The Detroit News reports the next chapter in the growing trend toward employee stock ownership programs. Kirk Kerkorian wants the United Auto Workers union to share in the "risks and rewards" of his proposed $4.5 billion buyout of Chrysler. And he's not the only one connected with the bidding for Chrysler that thinks that might be a good idea. The union president Ron Gettelfinger says other parties, probably private equity giants Cerberus and Blackstone, have approached him about an ownership role for the union.
But why would a billionaire like Kerkorian and the smart guys behind private equity want to share the risks (and return) of ownership? The short answer is that they want employees to buy into the change in ownership and they think they can use clever contracts to keep employees from really enjoying the benefits of ownership.
The best current example of this Machiavellian management is Samuel Zell's recent purchase of Tribune Co. His complicated scheme for controlling an $8.2 billion company will cost him only $315 million. How does he pull this off? I refer to the Chicago Tribune's own explanation:
The new company structure depends on the creation of what's known as an S Corp. ESOP, which is essentially a sole-proprietorship encased within an ESOP trust. The attractiveness of the structure, according to one source, is that it eliminates most of the corporate taxes Tribune would otherwise pay, which boosts the cash flow and allows the company to support a heavier debt load. If the structure had been in place in 2006, for instance, Tribune would have been able to avoid paying $348 million in taxes. For the first 10 years of an S Corp. ESOP, the trade-off is that the company has to pay capital-gains taxes on asset sales. That could explain why Zell has said he has no intention of breaking up the company, since most of the company's long-held assets would generate big capital gains. After 10 years, however, the company can sell assets without paying capital gains. So, at that point, the glue holding the company together might not be so strong. Zell will initially invest $315 million in the deal, which will close in several steps. In the first step, the ESOP will buy $250 million worth of newly issued Tribune common stock. Zell will invest $225 million and receive a note from the company. He will also pay $90 million for a warrant that can be converted into about 40 percent of the company if Zell pays $500 million. Meanwhile, the company will stage a tender offer for approximately 126 million shares at $34 a share. It will borrow $7 billion at the same time, using $4.2 billion to pay for the tender and $2.8 billion to refinance existing debt. Then, in a final step that will take place if or when various government approvals can be secured, Tribune will merge with the ESOP and convert into an S corporation and will borrow another $4.2 billion to buy the rest of the shares at $34 a share. When the deal is complete, the ESOP will hold all of Tribune's then-outstanding stock, with Zell holding a subordinated note for $225 million and the warrant entitling him to acquire 40 percent of the common stock for $500 million. In effect, the ownership split will be 60 percent employees, 40 percent Zell.
In effect, Zell hasn't even paid $315 million because at least initially $225 million of his investment will take the form of a loan that would be privileged in any bankruptcy proceedings before all shareholders. But how are the company's employees going to pay for their stock ownership program you ask?
Their 401k program will be gutted in exchange for the opportunity to buy shares in a business with decidedly poor long-term prospects. And the icing on the cake is that no employees can sell their newly purchased stock for ten years!
Zell might be getting into the newspaper business, but he's already demonstrated his mastery at taking a major corporation's workers to the cleaners.
