Baseball wary of Cubs sale structure – Tax-limiting plan would put heavy debt load on buyer

August 13, 2008

By Ameet Sachdev | Chicago Tribune reporter

Tribune Co.’s desire to minimize its taxes when it unloads the Chicago Cubs sets the stage for a possible showdown with Major League Baseball.

The Chicago-based media company is proposing a tax-avoidance strategy that likely would require a buyer to borrow heavily to pay for the team. That highly leveraged financial structure has produced concern among prospective buyers about their ability to operate the Cubs in a competitive manner, according to multiple sources.

In addition, Major League Baseball is nervous about any of its teams being saddled with too much debt.

“A financially troubled franchise in Chicago is a lot more detrimental to baseball than a bad franchise in Kansas City,” said Andrew Zimbalist, a Smith College economist who focuses on sports. “The league knows that Tribune has enormous amounts of debt and it wants to do things to maximize returns. There’s going to be some conflict here. I don’t know how it plays out.”

The league reviewed Tribune’s proposed financial structure before allowing the company to distribute confidential financial information to bidders in June. But its tolerance for such a deal won’t be known until Tribune presents the league with a purchase agreement. Three-fourths of MLB’s 30 owners must approve a sale.

The league has shown a willingness in the past to approve complicated ownership transactions. But that is balanced by its interest in ensuring the financial stability of its franchises, especially one as prominent as the Cubs. To that end, the league has conservative guidelines about the amount of debt ballclubs can carry.

Tribune Co., which also owns this newspaper, has had a running dialogue with league officials and is sensitive to their concerns, said a source close to the transaction. But the company also knows that this is a once-in-a-lifetime opportunity to buy one of sports’ iconic franchises and expects bidders to come up with creative solutions to satisfy both Tribune and the league.

Among those bidding for the team are Dallas Mavericks owner Mark Cuban, Chicago businessman Tom Ricketts, Chicago real estate investor Hersch Klaff and New York private-equity investor Marc Utay.

Huge tax exposure
Prospective buyers have to figure out not only how much to bid but also how much of the price can be shielded from taxes. Tribune faces enormous tax exposure from an outright sale of the team because it bought the Cubs in 1981 for $20.5 million.

If the historic franchise fetches about $1 billion, as some believe, Tribune could owe up to $400 million in taxes, said Robert Willens, a leading New York tax analyst. That’s a tax bill Sam Zell, Tribune’s chairman and chief executive, would like to avoid in an effort to continue making debt payments from the $8.2 billion leveraged buyout of Tribune he led in December.

Instead, he wants to create what’s known as a leveraged partnership between the buyer and Tribune to own the team. The partnership would borrow money to buy the team, and the proceeds from the loans would go to Tribune. The media company would retain a small stake in the partnership, less than 5 percent, giving it some exposure to the loans.

Under the terms of a leveraged partnership, only borrowed money can be distributed tax-free. Consequently, in some of these deals as much as 90 percent of the purchase price is financed with debt to maximize the cash payout, Willens said.

“When you set up a structure like that, it’s costly,” said a source close to one of the five remaining bidders who asked to remain anonymous. “The more debt you put on it, the more expensive it is. The more leverage, the more scrutiny you get from baseball.”

For the Cubs transaction, a new owner also would have another hurdle: The buyer could not start paying down debt until Jan. 1, 2018. That’s the 10th anniversary of Zell’s Tribune acquisition, in which he converted the company to an S corporation from a C corporation. In the 10 years after a conversion, an S corporation must pay taxes on asset dispositions. After 10 years, the capital-gains requirement expires.

Technically, a leveraged partnership is not considered a sale, even though the seller receives cash upfront. If Zell can defer the sale of the Cubs for 10 years, Tribune will avoid having to pay capital-gains taxes on the deal.

Willens expects the IRS to scrutinize any such transaction because the Cubs are such a high-profile asset. But, he added, “I don’t know if the IRS has a basis to challenge it.”

Limits on debt
MLB, however, might have something to say. The league, according to a complex formula, limits total club debt to about 10 to 15 times cash flow, according to its labor contract with the players union. But the agreement appears to provide some flexibility to its debt-service rule when it comes to sales transactions. In such deals, the commissioner must assure other owners and the union that the sale “will not create a persistent inability to comply” with the league’s debt rules.

Sources have pegged the Cubs’ 2007 cash flow at $31 million, which implies a debt ceiling of $465 million, an amount that likely would not satisfy Zell. One way to generate a bigger payout would be to put additional debt on Wrigley Field and structure a similar tax-advantaged transaction for that asset.

The debt-service rules are designed to ensure a level of financial stability in franchises, said Robert Manfred, MLB’s executive vice president for labor relations and human resources. He declined to comment on details of the Cubs sale.

The league had concerns in News Corp.’s 2004 sale of the Los Angeles Dodgers to Boston businessman Frank McCourt, according to published reports. Originally, McCourt proposed financing the entire $430 million price with debt, worrying league officials that he might not have enough cash to invest in new players. But after several meetings with baseball officials, News Corp. retained a small equity stake.

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