April 29, 2008: 2:05 PM EDT
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The Newsday chase

Why Tribune Co.'s Sam Zell is more likely to sell the Long Island daily to Murdoch than Zuckerman.

By Devin Leonard, senior writer

Rupert Murdoch's News Corp has an edge in the battle to acquire Newsday.

NEW YORK (Fortune) -- Mort Zuckerman, owner of the New York Daily News, isn't going to let his archrival, News Corp.'s Rupert Murdoch snatch away Newsday without a fight. He's matched News Corp.'s offer to pay $580 million for Tribune Co.'s Long Island paper. The Zuckerman camp is also warning that Murdoch's pending deal with Tribune may not withstand regulatory scrutiny.

But Tribune Co. CEO Sam Zell is unlikely to jettison Murdoch for the Daily News owner. That's because Zuckerman's bid may have its own regulatory challenges.

The proposed deal between News Corp. (NWS, Fortune 500) and Tribune must clear two governmental hurdles. First, Murdoch must persuade the FCC to allow his company to acquire the Long Island paper when it already owns the New York Post and two television stations in the region. (News Corp's ownership of the Wall Street Journal isn't as problematic, since it's a national newspaper.) Former FCC chief of staff Blair Levin, now a media analyst at Stifel Nicholaus, writes that while the agency has "relaxed" its cross-ownership rules, News Corp's bid for Newsday "would appear to push the envelope." That's what Zuckerman is banking on.

Murdoch and Zell don't seem to think this is that big a problem. They may be right, too. Murdoch has gotten special treatment from the FCC before. Stephen Lacy, director of the Michigan State University School of Journalism, notes that News Corp. currently has an FCC waiver to own the Post and his two New York stations, which he describes as "very unusual." Now News Corp's CEO is personally lobbying New York political leaders to support his Newsday bid. How many of them will stand in the way of such a powerful guy?

However, News Corp. must also get the deal through the Justice Department's antitrust division. This may be where the acquisitive media company CEO trumps his tabloid competitor.

News Corp.'s isn't seeking to buy Newsday in outright sale. It wants to create a joint venture between The Post and the Tribune's Long Island paper. Murdoch surely likes the idea because he may finally be able to staunch the tabloid's estimated $50 million in losses. Zell's company would save as much as $245 million in taxes on the transaction.

Predictably, Zuckerman has proposed a similar combination involving the Daily News. But the Justice Department is likely to look more favorably on the marriage of News Corporation's tabloid and the Tribune's suburban paper. Sure, Zuckerman can argue that he needs a joint venture to strengthen the News at a moment when advertisers are abandoning newspapers for the Internet.

But Murdoch can make the same case with more vigor. By all accounts, Zuckerman's Daily News turns a profit. The Post loses an estimated $50 million a year. "That gives [Murdoch] a big advantage," says John Morton, a newspaper industry analyst. "The Justice Department is like to defer to the New York Post because it's losing so much money."

Now you see why Zell and Murdoch are deep in negotiations. This is not a deal that hinges solely on price. The former chairman of Equity Office Properties, once the world's largest public real estate company, has always had a passion for minimizing taxes in his business dealings. In his former line of work, Zell popularized the real estate investment trust, which exempts property owners from corporate income taxes as long as they funnel 90% of their taxable income to shareholders in dividend payments.

Zell took a similar approach when he took Tribune private in December. He transformed Tribune from a C-Corp to S-Corp, meaning it is exempt from most federal taxes. All of the company's shares are held by its Employee Stock Ownership Plan, which doesn't pay corporate income taxes either. That's good for the Tribune. Zell saddled the company with $8.4 billion in debt last year. Most of its income currently goes to interest payments. But interest expense is deductible, too.

Having gone to all this trouble, you wouldn't expect the Tribune's CEO to sell Newsday for $580 million only to end up with a $245 million tax bill. The company has a $650 million payment due in December. Zell needs cash. No wonder he and Murdoch seem be to getting along so well.

Zuckerman needs to crash their deal-making party. One of the reasons the News is financially stronger than the Post is that it has far more advertising on Sunday. But if Murdoch gets his hands on Newsday, he could not only save money by combining the back-office operations of the Post and Newsday, He could also increase the Sunday Post's ad pages by offering package deals to Newsday's sponsors.

That could be nightmarish for the Daily News owner. Maybe Zuckerman needs to do more than match Murdoch's offer. He needs to write Zell a much bigger check. Maybe then Tribune's CEO will stop thinking about his tax bills. To top of page

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