Bitter pill to digest: How a publishing phenomenon lost its way

What happens when an irresponsible force meets an immovable object? The answer is the bankruptcy of Reader's Digest, the most-read magazine in the world, which has fallen into the hands of its banks. It is a sad tale, a worrying omen, and a test that will hint at the future of the magazine industry.

The immovable object is a magazine first published in 1922 as a compendium of articles summarised from other sources. It has been a staunchly conservative presence on coffee tables ever since, a feelgood sampling of what's important for the home and family, peppered with reader-inspired jokes and, more recently, the odd celebrity column, too. It's been on a gentle decline since its heyday three decades ago, as new readers preferred specialist publications to the catch-all digest it was proffering.

Knowing that an ageing readership will not sustain it for ever, it has expanded on the internet. But successive managements have struggled to shake off an increasingly fusty image. In June, it admitted that sales had been falling so precipitously that it would scale back distribution, claim only a base circulation of 5.5 million in the US (down from 8 million last year and less than half its circulation a decade ago), and publish only 10 issues a year instead of 12.

The irresponsible force? That's private equity, engorged on cheap debt during the credit bubble, which went on an unprecedented leveraged buyout spree. In this case, it was Ripplewood, a modest private equity firm founded by Tim Collins, a financier who also sits on the board of Citigroup. He snapped up The Reader's Digest Association, the parent company, for $1.6bn in 2007 and loaded the company up with so much debt that the interest payments always threatened to overwhelm it.

That's what happened this week. Ripplewood gave up its ownership of the company on Monday morning, saying it had arranged a deal with the banks, led by JP Morgan, who will take ownership, and replace the existing $2.2bn in debt with a much more manageable $550m.

Even that supposes some improvement in the ghastly outlook for advertising, and that the magazine can find its footing on the shifting media landscape. In June, the magazine promised to revisit its traditional roots: "Reader's Digest has always been about the values of home, family, community, optimism and country," its community president, Eva Dillon, said in a memo to staff. The parent company has also been branching out, launching a new subscription service with Rick Warren, the controversial evangelical pastor. But executives deny it is moving away from Middle America to bolster its conservative readership.

Reader's Digest has its unique problems, but its bankruptcy is hardly unique. Indeed, it is an omen of things to come. There is a burgeoning list of media companies in Chapter 11 bankruptcy protection in the US; most of them have succumbed to the same irresponsible force as Reader's Digest. Still more are in trouble. Black magazine Vibe was shut down by its private equity owners; Maxim's parent company changed hands in a debt-for-equity swap.

Publishers that went private in the leveraged buyout boom of 2006 and 2007 will find themselves having to refinance their debts in the next year or two, and many more will fail to do so, says Reed Phillips, partner at the media investment bank DeSilva+Phillips. "It is the swine flu virus infecting the media industry," he said. "We are in the midst of an epidemic."

The hope of the executives at Reader's Digest is that this particular flu is a mild affair, recovery is quick and the magazine will emerge immunised against the difficult advertising market. Mary Berner, installed by Ripplewood as chief executive and staying on in that role under JP Morgan, put an upbeat face on the imminent Chapter 11 filing, saying it will lift the company's debts and could be rubber-stamped by a bankruptcy court within three months.

"Our deal has already been negotiated and hammered out with a majority of our creditors," she said. "It doesn't affect our employees, it doesn't affect the vast majority of vendors, it doesn't mean we'll do mass layoffs, it doesn't mean we're going to be selling-off assets. It's business as usual."

What it might affect is the direction of the magazine, however, which is why a change of ownership of such an august title is being watched as a test case for the media industry. As every executive knows, at a time of great change, as old reading habits die fast and the internet cannibalises circulation and advertising, do the new owners at Reader's Digest and elsewhere have the stomach for the change?

Mr Phillips said he hoped they are in an "interim stage" only, and that banks will quickly sell the companies that have fallen, unasked, into their laps. "One of the questions that isn't being discussed is how good owners the banks are going to be, and I doubt they will be good owners. Private equity groups know how to manage companies, they know how to incentivise management. Banks don't know how to do these things.

"Banks know how to manage risk. They are much more likely to be laissez-faire owners, allowing a company to keep the status quo and lose the focus on growth. The banks are not the guys who are going to spend $10m on a company's digital strategy. The longer bank ownership continues, the more likely it is that a media company will lose steam."

The trouble is that steam is in particularly short supply at Reader's Digest.

Rise and fall of Reader's Digest

Minnesota native DeWitt Wallace borrowed $600 from his family to create a sample magazine containing condensations of articles he had read, but when publishers did not back him, he published Volume 1, Issue 1 of the 'Reader's Digest' himself, on 1 February 1922.

The magazine, edited jointly with his wife, Lila, took off in the Thirties, with circulation passing the million mark in 1934. The first international edition was published in the UK in 1938.

Today, 50 different versions are published monthly in 21 languages and distributed in 60 countries, giving a circulation of 17 million and a readership of almost 70 million. Its non-US operations are not part of the US bankruptcy filing.

In the US, more than 30 million people read the magazine. Their median age is 52. The parent company, The Reader's Digest Association, publishes 92 magazines in all, including 'Taste of Home', the best-selling food and cooking magazine in the world. The company has 5,000 employees and annual revenues of $2.9bn. It has been loss-making since 2005.