moneymaker during these years was such that cash from new investors poured through his doors like a tsunami. In 2000, when he bought his first Knight Ridder share, he was handling $5.9 billion spread over 977 individual portfolios. By the time of the San Francisco board meeting, the amount of assets under his management had quintupled, to about $30 billion, and the number of portfolios had sextupled, to more than 6,000. He recently raised PCM's minimum buy-in from $1 million to $2.5 million, to slow the flood of new clients.

In 2001, Sherman's little company hit pay dirt. It was purchased for $1.38 billion by Legg Mason Inc., the Baltimore-based financial giant. Legg Mason said it would make no management changes at PCM; Sherman and his partner, Powers, would continue to run the place as a Legg Mason subsidiary.

After that, according to Collier County property records, Sherman and his wife bought a $9.5 million penthouse in a high-rise condo overlooking the gulf.

Sherman is what they call a "value" investor. This means, as PCM explains on its Web site, that he looks to invest in companies with inherent value that the stock market has overlooked. He typically holds a stock for a period of years, until the price approaches what he thinks is the company's actual worth.

Discovering these solid but undervalued stocks is time-consuming. Although PCM has investments in only about 150 companies at a time, it claims on its Web site that it screens "thousands of publicly traded companies each year." PCM first subjects a candidate company to "rigorous financial analysis," the Web site says. Once satisfied with the financials, PCM says it interviews members of senior and middle management as well as the company's key customers, competitors and suppliers. "We immerse ourselves in the company," it says.

In his interview with Tanous, Sherman said, "I want to know more about the companies than anybody." And the way he learns is: "You read the material; make a lot of phone calls. You talk to the company's customers; get the investor relations people; get the management on the phone; see how they respond. Now, you don't go into a meeting and ask: What's your next quarter going to look like? That's what Wall Street does. Understand what your two-to-five-year time horizon is, and then go visit the company. The company visit is half of it."

One would suppose that Knight Ridder passed through this rigorous screening before PCM bought its stock. Oddly, however, I have been told that Sherman never showed his face at the company's San Jose headquarters during the years he was amassing its shares. "To my knowledge," says Knight Ridder spokesman Polk Laffoon, "he never called us, he never sought an audience with us, he never attempted to tell us how to run anything. We never even met him" until November 2004.

It's unclear what to make of this. PCM won't comment. However, one theory is that the growth of PCM's assets and client base have put a strain on its operations. In a 2004 report to the SEC, Legg Mason itself acknowledged that the "extraordinarily large increases" in the amount of money PCM manages could be a problem. "If an asset management firm is not able to invest new assets in a timely manner," the report said, "the firm's investment performance could be adversely affected."

For all its growth, PCM still isn't a large enterprise. It occupies the fifth floor of an office building not far from the beach in a section of Naples called Pelican Bay. Although the neighborhood is elegant and expensive, PCM's office space is functional and understated. PCM has, I was told, about 50 employees, but the work of deciding which new investments to make appears to fall on just a few people: Sherman, who is CEO; Powers, who is president; and Joseph J. Farley, who joined the firm in 2002 and whose title is managing director of investment research.

"A couple, two or three people, virtually make the decisions, and they don't look at much of any outside research," Legg Mason's chairman, president and CEO, Raymond A. Mason, explained in a conference call with stock analysts in 2004. He said PCM would like to enlarge its team of key decision-makers, "but it is more difficult because of the nature of what they do."

During another conference call a few months later, Mason told analysts that PCM had "added a third principal" – this would be Farley – "in the last 18 months who is very much involved in what they're doing, and continue to look to add someone else. The nature of that business is, it's a very focused portfolio and realistically I'm not sure how many people can get in the decision act."

In January 2005, during yet another conference call, Douglas Sipkin of Wachovia Securities took note of PCM's growth rate and asked Mason whether it had the capacity to handle so much new business. Mason seemed a bit evasive. "What they've tried to do," he said, "is keep their growth rates at a certain level and not let them get too strong, which is a marvelous problem to have."

In July, Sipkin raised the question again. "Is capacity weighing a bit at Private Capital," he asked, "because I know they've had pretty dramatic growth – tripling in four or five years' time. Is that something that's maybe starting to show itself out there?"

Mason replied that PCM had been trying "to slow things down, to regroup..because the flows were just coming in at such a rapid rate." He added that he didn't consider this a long-term problem.

The financial writer Lawrence C. Strauss recently questioned Sherman's practice of investing heavily in a relatively small number of securities. (PCM is often the largest or second-largest owner of the companies it holds.) By making "such big, concentrated bets," Strauss wrote in Barron's, "the firm could get trapped in some holdings that are hard to sell, costing shareholders dearly."

Stuart L. Gillan of Arizona State University, an expert on shareholder issues, explained to me that a major owner who tries to unload an underperforming stock runs the risk of driving the price even lower. "If you're trying to release a large amount at once, there's a supply-demand effect," he says. "Or, there can be a psychological effect, if it looks like the investor is trying to bail out. People might conclude there's something wrong with the company."

It's a bear market for newspapers, in any case. Since the news of Sherman's raid on Knight Ridder, financial analysts have wondered aloud why anyone would want to buy a newspaper company. A writer for Fortune magazine asked rhetorically how Sherman had gotten himself "mired in newspapers, a business that seems destined for dreary decline." Conrad Fink, a former journalist who teaches newspaper management at the University of Georgia, says he's never seen such panic over newspaper stocks before. The pessimism is mainly due to shrinking circulation and a strong fear of advertisers defecting to the Internet.

"The perception is that somebody invented Google and so you'd better get the hell out of newspaper stocks," says Fink.

But how does someone in Sherman's position do that?

At some point, after Knight Ridder's stock swooned in the spring of 2004, Sherman began complaining mightily to P. Anthony Ridder, the company's chairman and CEO. Last year the pressure from Sherman was such that Ridder offered him the opportunity to address the board of directors at its regularly scheduled July 19 meeting.

He also invited Knight Ridder's second- and third-largest shareholders, Southeastern Asset Management, which is headquartered in Memphis, and Harris Associates L.P. of Chicago. Southeastern owns almost 9 percent of Knight Ridder's stock, and Harris owns about 8 percent.

Executives at both firms say that PCM was the driving force leading to the July meeting. "Tony Ridder called and invited us to come," says Lee B. Harper, a vice president at Southeastern. Harris Associates got a similar invitation. It was the first time either firm had ever addressed the board of directors. According to Henry R. Berghoef, Harris' director of research, the firm's executives had expressed themselves in the past either on the phone or by speaking to Knight Ridder people at investors' conferences and other such meetings. They had also visited Knight Ridder's offices.

Up to that time, Berghoef says, he and his people had never urged Knight Ridder to put itself up for auction – at least not explicitly. But among themselves, they had long felt that a sale of the company might be one way to redeem their investment. While the stock was trading at eight times cash flow, they figured Knight Ridder might bring 12 or 13 times cash flow from a sale, since that has been the going multiple for newspaper sales in the recent past. (Thirteen times Knight Ridder's projected 2006 cash flow would be about $91 per share.) Berghoef says he and his people had discussed with Ridder the gap between the stock's price and what the company might sell for. "We always raised the point," he says.

When representatives of these three stockholding institutions converged on San Francisco's Ritz-Carlton, they were constrained by securities trading regulations as to how much they could say to one another. Insider trading considerations also limited how much the board of directors could say to them, since a company is not supposed to give one shareholder important information that other shareholders don't receive.

Presumably for these reasons, the three groups addressed the board one at a time. The board members, I was told, listened in silence to each presentation.

Berghoef was accompanied by another Harris executive, William C. Nygren, and by a company attorney. Their presentation was brief. "We reminded them who we were," Berghoef later told me. "We said we were acting independently. We mentioned the large discount of the stock to the business value [that is, the company's value if sold]. We said we thought any board had an obligation to see the gap closed. We encouraged them to think broadly about what kinds of paths could produce the greatest value."

He remembers mentioning several specific alternatives. One was for Knight Ridder to buy back a large amount of its stock, a classic way of returning value to shareholders. "We did not advocate per se any single course of action," he says, "although we did say one of the potential courses of action they should look at is sale of the company."

Sherman's presentation seems to have been more pointed. In a letter on file with the SEC describing his appearance that day, he recalled saying that "PCM has long respected Knight Ridder for its distinguished history of serving the public" and for the high quality of its newspapers. However, he said, in light of its failure to give shareholders a fair return, the board "should aggressively pursue the competitive sale of the company."

The board did not do that. At least not right away.

Instead, before the meeting ended, it voted to pay shareholders an increased dividend of 37 cents. It also authorized the company to repurchase 10 million of its shares. In September, Knight Ridder made another move designed to placate its restive owners. To cut operating costs, it announced that it was reducing the size of newsroom staffs at three papers – the Philadelphia Inquirer, Philadelphia Daily News and San Jose Mercury News – by a combined total of about 15 percent.

This announcement – coming on top of a decade and a half of staff cuts at these papers – shocked and enraged many editors and reporters. Amanda Bennett, the Inquirer's top editor, told one of her writers that the extent of the cuts had come as a surprise to her. The anxiety had caused her to lose sleep and even to vomit, she said.

None of these measures had the intended effect of boosting Knight Ridder's stock. Instead, the stock kept sinking. By the end of October it was at $53 – $9 lower than at the time of the July meeting – and Sherman's patience was spent.

His overall investments remained in a slump. In his third-quarter report to clients, he was forced to write that PCM had "underperformed the market." He urged his investors to have patience.

On November 1 he sent a tough letter to the board of directors of Knight Ridder, calling on them to put the company up for sale to the highest bidder. If they refused, Sherman threatened "more aggressive efforts," which he said might include unseating some board members and replacing Ridder and his management team. Sherman filed a copy of the letter with the SEC, making the whole drama public for the first time.

(Only on learning of this letter did newsroom employees in Philadelphia and San Jose begin to understand what had prompted the sudden staff cuts.)

Berghoef, of Harris Associates, has said that after reading Sherman's letter, he quickly concluded that a sale was the best way to go. On November 3 he and Nygren sent a letter to the Knight Ridder board demanding that it "solicit offers for the Company."

The third major shareholder, Southeastern Asset, didn't go that far. But it gave notice to the SEC that it planned to discuss various options with other stockholders, and that whatever position it finally took would depend in part on how Knight Ridder responded to Sherman's sale proposal.

When Knight Ridder issued a noncommittal statement, promising only to respond to Sherman's letter "in due course," Sherman declared war. He served notice in a new SEC filing on November 10 that PCM was prepared to "nominate a slate of directors for election by shareholders at the Company's 2006 annual meeting," which is scheduled for April. He also declared that PCM would be working with other shareholders toward that end.

Tony Ridder and his board gave in. They announced on November 14 that they had asked investment bankers to seek out potential buyers. And Ridder told employees that all three of the main stockholders, who together owned more than 35 percent of Knight Ridder, were now united in demanding a sale.

Before the month was out, an analyst for Morgan Stanley & Co. published a report suggesting that a buyer – perhaps Gannett or a private equity group – could turn a good profit if it paid $70 a share for Knight Ridder and then cut costs company-wide.

The report offered two scenarios. One, which it called a "moderate" plan, would wipe out 5 percent of Knight Ridder's 17,735 newspaper jobs, reduce corporate overhead by $50 million and impose $35 million in other cost cuts. A more extreme, "scorched earth" plan would cut 6 percent of the newspaper work force, reduce corporate overhead by $70 million, close the Philadelphia Daily News and impose $75 million in other savings. (The "other savings" category includes cuts in such newsgathering expenses as travel and bureau operations, along with marketing and promotion and miscellaneous overhead.)

One got the feeling that Wall Street was licking its lips, not just at the prospect of a Knight Ridder sale but at the possibility of other deals as well. A Merrill Lynch report, published in November, looked at deal-making prospects at the Tribune Co. "We sense the company is under pressure to start investing in higher growth..and/or to monetize [that is, sell] some of its current assets," the report said. Because it doubted any single buyer could swallow the entire company, the report tried to predict how much shareholder value could be gained if Tribune sold off just its newspapers or, alternatively, just its TV stations.

Speculation was mounting. Fink of the University of Georgia says he thought Sherman's move against Knight Ridder might set off a chain of such events. He notes that Sherman is also a major holder of other newspaper chains; he owns 37 percent of McClatchy, for instance.

"If this guy can break Knight Ridder loose and pick up the shares to $75 or $80 or even more," Fink says, "what's he going to do with McClatchy and others? It seems to me that this is just the first in a series."

Or maybe not. Bruce Sherman isn't a classic corporate raider, who pillages his way to infamy and fortune. He isn't Carl Icahn, who buys stock in Time Warner to try to gain control of its board of directors so he can break the company into pieces. Or Edward Lampert, who takes over Kmart and Sears, merges them and starts selling off the assets.

Still, Knight Ridder is not the first company Sherman has tried to push around. For instance, during his interview with Peter Tanous, Sherman's secretary called him out of the room to take an important phone call, which turned out to be from the CFO of Albank Financial Corp., a bank in which Sherman was the largest stockholder. Sherman came back from the phone conversation exasperated, and vented his rage to the interviewer.

"The stock is now 28," he said. "They just turned down an offer of $35 a share for the company. I am leaping out of my chair! Not only did I write the management a letter, I sent a copy to all the directors...

"They have a fiduciary obligation!" he went on. "If they turned down the offer, I want to ask them: Why did you turn it down? What other alternatives do you have?

"They said, 'If we sell, now is not the right time and we're not sure they're the right purchaser.' My question is, who is the right purchaser, and when is the right time? They have an obligation." (Albank did eventually agree to be purchased, by a much larger company.)

Sherman then explained that, in his view, money managers have a duty to "get in there and mix it up" with the companies they own. "Shareholders have rights and they need to be protected," he said. "Michael Price did it with Chase. We can do it on a smaller scale."

The reference to Michael Price is telling, because Price, a mutual fund manager, was a pioneer in what has come to be called the "activist investor" movement. During the 1990s he developed a strategy of buying heavily into a company and then using his clout to force a merger or other reorganization that would drive up the stock price. In 1995, owning just 6 percent of Chase Manhattan Corp., he pushed that company into a merger with Chemical Bank – a record-breaking deal that made billions for stock owners but reportedly cost 12,000 employees their jobs.

It's easy to see parallels between that and Knight Ridder's current plight.

As this article went to press, Knight Ridder was making economic presentations to various groups of potential buyers. That process was expected to last for several weeks, after which any of those buyers could make a bid for the company. Since early November, the anticipation of such a sale had pushed Knight Ridder's stock price into the mid-$60s range – roughly where it was in July when Sherman began his assault.

The Morgan Stanley report assumed that a buyer should be willing to pay $70 a share for Knight Ridder, a price that might rescue Sherman from his predicament but might not give him a profit, if one allows for inflation. (This is by my estimate; PCM refused to comment.) The report also estimated that Knight Ridder's actual fair value – including everything the company owns – is $74 a share before any takeover, and that this value could rise to $91 with cost cuts. Generally, the more a buyer pays for a company, the deeper the cuts that buyer will inflict after taking over.

Although all potential buyers were pledged to secrecy and Knight Ridder had no official comment, news reports said that several newspaper companies – Gannett, McClatchy and MediaNews Group – had shown an interest. Several private equity firms were also mentioned as potential buyers, one of which, Kohlberg Kravis Roberts & Co., is a notorious leveraged buyout operator known for taking over companies and sacrificing large numbers of jobs. Kohlberg Kravis arranged the takeover of RJR Nabisco in 1989, a $25 billion deal immortalized in the book "Barbarians at the Gate."

Journalists have made some faint attempts to influence these events. A Philadelphia Daily News columnist floated the idea of loyal readers organizing a protest movement against any new owner who tries to close that paper. And a group of former Knight Ridder journalists, organized by former Philadelphia Inquirer Executive Editor James M. Naughton, was attempting to line up its own set of director candidates for the next shareholders' meeting. "We will support and counsel only corporate leadership that restores to Knight Ridder newspapers the resources to do excellent journalism," the group said in an open letter.

Polk Laffoon of Knight Ridder called Naughton's effort a nonstarter. About 94 percent of the company's stock is owned by institutional investors, and their interests, says Laffoon, are more in line with Sherman's than with the journalists'.

Meanwhile, the possibility remained that Knight Ridder might not bring a premium price from any of its potential bidders. Both on Wall Street and within Knight Ridder, it was noted that such a development could lower investors' faith in the entire industry, deflating newspaper stocks even further across the board. In that event, Bruce Sherman would have shot himself in the foot.

So this is the nature of Sherman's gamble. And he isn't just gambling with his investors' money; it's also a gamble affecting thousands of newspaper employees, millions of readers and, conceivably, the future of the newspaper business and the quality of our democracy.

Senior writer Charles Layton (charlesmary@hotmail.com) wrote about the Dallas Morning News in AJR's April/May 2005 issue. He was a reporter and editor for Knight Ridder's Philadelphia Inquirer for 22 years, leaving the paper in 1996.