Ziff-Davis Is Printing in Red Ink
Despite Web-site hoopla, the cyber-biz publisher is hurting
As the nation's leading media company dedicated to matters cybernetic, Ziff-Davis
Inc. understandably caught the attention of investors when it launched an initial
stock offering last April. After all, Ziff's 26 computer magazines, including
heavyweights PC Magazine and Computer Shopper, lead the tech-magazine
industry in ad revenues. The company has a tech-oriented television channel and
dominates computer trade shows with 50 events a year, notably the fall Comdex
extravaganza in Las Vegas. Still, by October, Ziff's stock price had seriously
slumped, from the IPO price of 15 1/2 to less than 4.
The problem was that for all its connections to the fast-growing industry, Ziff
itself was in a slump. But it turns out the New York company has a safety net: the
Internet, Wall Street's darling. In December, word that Ziff planned to offer stock
in its popular ZDNet Web site lit a fire under Ziff's shares. They soared 80% over
three days, to 20 3/4.
But the Internet halo effect is only obscuring Ziff's weak financial picture.
Publishing still contributes two-thirds of Ziff's revenues--and there, it's gushing
red ink. Moreover, the company took on a crushing debt load under its
Japan-based parent, Softbank Corp., yet it's paying cash to buy subsidiary ZDTV
from Softbank. And despite its wobbly performance, Ziff has shown a penchant
for showering goodies on insiders.
SWEET DEAL. Case in point: In September, with its stock swooning, Ziff
slashed the exercise price for its executives to purchase stock options, from 16 to
6. Moreover, the favor was extended to five of nine directors--four company execs
and one official at Softbank. Questions about Ziff and Softbank's financial dealings
exacerbated the share slide that followed the IPO. Says Charles Mehlhouse, a
portfolio manager with Fortis Advisers Inc., which dumped 160,000 shares last
summer: ''We didn't like how they were doing things at all.''
Why does Ziff appear to be in such sorry financial shape? For one thing,
advertising in its computer magazines is off since 1997. Falling retail prices for
PCs have hurt small manufacturers and curtailed their ad outlays. In 1998, Ziff's
ad revenue was down 7.6%, to $653 million, says Adscope Inc.
BIG DEBT. That doesn't explain why Ziff has run four years of red ink while
chief competitor CMP Media Inc. (CMPX) remains profitable--even though CMP's
titles have endured their own ad falloff. The difference? Ziff has to service an
onerous $1.5 billion debt load. The borrowing spree started with the company's
1994 purchase by Forstmann Little & Co. from the Ziff family. It intensified with
the 1996 sale to Softbank, which now owns 72% of Ziff.
The result: Ziff is barely covering its debt service. Add in hefty charges for Ziff's
rich acquisition premiums, and the result is a 1998 loss of $78 million, according
to estimates by Merrill Lynch & Co. analyst Lauren Rich Fine. That's 10% worse
than 1997's showing, on slightly lower revenues of $1.1 billion.
Given Ziff's problems, some analysts are troubled that it is paying cash to buy
assets from Softbank's CEO and controlling shareholder, Masayoshi Son. Ziff
ponied up $370 million about a year ago to buy ZDNet and other operations from
Son's finance vehicle, MAC Corp. And now, Ziff is in the process of paying $85
million to MAC for ZDTV. Ziff's rationale is that this will allow closer
integration of its various tech-media properties.
It's easy to understand why Son needs the money. Dogged by Asia's economic
distress, software distributor Softbank suffered a $22 million loss in the six months
ended last September. Though Softbank is sitting on unrealized gains from some
hot investments--including an early stake in Yahoo!--that doesn't help its cash
position. Son was not available to comment, but Ziff CEO Eric Hippeau defends
Softbank's dealings. He notes that early last year, Son lightened Ziff's burden by
forgiving $900 million of Ziff's debt. ''That was a big help,'' says Hippeau.
No doubt. But at the same time, Ziff borrowed $1.5 billion from other lenders to
repay the remainder of its debt to Softbank, effectively shifting Ziff's debt to
bondholders and banks. Those outside creditors were much less forgiving, as Ziff
found out last fall when its lagging finances violated cash-flow covenants. To
satisfy banks, Ziff now pays a higher interest rate. Ziff's chief financial officer,
Timothy O'Brien, acknowledges that Softbank's loan had no such covenants. Says
one portfolio manager who sold his Ziff stock last fall: ''Softbank took care of
itself at Ziff-Davis' expense.'' Moreover, Softbank's stake in Ziff is now worth
more than $1 billion.
Investors, troubled by the financial machinations and mounting losses, dumped
Ziff shares through the spring and summer. Four separate class actions were filed,
alleging that Ziff execs must have known before the IPO how poor the ad outlook
was for the remainder of 1998. The company won't comment on the litigation, but
the risks of possible ad softness were mentioned in its offering prospectus. The
stock slide halted only after Ziff announced in October it would cut costs by
trimming 10% of its 3,800 employees and closing three magazines.
OFF-TRACK. What really got the stock moving in December was news of the
ZDNet stock sale. The deal is expected to raise $114 million in March through the
sale of a tracking stock that is supposed to mirror only Ziff's Internet operations.
ZDNet furnishes just 2% of Ziff's revenues and is losing money. But investors
think the popular site--which contains software, computer-buying help, and other
tech information--has big potential to draw Web advertising. And ZDNet's losses
are narrowing, to $7.6 million in the first nine months of 1998. The site also has a
growing audience. Its page views in October were up 76% from a year earlier.
But the real problem with the ZDNet offering is where the $114 million is
headed--into Ziff's general coffers, to pay down debt, not directly into the sexy
Internet business. Robert Willens, Lehman Brothers Inc.'s corporate-finance
expert, says tracking-stock proceeds almost always are restricted to the activity for
which they're raised. ''This is damn odd for Ziff to do,'' says Daniel E. King, an
analyst at LaSalle St. Securities Inc., a Chicago brokerage with a strong tech focus.
Hippeau defends the move, vowing that Ziff management will ensure ZDNet gets
the capital it needs.
PROFIT OPTION. Meanwhile, management has protected itself. When the stock
dipped into the low single digits last fall, board members voted to reprice options
for 800 Ziff managers and prized employees. The repriced options, which they can
begin to exercise in March, affect CEO Hippeau, three other Ziff execs who are
directors, and Ronald D. Fisher, head of Softbank's U.S. operations. At the current
price of 18, Hippeau's gain on his 1.1 million options is already worth $13.2
million, $11 million more than it would have been without the repricing. In
addition, Son and his finance chief, Yoshitaka Kitao, have been given the right to
receive additional options at 6, says Ziff CFO O'Brien, although they have so far
elected not to take them. Exempted are two independent directors.
Hippeau and independent director Jonathan Lazarus, a former Microsoft executive,
defend the repricing as vital to keep talent from jumping ship. But by extending
the benefit to some directors, Ziff broke disturbing new ground, says
compensation expert Graef Crystal: ''For a board, there's real potential for
conflict of interest here.''
Hippeau insists Ziff's current difficulties will pass. Once computer prices stabilize
and advertisers return from the sidelines, he says, publishing will rebound. Plus,
he's counting on forays into the Internet and TV to push Ziff's growth. Trouble is,
that won't happen overnight. And Hippeau concedes magazine ad pros-pects for
1999 remain lousy. All of the excitement over a Web site can't hide the fact that
Ziff's shiny model of cyber-prosperity is wavering on the screen.
By Larry Light in New York |
