The good, the bad and the ugly: Canwest Global Communications

Canwest seems to have little breathing room, especially if conditions in the battered advertising industry worsen.

Canwest Global Communications (TSX: CGS) International media company
Established: 1979
Employees: 8,803
Altman’s Z-Score: 1.57
Probability of bailout: low

How did it go bad?

The closed-door meetings at Canwest Global Communications these days might make for decent reality TV. The Winnipeg-based media company, whose assets include the National Post and the Global Television network, finds itself scrambling to cut costs and reduce debt in hopes of appeasing some very serious judges: Bank of Nova Scotia and other lenders of its credit facility, whose initial conditions Canwest couldn’t apparently meet during the second quarter of this year. (The covenants require Canwest to stick below numbers that measure the company’s financial leverage and are based on quarterly figures.) At press time, the parties had agreed to permanently reduce the credit amount to $112 million from $300 million and waive certain borrowing requirements until at least March 11. But with $92 million already drawn on the facility, Canwest seems to have little breathing room, especially if conditions in the battered advertising industry worsen. And if the company’s cash runs out, it could face an extreme makeover in CCAA.

President and CEO Leonard Asper, whose family controls Canwest, blames the tanking economy. And there’s no question the global slowdown has hurt overall demand for advertising in Canada, Australia and other countries where Canwest competes. But other industry watchers might point to other reasons for the company’s financial problems.

Take Chris Diceman, a senior vice-president of DBRS, the Toronto-based bond rating agency. He says management should have focused on paying down debt after Canwest’s $3.5-billion acquisition of the National Post, other newspapers and Internet portals from Hollinger Inc. in 2000. Instead, Canwest embarked on international expansion. “They seemed to have this focus: We’re this media company. We can be really global, leverage our expertise around the world and possibly model ourselves after News Corp.,” Diceman says.

Canwest did reduce some of its debt, paring it to $2.6 billion in 2006 from $3.8 billion in 2001. But in 2007, it teamed up with GS Capital Partners, a private equity firm, to acquire Alliance Atlantis for approximately $2.3 billion. That pushed Canwest’s long-term debt back above $3 billion. The company did gain valuable assets in the process: 13 specialty channels, including HGTV and the Food Network. Revenues of specialty channels continue to grow, and since they mainly come from subscription fees, they are a much more stable source of sales than conventional broadcast networks, which rely on advertising. CW Media, the Canwest division which holds its specialty channels, generated $121 million in operating income in the latest fiscal. But the problem is that because of Canwest’s structure, the cash from that business doesn’t directly alleviate the financial troubles with the Bank of Nova Scotia and other lenders.

How ugly is it?

It’s uglier than the back-stabbing on Survivor, if you look at the stock. Canwest subordinate shares have lost about 95% of their value over the past year, and recently traded at 29.5¢. That decline suggests investors believe Canwest is headed into bankruptcy or CCAA, which typically wipe out shareholder value. Not surprisingly, 70% of analysts who cover the stock rate it a Sell. As one analyst, who asked to remain unnamed, puts it: “I’m amazed the stock isn’t trading at a penny. I’m saying to my clients, ‘Get out.’”

Media buyers see the company in a more flattering light. “The cable brands Canwest picked up from Alliance Atlantis are among the best, if not the best, in Canada,” says Sunni Boot, president of ZenithOptimedia Canada. Boot also raves about Canwest’s newspaper properties, including the Ottawa Citizen, the Calgary Herald and the Edmonton Journal. Despite declining circulation, not everyone thinks the medium is dead. Revenues in Canada’s newspaper industry will grow to US$3.8 billion in 2012, from US$3.5 billion in 2008, according to Pricewaterhouse-Cooper’s Global Entertainment and Media Outlook. Over that period, PwC assumes print advertising and subscription sales to remain flat, but sees a 23.9% compounded annual growthrate in digital advertising, fuelled by increased website readership.

Boot concedes that Canwest’s competition becomes much larger online, and free services like Craigslist make advertising in the classified sections of papers much less attractive. Still, she says, strong brands have a competitive advantage in cyberspace. “You’re going to trust the Global News website more than the Sunni Boot News,” she says.

Optimism aside, Canwest’s mountains of debt might scare away financial backers. DBRS’s rating for the company’s two borrowing entities, Canwest Limited Partnership and Canwest Media, are CCC High and CCC, respectively — meaning debt issued by them is “highly speculative and in danger of default of interest and principal.” Secured bank debt, such as that held by Bank of Nova Scotia, gets a slightly more favourable rating from DBRS of B, but that is still considered “highly speculative” and carries a “reasonably high level of uncertainty as to the ability of the entity to pay interest and principal on a continuing basis in the future.”

What if?

Canwest has at least a few lifelines to get itself out of its financial mess. For starters, management might be right that the company has enough cash to operate normally. Canwest could enter CCAA and then emerge a much more sustainable business with less debt; that would likely mean an end to the Asper’s family control of the company. Fairfax Financial Holdings, which is Canwest’s largest non-family shareholder, could plow cash into the company to help reduce debt. But the risk of bankruptcy remains.

While Scotiabank and other lenders might not like the idea of selling Canwest’s assets in an environment of depressed media values, they may prefer that to possibly getting even less in the future. Astral Media and Corus Entertainment are reportedly interested, particularly in the specialty channels. But the actual amount lenders could receive from a specialty-channel sale remains unclear, since many of the key details of Canwest’s agreement with GS Capital Partners were removed from public documents on the deal. One rumour circulating on Bay Street is that GS has a guarantee it will get back its initial investment and a specific rate of return, which if true could leave little for other lenders.

As for the Global Television network, it would likely survive, since it’s generating cash. But for regulatory reasons, its eventual owner may not be one of the traditional broadcasters, Diceman says. He points out CTVglobemedia also has significant leverage, although not to the degree of Canwest, and Corus and Astral might have problems raising the capital to buy Global. Diceman says Rogers Communications might be interested in buying pieces of Canwest. Rogers passed on the opportunity to buy Canwest’s money-losing E! Channel, but a spokesperson said the company would look at any assets that become available.

Finding a buyer for the National Post might be a bigger challenge. Canwest management says the paper finally turned a profit in the last quarter, but that’s hardly a track record. The asset may not even have appeal as a strategic one within a group of Canwest’s assets; Boot says the disappearance of the National Post would not significantly impact her spending on Canwest’s other media properties.

Asper has given no signs his family empire is at risk of collapsing. In fact, he recently pointed out to employees in an internal memo that Canwest’s businesses are highly profitable and generate over $500 million a year. But shareholders appear to have tuned him out.