The Hedge Fund Era   

Financial firms are investing heavily in newspapers. What does that mean for journalism? Posted: Thu, March 3, 2011

Time was, it was mostly newspaper people who owned newspapers. There was something comforting about that. As disappointing as some newspaper owners could be, in most cases their hearts were in newspapering. They may also have made serious money in the process, but this was not their sole preoccupation.

Today, many newspapers find themselves in the hands of hedge funds, whose sole preoccupation is making money. Hedge funds invest in all manner of financial instruments and companies. When it comes to newspapers, they specialize in buying, at exceptionally low prices, the debt of bankrupt companies or ownership positions in financially distressed companies either coming out of bankruptcy or trying to avoid it. They are not doing this because they have a warm glow about owning socially useful enterprises devoted at least partly to serving the common weal. They are in it because they perceive a chance to make a lot of money a few years down the road.

By then, they reason, the nation's beleaguered newspapers will be healthier, thanks to cost-cutting, better management or a revival of the market forces that newspapers depend on -- or a mix of all three. When this prosperous future arrives, they believe, the newspapers will be worth a whole lot more than what the hedge funds paid for their interest. And then they'll force a sale, either back to the original owners or to outsiders. In investment parlance, this is called "flipping."

A hedge fund is a type of mutual fund that can have no more than 100 investors (individuals, institutions or a combination); is lightly regulated by government agencies; and is allowed to engage in aggressive investment tactics (short-selling, arbitrage, derivatives, swaps, etc.) denied to more closely regulated conventional mutual funds. Another type of investor currently in the newspaper industry is the private-equity firm, which typically buys majority control. For the purposes of this discussion, when it comes to newspapers, private-equity funds pretty much follow the same strategy as hedge funds.

These investors now have large stakes or majority ownership in numerous newspapers -- in Minneapolis, Philadelphia and San Diego, for example -- and in such newspaper chains as Tribune Co., Freedom Communications, MediaNews Group and Journal Register Co. (Some of them have also bought substantial positions in publicly traded companies like Gannett, Lee Enterprises, McClatchy and the New York Times Co., but never of sufficient size to influence management significantly.)

So what does this mean for newspapers? There are several things to worry about. First of all is uncertainty, which never is good for employee morale or management's focus on how to operate in a highly competitive landscape. For the first time in modern history, newspapers have a powerful competitor -- the Internet -- that does what newspapers do: present mass amounts of detailed news and advertising to consumers. Neither radio nor television do this, which is the fundamental reason newspapers continued to prosper despite the creation and ultimate ubiquity of broadcast media.

Second, these new investors may be highly adept at parsing balance sheets and profit-and-loss statements, but they do not have a deep understanding of how the newspaper business works. They apparently realize that newspapers have made substantial reductions in operating costs, and they apparently are banking on the notion that once the industry starts to regain business lost during the recession, most of the higher revenue will fall to the bottom line.

What they do not seem to understand is that newspapers started losing advertising revenue well before the recession began in late 2007, even though the traditional sources of that revenue -- sales of everything from automobiles to household goods to homes -- did not decline until the recession hit. The recession, of course, made everything worse, to the point that by last year newspaper advertising revenue was significantly less than half what it was in 2005.

Most industries that lose in a short time more than half of the dollar stream that contributes three-quarters of their total revenue would be out of business by now, or close to it. That didn't happen to newspapers because, until the storm hit, they had enjoyed extraordinarily high profit margins -- on average well above 20 percent. Now profits are under 10 percent, and the prospects for improvement are not great.

The reason for this, of course, is the shift of great amounts of advertising to the Internet. Newspapers now have intense competition for advertising never previously experienced. Moreover, they face a future in which a consumer wanting to know what a favorite department store has on sale can get the answer directly from store's Web site, no advertising needed.

My fear is that if the new investors' strategy begins to falter, they will press for more cost-cutting, which inevitably will hit newspaper journalism the hardest. That means a weaker product in an increasingly crowded marketplace. This will do nothing but complicate newspapers' already formidable challenge of recasting their business models to find new sources of revenue.