• by Erik Sass  @eriksass1, August 18, 2008

Sam Zell is finding less room to maneuver when it comes to servicing the $8.4 billion debt incurred by Tribune Co. in the employee-owned deal he engineered. Although the company has met all of its debt obligations to date, the possibility of default sometime in 2009 looms ever larger with each new negative earnings release.

Last week, Tribune said total revenues declined 6% to $1.1 billion, due mostly to a 15% or $91 million decline in ad revenue in its publishing division. Its digital revenues fell 4% because of the decline in online classifieds. As a result of the continuing contraction of newspaper advertising, the company incurred a massive loss of $3.8 billion in the second quarter, including writedowns of goodwill and intangible assets.

And it gets worse. Tribune also said operating cash flow declined 2% to $221 million. This follows a 16% decrease in first-quarter operating cash flow, to $200 million. These figures are important because, per the terms of its debt agreements, Tribune must maintain a ratio of debt to operating cash flow of no more than 9-to-1, based on the present and three previous quarters. If the ratio climbs above 9-to-1, the company could be declared to be in default by lenders.

Because the debt agreements are relatively new, there are only two quarters of data to consider, but the trend is not promising. Altogether, the company's operating cash flow in the first half of the year was $417.6 million, down 6% from $445.6 million in the first half of 2007. If the trend holds up with a 6% decline in the second half, operating cash flow for the full year will be around $932 million.

Tribune paid down $807 million on the principal $8.2 billion debt in the second quarter, bringing it to $7.4 billion. Thus, the ratio of cash flow to debt stands at about 8-to-1, within the bounds of the covenant.

But to make the payment this quarter, Tribune had to borrow a further $218 million--plus a $7 million fee--under a financial arrangement called a trade receivables debt securitization facility, which has an upper limit of $300 million. That leaves $75 million for future emergency borrowing.

Trends in the newspaper business are all pointed sharply downward, and some analysts expect losses to accelerate during the second half of the year. That means Tribune's cash flow could shrink much faster than the 6% rate of the first half. If it shrank at a 20% rate--closer to the rate in the first quarter and 2007--its cash flow for the full year would be under $800 million, in violation of its covenant by about $200 million.