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Industry pressures put print, Herald-Leader at crossroads

LEXINGTON, Ky.—Fresh into the new year, aboard a flight to New York, Lexington construction executive Jim Gray pondered the future. But it wasn't a groundbreaking he had foremost in mind. It was the future of his hometown newspaper. He wants to own it.

"How many times in a century does an opportunity like this arise?" said Gray, who has woven his business savvy into local philanthropy, politics and the arts.

Just over two weeks later, fewer than a dozen Herald-Leader journalists gathered over pizza and soft drinks at a Delaware Avenue union hall. They came with questions for a representative of the Newspaper Guild, a union that represents newspaper employees. He was ready to rally the troops in an effort to purchase the Herald-Leader and eight other unionized Knight Ridder papers.

And this month, Herald-Leader Publisher Tim Kelly flew to San Jose, California, headquarters of Knight Ridder, and fielded questions about the Lexington paper from potential investors. They were among several private-equity and media companies that over the past few weeks have pored over Knight Ridder financial documents and met with company executives, considering whether to put in a bid to buy the nation's second-largest newspaper publisher, which was put up for sale in November.

The prospect of ownership change in the parent company of the Herald-Leader, a local institution with roots that date back to 1870, signals a time of transition for the American newspaper industry, which is battling for its turf on the evolving and lucrative media landscape.

Competition from radio, television and the Internet have put a squeeze on newspapers, luring away more and more advertising dollars. At the same time, rising newspaper expenses, changing consumer preferences and Wall Street's expectations for higher profits have all pressured newspapers, which have seen their online readership soar but their daily circulation drop nearly 8 percent from 1994 to 2004—that's 4.7 million fewer papers on newsstands and front porches.

All those forces have culminated in a confluence of demanding investors, angst-filled newspaper employees and migrating readers that has led Knight Ridder to put itself on the auction block, spurring speculation about the future and character of papers like the Herald-Leader.

Shareholder dissatisfaction

When Knight Newspapers decided in 1969 to sell stock in the company to the public, Editorial Chairman John S. Knight met with Wall Street analysts to discuss the company he and his brother built from a one-newspaper operation in Akron to a chain that would eventually become Knight Ridder.

In his opening remarks, Knight, a Pulitzer Prize-winning editorial writer warned, "Ladies and gentlemen, I do not intend to become your prisoner. ... As long as I have anything to do with it, we are going to run the papers."

Thirty-six years later, Bruce Sherman, CEO of investment firm Private Capital Management, stood before Knight Ridder CEO Tony Ridder and his board at their July meeting in San Francisco's Ritz-Carlton Hotel. He was concerned. Eighty-six percent of Knight Ridder is owned by financial institutions, and Sherman's firm then owned 19 percent of the company, which was not performing to the top shareholder's satisfaction. Sherman and executives representing the second- and third-largest shareholders, Southeastern Asset Management and Harris Associates L.P., urged the Knight Ridder board to rectify the situation.

Knight Ridder responded quickly, selling in August one of its largest newspapers, The Detroit Free Press, to rival Gannett for $285 million and swapping its Tallahassee (Fla.) Democrat and $239 million in cash for three Gannett newspapers, in Idaho and Washington state.

Then, in September, Knight Ridder cut positions from the newsroom staffs of three of its largest papers: the Philadelphia Inquirer, Philadelphia Daily News and San Jose Mercury News. At the same time, all Knight Ridder papers, including the Herald-Leader, significantly reduced costs by freezing hiring, limiting travel and cutting pages. The company also repurchased 5 million shares of its stock, a move designed to convince investors that a company thinks its stock is undervalued.

The stock price failed to respond. In fact, over the next 3{ months, it sank from $62.23 after that July 19 meeting to $53.38 on Halloween.

Sherman's patience ran out.

The next day, he sent a letter to Knight Ridder's board, urging that it sell the company. Days later, Harris executives also called for a sale. Two weeks later, Knight Ridder announced it would seek bids from potential suitors.

Stiff challenges

In the age of Google, iPods and text messaging, younger consumers increasingly find their news on flat-screen pixels rather than ink on pulp.

While 70 percent of people age 65 and older read a daily paper, only 39 percent of 18- to 34-year-olds do, according to the Newspaper Association of America.

Younger readers are "not particularly favorably disposed to print," said former Herald-Leader Editor John Carroll, who retired as editor of the Los Angeles Times last year and is a visiting lecturer at Harvard. "They like the electronic formats. They also have tastes in news: They tend not to read long stories and tend to be absorbed with things on the fringes of traditional news, such as entertainment."

From 1994 to 2004, daily newspaper circulation fell 7.9 percent to 54.6 million, according to the NAA. Circulation typically accounts for only one-fifth of a newspaper's revenue—17.6 percent for Knight Ridder in 2005—while advertising kicks in most of the rest. But papers can charge more for their ads if they have higher circulation.

Complicating newspapers' advertising woes is the explosion of specialized media. Cable TV, the Internet and niche publications have grown, offering specialized audiences to advertisers. In 1994, newspapers attracted 22.8 percent of advertising dollars. That dropped to 17.7 percent in 2004, according to the NAA.

And while print circulation has declined, Internet usage in U.S. homes has soared. Census data shows that 54.7 percent of U.S. homes had Internet access in 2003, compared with 18 percent in 1997. The percentage of Kentuckians with Internet access at home was 49.9 percent in 2003.

Over time, newspapers have grown to look to the Web less as a competitor and more as an opportunity. It's where Knight Ridder is seeing its greatest revenue growth. Knight Ridder Digital, which operates Knight Ridder newspapers' Web sites, generated $164.5 million in revenue last year in online advertising, 54.5 percent more than the year before, executives said. The Herald-Leader's Web site, Kentucky.com, which had 7.8 million page views last month, compared with 6 million in July 2005, generated nearly $4 million of that revenue. Still, Knight Ridder's online revenue accounts for less than 6 percent of the company's total.

As newspapers have scrambled to build or improve their own Web sites, they also have seen the huge success of sites designed to rob them of a prime revenue stream: classified advertising.

Classified advertising has tended to mirror the state of the economy—if the economy was good, so was classified ad revenue. But as the economy began to regain footing after the tech bubble burst in 2000 and the post-9/11 skid, competition for classified ad dollars also emerged in the explosive popularity of such sites as eBay's online auction site and Craigslist's free online classified ad service. In 2001, Knight Ridder reported its classified revenue at $884 million, down from more than $1 billion the previous year. Last year, the company made $905 million in classified revenue.

Newspapers have made inroads in the online classified advertising market. Knight Ridder, Gannett and Tribune each have a one-third stake in CareerBuilder, an online job-search site and one of the most valuable items in Knight Ridder's portfolio.

Further complicating the print media's financial picture has been an increase in the cost of newsprint. Despite Knight Ridder's newspapers using 5.4 percent less newsprint last year than the year before, their costs of newsprint, ink and supplements still rose 4.6 percent.

Also contributing to Knight Ridder's vulnerability, analysts said, is that it is not as diversified as its counterparts. Knight Ridder owns newspapers and their Web sites almost exclusively. Rival media companies Gannett and Tribune own numerous television stations, and The Washington Post Co. owns Kaplan, the education and training service.

"We decided 20 years ago that we wanted to be a more diverse business and not be so focused on advertising," said Washington Post Co. Chief Financial Officer John Morse. He added that while Knight Ridder is probably more cost-efficient because of its focus on papers, the Post is more insulated when newspapers enter a down cycle.

That down cycle is felt most sharply at Knight Ridder's largest papers.

Newspapers in the company's top nine markets, including Philadelphia, Miami and San Jose, contribute about 75 percent of revenue but only 64 percent of operating profit, Knight Ridder spokesman Polk Laffoon IV said.

In Lexington, the Herald-Leader generated more than $85 million in revenue last year, according to Herald-Leader Publisher Tim Kelly. That's 2.8 percent of Knight Ridder's total revenue pie of $3.004 billion.

Kelly declined to share the Herald-Leader's profit figures. But Gray, who went over financial details of the Herald-Leader with investment bankers on his trip to New York, said those bankers estimated the paper's operating profit margin to be from 26 to 28 percent, compared with 16.4 percent for Knight Ridder as a whole. At that rate, the Herald-Leader made about $23 million in operating profit last year.

Tough choices

Walk through the Herald-Leader newsroom, and you'll find more empty desks than in previous years. From press operators to obituary clerks, the Herald-Leader had the equivalent of 501 employees in 2005, compared with 558 in 2000. (Herald-Leader personnel is measured in "full-time equivalents" or FTEs, which take into account part-timers, free-lancers and overtime costs.) The newsroom today has 133 FTEs, down from 159 in 1999.

Pick up the paper, and you'll notice it's smaller: It's narrower and has fewer pages than in years past. On the first Sunday of this month, the Herald-Leader had 54 pages in its news, features, sports and editorial sections, compared with 72 pages on the first Sunday in February 2000.

Both observations point to recent belt-tightening at the Herald-Leader, which at the same time has kept its monthly subscription price the same since 2001. The cost cutting, which has taken place at newspapers across the country, has taken many forms:

Hiring freezes: When employees leave the Herald-Leader, they are not necessarily replaced. The Herald-Leader is filling only vacancies of advertising account executives, district circulation managers and part-time specialists in the packaging facility on Fortune Drive, Kelly said.

The Herald-Leader underwent a series of employee buyouts from 2000 to 2002 that shed 29 positions. Since then, the newspaper has cut its staff through attrition.

In San Jose, Knight Ridder cut 52 newsroom positions from its hometown paper, the Mercury News, which now has a news staff of 280, compared with 404 at the height of the tech boom. Outside Knight Ridder, The New York Times cut 45 newsroom jobs, and the Los Angeles Times slashed 85 newsroom positions.

Downsizing news space: To save newsprint, the Herald-Leader reduced the number of pages, cut stock listings, removed TV listings Monday through Saturday and shrank the size and pages of Sunday comics. In 2002, the paper also trimmed the width of its pages by an inch.

It's an industry trend. The Chicago Tribune recently cut almost all stock listings in its daily editions, directing readers to its Web site. And The Wall Street Journal is planning to cut the width of its newspaper next year.

Cutbacks in travel, bureaus and staff: Early last year, Herald-Leader reporter Jim Warren and chief photographer Charles Bertram traveled to Canada to report on a Kentuckian who'd deserted the U.S. Army. Such a trip now would be doubtful because of budget constraints, Editor Marilyn Thompson said, "although I would do everything possible to find the money somehow."

And the paper has trimmed the number of staff members it has sent to cover some recent University of Kentucky football and men's basketball games, Thompson said, "mainly because there was simply nowhere else to cut."

The newspaper's Hazard bureau has not been staffed since 2003. The Courier-Journal announced a similar move in December, saying it would close its Hazard, Paducah and Elizabethtown bureaus early this year, leaving only its Frankfort bureau open.

The Herald-Leader continues to have bureaus in Frankfort, Paintsville and Somerset. The paper also has bureaus in the growing neighboring communities of Georgetown, Nicholasville and Richmond. "You have to make choices," Kelly said, "and obviously we have a lot of circulation in those counties, and those are counties that are growing dramatically."

Despite the cutbacks, Thompson said the paper has strived to maintain its efforts in enterprise journalism, such as three extensive projects at the end of last year, which took significant resources to publish.

Quantifying quality

Former Herald-Leader editor Amanda Bennett's attempt to restructure the newsroom during her 21 months in Lexington were hampered by a hiring freeze. She faced an even bigger task at Knight Ridder's Philadelphia Inquirer, where she became editor in 2003. Agonizing over the September corporate-mandated slashing of 75 newsroom jobs caused her to vomit, she said.

"It was just so stressful because the number was so much bigger than we expected," Bennett said. But, she said, such moves are requiring newspapers to rethink their structure and their focus.

In redesigning the Inquirer newsroom, Bennett said she focused on emphasizing high-quality journalism rich with investigative pieces instead of daily-grind stories.

"Even at the Herald-Leader, I was always talking about the fact that we just couldn't Swiss cheese the operation," Bennett said. "You couldn't just pull people out and say 'Well, we're just going to work faster, work harder and stretch things,' because to me that was a formula for crappy journalism."

At the Inquirer, Bennett said she has emphasized more thematic stories geared toward broader interests.

William Dean Singleton, CEO of MediaNews Group, a reported bidder for Knight Ridder, said newspapers should shift resources and focus from what he deemed "all the vanity coverage," specifically mentioning sending reporters to Iraq. Singleton said papers and its readers would be better served to focus more on local issues.

"Today there are four 24-hour cable (news) channels plus the networks plus the Internet," he said. "But consumers don't have access to coverage of city hall corruption, tax increases, local sports and all the things that are important to their local lives. They can't get those on cable channels and can't get them on the Internet except through us."

While to Singleton, a local focus helps define quality journalism, its definition, appreciation and value are up for debate.

"Over the long term, if you've got a better product, you ought to have better-quality readers, and better-quality readers ought to attract better advertisers," said Morse of the Washington Post Co.

A single story or series wouldn't do it, though, Morse said. In fact, such a piece "probably has more risk on the negative side because if you write about a company that's an advertiser and you write negatively, they may pull the ad."

When the Herald-Leader published a Pulitzer Prize-winning series of stories in 1985 alleging the UK men's basketball program violated NCAA rules, 385 readers canceled their subscriptions.

Analyst Ed Atorino of Benchmark Capital called high-quality journalism "almost irrelevant" to a newspaper's overall financial health. He said a paper should provide timely, interesting information without errors. "But does it have to be Pulitzer Prize-winning?" he asked. "No."

Atorino cited his former hometown's weekly newspaper, the Chatham (N.J.) Courier (circulation 3,000), which "covers local stuff: the Kiwanis, the football game, pictures of the 80-year-old lady that retired. You don't need 'quality' journalism. It's information. It's value.

"I think the whole idea of quality journalism is overrated," he said. "Pulitzer prizes haven't saved Knight Ridder, case in point. I'm sure from some perspective quality journalism is better than lousy journalism, but perfectly average journalism is fine."

Not everyone agrees.

"I think readers are very wise, and they can tell maybe not from one day's paper or two days' papers, but over a week or a month or a year they can recognize a paper whose staff has been trimmed too much," said Pam Luecke, editor at the Herald-Leader 4{ years through May 2001. "Doing good journalism costs money."

Former Lexington mayor Pam Miller lauded the Herald-Leader for its stories that identified statewide education inequities that were addressed by the Kentucky Education Reform Act in 1990.

"I'm not sure that some of those reforms would have passed or been retained without that action," Miller said. "Now whether the average person appreciates that or not, his children are going to better schools now than they were 15 years ago."

More recently, Herald-Leader enterprise reporting has prompted increased federal funding to fight prescription drug abuse in rural Kentucky, has led to the defeat of legislation that would have allowed much heavier trucks on Kentucky roads and has sparked reforms designed to provide more insurance for low-paid workers in the thoroughbred horse industry.

Knight Ridder's company charter does take a stand for "journalistic excellence" in the case of a sale. The company's articles of incorporation say that unless an independent panel determines a would-be owner continues "the same degree of journalistic excellence, integrity and independence" as Knight Ridder, the buyer must win 80 percent of shareholders' votes for sale approval, rather than 67 percent.

However, newspaper analysts, brokers and industry observers said it's unlikely newsrooms will be restored to the previous sizes that advocates say is needed for a high-quality newspaper. And observers said prospective buyers would most likely continue cuts that have been the industry trend in an effort to raise the profit margin.

Morgan Stanley analyst Douglas Arthur released a report late last year suggesting a buyer for Knight Ridder could save up to $350 million in a "scorched-earth" cost-cutting that would include reducing the work force by 6 percent and closing the Philadelphia Daily News.

A change in ownership could also mean a change in executive positions at Knight Ridder's papers, including the Herald-Leader's publisher, editor and directors of circulation, advertising and marketing. A change in leadership would be most likely at the corporate level. If they are removed, some top Knight Ridder executives would get three times their annual salary and bonuses; life and health insurance for three years; and immediate vesting of their stock options. Ridder, for example, could receive at least $5.7 million, in addition to potential proceeds from the more than 1.4 million shares or options for Knight Ridder shares he controlled as of February 2005.

The price tag

In Lexington, Jim Gray is teaming with former newspaper publisher Al Smith, host of Kentucky Educational Television's Comment on Kentucky, in pursuing a possible purchase of the Herald-Leader.

If successful, they say they would add staff to pursue the kind of journalism that helps "open the minds of a lot of people to new ideas and to change," Smith said.

But Gray and Smith are not alone in their quest for local ownership. Former state Commerce Secretary Jim Host, founder of sports marketing firm Host Communications, is seeking to buy six Knight Ridder papers in college towns—Lexington; Boise, Idaho; Columbia, S.C.; Columbus, Ga.; State College, Pa.; and Wichita, Kan.—"because I understand the college markets," he said.

But Knight Ridder executives have said that if the company is sold, it will be sold as a whole. Therefore, a purchase of any one of the 32 daily Knight Ridder newspapers would come through a subsequent sale by the chain's buyer.

So, Gray, Smith and Host—and possibly other local interests—are biding their time.

Gray and Smith said they have spoken with other potential investors but have not lined up any firm commitments for their potential bid.

"Jim and I both believe ... that if there was a reasonable price opportunity to make this buy, that people in Lexington with money would be standing in line to take part," Smith said.

So, if Knight Ridder is sold, broken up and the Herald-Leader is resold as a separate entity, how much would this paper cost?

Calculations put the price tag between $312 million and $390 million. (These figures are derived by taking a company's EBITDA—earnings before interest, taxes, depreciation and amortization—and multiplying it by a number based on previous sales of similar companies. In the case of the Herald-Leader, Gray said, the expected multiple would be 12 to 15. Gray was told the Herald-Leader's EBITDA last year was $26 million.)

"I've heard (Tony Ridder) refer to it as one of the jewels in the crown of Knight Ridder," Kelly said of the Herald-Leader, although he declined to speculate on a purchase price. "I have been told that over the years people have approached them about Lexington. ... At no time have they expressed any interest in selling."

Since Knight Ridder has been put up for sale, Kelly has referred all local inquiries about the Herald-Leader to investment banker Goldman Sachs, which is representing the publishing company.

But local ownership may raise some vexing issues. If Gray, a former mayoral candidate and current at-large Urban County Council candidate, and Smith succeeded and a consortium of wealthy Lexington residents bought the paper, would the investors seek to influence the newspaper's editorial board or nix unflattering stories about themselves?

Smith said the Herald-Leader has been known for its editorial independence. "If there is a single protected entity in this town that is immune from this paper," he said, "I don't know what it is."

But both he and Gray said the investors would steer clear of news decisions because such interference "would be destructive," Smith said.

Host said new ownership could institute an editorial shift because local investors are more likely to be conservative. "An investor wouldn't get involved in it if he or she didn't feel like they could have a voice in it," said Host, who added he would not make such a change.

Meanwhile, the Newspaper Guild is interested in leading an employee-backed buyout of nine unionized Knight Ridder papers: in Lexington; San Jose; two in Philadelphia; St. Paul, Minn.; Akron, Ohio; Duluth, Minn.; Monterey, Calif; and Grand Forks, N.D. The cost for such a purchase would easily be in the billions.

Last week, the union announced a partnership with the investment firm Yucaipa Companies to help finance a purchase. The union's effort would also give employees the option to contribute part of their retirement savings to the deal, said Newspaper Guild President Linda Foley, a former Herald-Leader copy editor.

The union-backed plan is considered a long shot at best and, by some, not even in the best interests of the papers.

"If you need to cut costs to battle recession," UBS publishing analyst Brian Shipman said, "a union is less likely to be willing to make the hard decision to fire people when they need to."

Inside track

Strategically, many industry watchers consider either Gannett or an investment partnership to have an inside track to buy Knight Ridder.

Gannett is reportedly working with Singleton's MediaNews in a possible joint deal in which they would either operate Knight Ridder papers in partnership, as they do with several current holdings in New Mexico and elsewhere, or split the properties between them. Neither company would confirm such an effort.

Another newspaper company in the running is McClatchy, which owns 12 daily papers, including the Sacramento Bee, whose staff includes editorial page editor David Holwerk, who once held the same post in Lexington, and deputy editorial editor Maria Henson, who won a Pulitzer at the Herald-Leader in 1992.

Gannett's owning the Herald-Leader makes sense geographically and strategically, considering that the chain also owns The Courier-Journal in Louisville, The Cincinnati Enquirer, The Indianapolis Star, the Tennesseean in Nashville and the Herald-Dispatch in Huntington, W.Va. Adding the Herald-Leader to its fold would allow Gannett to streamline some operations, such as combining Louisville's and Lexington's capital bureaus in Frankfort or production facilities for nearby properties.

The fate of Knight Ridder and the Herald-Leader is expected to play out in the next few months. Knight Ridder has postponed its April shareholders meeting, but media analysts expect some movement in the bidding process before then. How it will turn out is anyone's guess. For many, it's a time to wait and see; for others, it's a time to make their best offer.

"It's a business in transition, and it's going to keep transitioning," Singleton of MediaNews said of newspapers.

"If I'd have been born 20 years earlier, I would have avoided all this. Or if I'd have been born 20 years later, it probably would have been all in place by then. Unfortunately, I and you happen to be living in the times of the most dramatic change newspapers have seen in two or three generations."

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(News researcher Linda Smith-Niemi contributed to this report.)

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(c) 2006, Lexington Herald-Leader (Lexington, Ky.).

Visit the World Wide Web site of the Herald-Leader at http://www.kentucky.com/

Distributed by Knight Ridder/Tribune Information Services.

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