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Hollinger mess could have been avoided

Globe and Mail Update

Conrad Black took a simple approach with his shareholders: If they don't like what I'm doing, let them sell the stock. The shareholders took him up on his offer and Hollinger International, his main operating company, has carried mutt status for years. Underperformers eventually run into trouble and need saviours, which is exactly why Lord Black has being trying to recruit a new investor (thought to be Bain Capital of Boston). If there's a tragedy here, it's that the whole mess could easily have been avoided.

In retrospect, the decision that led to Lord Black's transformation from head of the world's fastest-growing newspaper empire to beggar happened some time before the initial public offering of Hollinger International, owner of London's Daily Telegraph and the Chicago Sun-Times, in 1994.

Lord Black and his tight group of insiders at Ravelston, the private holding company at the top of the Hollinger ladder, would earn their compensation primarily through management contracts that -- surprise -- would be set by Ravelston, not the publicly traded company, and would have a funny habit of going up in value.

Now imagine if the Ravelston lads had taken a more catholic approach by ditching the management contract and tying their compensation entirely to salaries, share option plans and similar incentives.

Under this scenario, the value equation would have changed dramatically. Boosting the share price would have been the primary performance motivator. If the shares had even met the market average, let alone exceeded it, they would have made even more money than the management contract paid them.

This, of course, would have created other benefits. Investors who own rising share prices tend to forgive executives who pay themselves exceedingly well. Rising share prices also make good acquisition currencies. Since Hollinger International never had a fat price-to-earnings multiple, it tended to finance deals with debt, not paper. Debt, as a result, climbed. Ravelston now finds itself in the unusual position of returning some of the management payments to Hollinger Inc., the parent company of Hollinger International, so the former can meet its debt obligations.

Because Hollinger International has been a stock market laggard, investors looked for a culprit and found it in the form of the management contract. Between 1995 and 2002, the contract paid a total of $202.7-million (U.S.) to Ravelston and associated companies. The amount sounds outrageous and makes good headlines. But it loses much of its shock value when you spread it over seven years, an average of $29-million a year, and five or so executives. We're not talking Dick Grasso territory here.

The figure probably would have been ignored had the shares been winners. They weren't. Since 1994, Hollinger International shareholders have earned an average of 3.3 per cent a year, including dividends. The Dow's equivalent return was 12.4 per cent.

Hollinger International does, in fact, have a fairly ample stock option plan. But it clearly wasn't a motivating factor (the last grant round carried an exercise price of $11.13 a share, only around a buck below the latest share price). Why bust your butt to get the shares moving when the management contract would deliver secure payments? Don't forget, the Ravelston crew was also the beneficiary of non-compete agreements, struck with the buyers of papers. Tweedy Browne, the New York institutional investor that is questioning the validity of Ravelston's various income streams, thinks the non-compete payments should have gone to Hollinger International instead.

To be sure, there is no guarantee that Lord Black and his top lieutenants, absent the management contract, would have been able to deliver good share performance. But the Ravelston names -- among them David Radler and Dan Colson -- are no dummies. They are considered among the top newspaper operators, if not shareholder value creators, in the industry. Surely a slight reallocation of their energy would have paid off on the stock market.

Let's do some simple math. Hollinger International made its debut at $13 in 1994. If they had performed merely by the Dow average since then (excluding dividend payments) they would be worth about $31 today, or about $18 more than yesterday's share price. According to the most recent proxy statement, Lord Black "beneficially owned" 27.9 million class A Hollinger International shares. If they were trading at $31, that stake alone -- we'll forget about his B shares -- would be worth about $865-million. Instead, their current market value is less than $350-million. The difference is $515-million, or 2½times more than the amount Ravelston collected through the management contract over the seven years.

If Lord Black could roll back the calendar and do it all over again, would he have chosen a more traditional compensation plan?

Hollinger International shareholders no doubt have done similar calculations. Small wonder that some of them are on the warpath.

In my Thursday column, I said Tweedy Browne wanted Conrad Black gone, along with the dual-class share structure that allowed him to keep control of the Hollinger companies. Tweedy says, in fact, it has no particular view as to whether they should go; its primary concern is the "appropriateness" of the funds paid to him and his associates.

ereguly@globeandmail.ca

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