Donald Gutstein

It’s no secret that Postmedia Network, publisher of the National Post, Ottawa Citizen, Montreal Gazette, Calgary Herald, Edmonton Journal, Vancouver Sun and other major Canadian dailies, is hemorrhaging money.

For the year ending August 2013, the company lost $154 million. And the bleeding continues. In the six months since, the company lost an additional $37 million. Revenue from the company’s traditional mainstay, print advertising, has tanked.

What isn’t as well known is that during this downward spiral, Silver Point Capital, an American hedge fund, bought a 19-percent stake in the company.

It joins Postmedia’s largest shareholder, Golden Tree Asset Management, another American hedge fund. Golden Tree acquired its holding in Postmedia from the ashes of CanWest Global Communications, before the media company filed for creditor protection in 2009. The debt owed to Golden Tree was turned into shares in Postmedia on CanWest’s reorganization. Golden Tree boosted its holding in the company from 35 to 39 percent after Silver Point bought its stake. That give the two American companies 58 percent ownership of Postmedia.

If you’re wondering how a Canadian newspaper chain can be owned by foreign interests, especially by interests with little background in the news business, you’re not alone. Postmedia must be designated as a Canadian publisher of Canadian newspapers under Section 19(1) of the Income Tax Act, or else its advertisers can’t deduct from their profits the cost of their newspaper ads as a business expense. Under foreign ownership, Postmedia’s advertising revenue would vanish.

Section 19(1) is a 60-year-old policy designed to ensure Canadian newspapers are owned by Canadians. But Postmedia CEO Paul Godfrey and clever corporate lawyers figured a way around it.

The Income Tax Act defines a Canadian publisher as one in which 75 percent of its shares are owned or controlled by Canadians. But since the two hedge funds own nearly 60 percent of the shares, the company fails this test.

There is a second way to qualify as Canadian, though. If a company is listed on a Canadian stock exchange and if it is not “controlled” by non-Canadians, even though they may own the company, the company is Canadian.

Postmedia’s bylaws provide that 75 percent of company directors must be Canadian and shares owned by non-Canadians can never surpass 49.9 percent of votes cast at a company meeting. Paul Godfrey and his fellow Canadian shareholders, with their miniscule holding in the company, can rule the day.

Ergo, Canadian.

Never mind that most Canadians likely don’t fancy foreign ownership of a major source of information, as pro-business as it might be.

There’s a larger question. Why would anyone, Canadian or not, buy shares in a company that’s losing buckets of money? Do Silver Point and Golden Tree expect advertisers to come back in droves to the print medium? Do they think Postmedia will be able to replace print revenues with digital ones?

Probably not. That’s because the hedge funds—aptly referred to as vulture funds—specialize, not in building companies, but in profiting from their distress through corporate bankruptcies, restructurings and financial liquidations. They get rich by lending money to companies “at or near the end of their present financial ropes.”

If Silver Point and Golden Tree live up to their track record, Postmedia Network is not long for this world, at least not in its present form. Postmedia may already be entering a death spiral. It slashed its workforce to the bone and contracted out a host of operations. And it’s selling off assets to pay down debt, which is an ultimately self-defeating strategy. How long before the company runs out of things to sell?

Or is it merely preparing for the vultures to swoop?

Silver Point is owned by two Goldman Sachs alumni who built reputations for making money from “distressed debt.” These are securities such as bonds and stocks of companies that are in some sort of distress and are usually heading towards, or already in, bankruptcy. These securities trade at a much reduced price and offer the potential for elevated profits if the company can be turned around in some way.

According to its publicity, Silver Point excels in what it euphemistically calls “profit enhancement.” This usually means mass firings of employees and savaging worker pension funds. How else do you enhance profits?

American car parts maker Delphi is a case in point. The company was in and out of bankruptcy several times, kept afloat with loans from Silver Point and other hedge funds. It emerged from bankruptcy with greatly reduced labour costs—a work force slashed from 180,000 to 100,000, new factories opened in low-wage China, and 15,000 salaried retirees forced to give up their health-care benefits and a big chunk of their pensions.

That’s how Silver Point does profit enhancement. One can only wonder what the vultures have in store for our daily newspapers.

There’s an irony in the Postmedia saga. A recent study by the Federal Reserve Bank of San Francisco assigns most blame for the 2007-09 financial crisis to hedge funds and not commercial banks, investment banks, or insurance companies. Hedge funds—like Golden Tree and Silver Point—are fingered in the study because they are unregulated and highly leveraged and they transmitted risk and volatility to the rest of the financial system.

That volatility nearly brought down the economy. Silver Point and Golden Tree suffered along with everyone else, including CanWest Global.

But unlike CanWest Global, which was already deeply in debt to Golden Tree, the hedge funds bounced back expeditiously, profiting greatly by focusing on opportunities that arose from the financial crisis they caused.

 Postmedia Network may be one of those opportunities.

Posted in Foreign ownership, Golden Tree Asset Management, Hedge funds, Postmedia Network, Silver Point Capital