Hallmark Prods Crown

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Crown Media, parent of the Hallmark Channel, fresh off the resignations of its CEO and top programming executive, has another big decision to make in the next several weeks. It must decide whether to accept a deal from its largest creditor and equity holder that would shave more than half the debt from its books, thereby avoiding a potential default scenario, but dilute its minority shareholders practically into oblivion.

May was an active month for Crown. Its CEO Henry Schleiff resigned, replaced by long-time national ad sales executive Bill Abbott. On May 19, programming chief David Kenin said he was asked to leave the company and submitted his resignation.

And on May 28, Hallmark Cards, holder of 70% of Crown's outstanding equity and 85% of its voting shares, unveiled a recapitalization plan that would reduce its debt from about $1.1 billion to $500 million through a series of refinancings and debt swaps.

In a letter to the company filed with the Securities and Exchange Commission on May 28, Hallmark Cards requested that a decision be made on the proposal “prior to the filing of the company's second quarter form 10-Q.” That filing is expected sometime in late July or early August.

While Hallmark's debt has been a concern for Crown for years, the most recent proposal has raised the hackles of at least one major investor, who sees the deal as favoring one shareholder only: Hallmark Cards.

“I think this is absurd,” said Salvatore Muoio, principal and chief investment officer of S. Muoio & Associates and a holder of 5.2% or 3.9 million shares of Crown Media stock. “They should reject this out of hand.”

Crown spokeswoman Nancy Carr said the company would have no comment beyond the SEC filing. Hallmark Cards public relations director Julie O'Dell in an e-mail message also declined to comment beyond the SEC filings.

In those filings, Hallmark said the proposal would help Crown not only avoid a default, but would reduce interest payments by $70 million in the first two years and pares its overall debt by 55%. It would also remove the uncertainty surrounding Crown's ability to meet its obligations and remove a class of super-voting stock.

Investors also appeared unhappy with the arrangement. Crown Media stock has fallen 34% ($1.03 per share) from $3.03 on May 28 to $2 on June 4.

On the surface, the proposal appears to do little for Crown — it extends the maturities on $500 million of its debt for one year, to Sept. 30, 2011 — and swaps the remaining $550 million in debt for convertible preferred shares. The last part of the deal is what rankles Muoio, a long-time investor in the company, most. Essentially, it would give Hallmark Cards and its subsidiaries a 95% equity interest in the company, leaving 5% for the remaining investors.

“They [Hallmark] are squeezing out the public shareholders because of decisions they made — partially the library sale mess and monetizing programming rights into debt owed to the [Hall] family, which raises the issues of pricing of various programming all along the history of the channel,” Muoio said. “There are a lot of issues here.”

The Hall family founded what became greeting card giant Hallmark Cards in 1910 and has controlled the company ever since. Currently the company is led by chairman Donald Hall, his sons CEO Donald Hall Jr., and David Hall, president of Hallmark's personal expression group. Donald Hall Jr. and David Hall each serve on Crown Media's board of directors.

Most of that $1.1 billion in debt stemmed from a $400 million note secured by Hallmark Entertainment Holdings in 2003 that helped Crown undo a messy preferred stock deal. That $400 million, through accumulated interest, ballooned to about $700 million this year.

In 2006, Crown sold its content library consisting of 600 TV movies, miniseries and series to Robert Halmi Sr.'s RHI Entertainment for $160 million. Crown originally purchased the library from Halmi, the producer who created most of that content, in 2001 for $820 million.

Crown said it is in the process of forming a special committee of its board of directors, comprised of independent board members, independent counsel and financial advisers, to consider the proposal.

What is most surprising is that Hallmark has allowed Crown to forgo paying off the debt for years and as recently as May 4 extended its standstill agreement for another year. But in the past 24 days, Hallmark appeared to change its mind. In a filing with the SEC May 28, Hallmark said that it would no longer extend the standstill agreement, which expires May 1, 2010. What's more, Hallmark said Crown can't pay the $1.1 billion Hallmark is owed.

“We understand that in light of the company's financial condition, results of operations and cash flows, and the state of the credit markets, the company believes that it is unable to refinance the HCC Debt, notwithstanding the refinancing covenant in the standstill agreement,” Hallmark Cards said in the filing. “Consequently, the company faces default on over $1 billion of HCC Debt on May 1, 2010. Such a default is not in the interest of the Crown stockholders, as it could eliminate any value associated with their equity. In order to avoid such default, HCC is proposing a recapitalization of the HCC Debt.”

Crown is coming off one of the best years in its history — it recorded its first year of positive cash flow in 2008 — and appeared headed for a strong 2009. In the first quarter, revenue rose less than 1% to $71 million but cash flow was up a healthy 28% to $18.6 million from $14.5 million in the prior year.

But making a lump sum $1.1 billion payment in the next 12 months is far beyond the company's reach.

“In essence it seems like they are threatening the company with bankruptcy if they don't agree to it or find some other financing before next May,” Muoio said.

The proposal also seems to contradict what Hallmark's own management said was its ultimate goal regarding its debt just a few weeks ago. In its first quarter earnings conference call with analysts on May 7, chief financial officer Brian Stewart said that the company did not expect to have to refinance its debt for at least another year. And when it did, the impetus would be on growing cash flow to the point where it could refinance the debt with a third party, not Hallmark.

In late May, Crown investor relations spokeswoman Mindy Tucker said that taking Hallmark out of the debt mix was a priority.

“Hallmark doesn't want to be the company's banker,” Tucker said in the earlier interview.

While that has become painfully apparent, Muoio said that he is evaluating his options, including taking possible legal action.

“We as shareholders have a right, for our clients, to stand up for what we believe is right,” Muoio said. “We're just exploring what the right thing is to do.”

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