Sloan: The Double Dummy Can Be Very Smart

Tax law isn't exactly a bundle of laughs. But tax lawyers occasionally compensate by inventing hilarious terms like "horizontal double dummy" to describe the paper-shuffling that they do. Most of us, of course, wouldn't recognize a double dummy if we tripped over it (or is it them?). But knowing about double dummies—a term apparently borrowed from bridge— is the key to unlocking one of the little mysteries of the newspaper business. To wit: why can McClatchy Newspapers get a tax break by selling its Minneapolis operations for less than it paid, while the New York Times Co. can't do that with The Boston Globe, and Tribune Co. can't do it with the Los Angeles Times? The answer: McClatchy did a double-dummy deal when it acquired the Star Tribune's parent company, Cowles Media, in 1998. But Times and Tribune did standard corporate reorganizations when they bought Affiliated Publications and Times Mirror, respectively, in 1993 and 2000. Most acquiring companies could do double dummies, but few go that route.

McClatchy completed the sale of the Minneapolis Star Tribune—or, to be technical, the McClatchy subsidiary that owned the Star Tribune—to Avista Capital Partners for $530 million last week. In addition, McClatchy says, the sale will generate a tax loss worth about $160 million, bringing total proceeds to $690 million.

The double dummy is helping McClatchy make the most of a bad deal. It paid a whopping $1.2 billion for Cowles in 1998: about 85 percent in cash, the other 15 percent in McClatchy stock. (Disclosure: NEWSWEEK's owner, The Washington Post Company, owned 28 percent of Cowles, and made a big profit on the 1998 sale.) Because McClatchy used a double dummy, anyone who got McClatchy stock in the deal had a tax-deferred transaction. In conventional deals, a buyer has to pay at least 40 percent of the price in stock for sellers to get the tax deferral. Even better, McClatchy got to add the $1 billion of cash that it paid in the deal to its "tax basis" in Cowles—the amount at which it valued Cowles for tax purposes. McClatchy wouldn't disclose its basis in Cowles. But by my math, without that $1 billion bump-up in basis, selling the Star Tribune for $530 million might have triggered a tax bill, not a refund.

"You can get the best of both worlds when you use a horizontal double dummy for a cash-and-stock transaction," says Lehman Brothers tax expert Robert Willens, who deconstructed the McClatchy-Cowles deal for me. "Selling stockholders worried about taxes can defer their gains by taking stock, and you can add the cash you pay to your tax basis in the acquired company."

Then there were the folks who didn't go the dummy route. When Tribune bought Times Mirror for $8.3 billion (of which $3.1 billion was cash) and New York Times bought The Boston Globe for $1 billion ($160 million cash), they did standard corporate reorganizations rather than horizontal double dummies. This means the buyers inherited the original owners' low tax basis in the acquired properties. Tribune, currently struggling to do some sort of tax-efficient deal, would doubtless be happy to have an extra $3.1 billion of tax basis in its newspapers. Times took an $814 million loss (for earnings purposes) in January on the decline in value of the Globe and the Worcester (Mass.) Telegram & Gazette, which it bought for $296 million in 1998. But selling those properties even at their current, lower value would probably trigger a tax bill because the papers' tax basis is below their market value. (Times says it has no plans to sell either paper.)

How do you do a double dummy? I thought you'd never ask. Instead of one company's absorbing the other, you set up a holding company to own both your company and the one you're acquiring. The holding-company structure may complicate life a bit—ask any corporate or tax lawyer why— but it can provide nifty breaks. Among them: if you sell the acquired company someday, your tax bill will be smaller (or your refund bigger) than with a conventional deal.

"Some people just don't like having a holding company," says Michael Solomon of Pillsbury Winthrop Shaw Pittman, who's advising Vulcan Materials on the tax aspects of its pending double-dummy cash-and-stock takeover of Florida Rock Industries. He says there's usually no reason not to go the double-dummy route, which he calls "a classic opportunity to find a gold nugget in the tax code."

Solomon says we don't see more such deals because most takeover players don't know this structure exists. To which I'd add a second factor: most acquirers never think to plan for the day that they may have to unload their shiny new property for less than they paid for it. Which, I suppose, makes them ... double dummies.