Apax works to restructure Cengage debt

The educational publisher, bought by Apax and OMERS at the height of the credit bubble, is facing a $2.1bn refinancing wall next year.

Cengage Learning, the educational publisher controlled by UK-based Apax Partners, has hired Alvarez & Marsal as it struggles to restructure a debt load that, combined with the company’s lagging performance, has threatened to push the company into default. Cengage also recently announced it borrowed another $430 million – almost all of its remaining revolving credit facility – to ensure it can meet its near-term capital needs. 

The news comes shortly after further credit downgrades by two major rating agencies, citing heightened default risk at the company. Standard & Poor’s cut the company’s rating on 21 March, indicating that Cengage is dependent on a favourable environment to meet its financial commitments, whilst Moody’s downgraded Cengage at the end of last month to levels judged “speculative of poor standing” and “subject to very high credit risk”. Both agencies maintained their rating outlook as “negative”.

These developments hint at the mounting financing woes facing the company, which Apax acquired along with the Ontario Municipal Employees Retirement System in 2007 for $7.7 billion. “The downgrade reflects the deterioration in the company's liquidity profile and performance, and our expectation that the company will likely default over the near term,” said Standard & Poor's credit analyst Hal Diamond in a statement.

Apax and OMERS declined to comment about the Cengage situation. The company is led by chief executive officer Michael Hansen.

Building a company

After the 2007 transaction, Apax and OMERS worked on growing the company through restructuring and acquisitions, appointing outside managers to executive positions and investing in the development of digital products. Milestones included the acquisition of Houghton Mifflin college publishing assets in late 2007 for $750 million. 

Despite being the second largest higher educational publisher worldwide, however, Cengage has since struggled to

Michael Hansen

adapt to structural changes facing the industry and faced a number of company-specific problems. 

“Cengage's sales to for-profit educational institutions are declining, because these buyers are experiencing enrolment pressures as a result of regulation that significantly tightens their marketing practices. In addition, lower funding from state and local governments is hurting the company's library reference and school publishing businesses,” commented Standard & Poor’s in the wake of the downgrade. 

This has led the company to post paltry results in 2012, including an 18 percent fall in revenue in the six months to 31 December.  The resulting squeeze on cash flows has impaired its ability to deleverage its outstanding debt totalling $5.36 billion at the end of the year. 

The company has since tried to alleviate the burden by buying back its own debt at a discount, with nearly $50 million spent in the first quarter on bond repurchases. But rating agencies have remained unconvinced this would pull Cengage out of its financial quagmire. 

“The debt repurchases have not offset earnings deterioration and Cengage's leverage has increased to an unsustainable level,” said Moody’s said in its latest rating report on the company.  

All told, Cengage has $2.08 billion of low-cost term loans due July 2014, which are trading at what Standard & Poor’s regards as a distressed yield – meaning that any refinancing could only be done at punitive cost. It is also close to breaching its senior secured leveraged covenants, an event likely to put further pressure on liquidity and aggravate the risk of default. 

The debt repurchases have not offset earnings deterioration and Cengage's leverage has increased to an unsustainable level.

Moody's Investors Service

These cumulated concerns, commented a source close to the firm, have probably dictated the timing of Apax’s decision to sanction a restructuring. The firm bought back Cengage debt at an increased pace in the first quarter – most of it in first liens – potentially giving it more clout in any negotiation with other creditors. 

Fund performance

Cengage’s situation only adds to the challenges the firm is facing on other fronts. The bulk of Apax’s equity exposure to Cengage – worth $757 million in equity investment – was held in Apax Europe VII, the €11.2 billion 2007 mega-fund, according to Apax presentation documents from 2012 seen by Private Equity International. As of 31 December, 2011, Apax was marking Cengage at 1.2x, according to the documents, but it’s not clear if that has changed.

Europe VII also held Apax healthcare investment Marken, another troubled company the firm had been marking at 10 cents on the dollar last year. Apax hired Houlihan and Lokey last year to restructure Marken. The firm exited the company over the last quarter of 2012 as the result of the operation, which saw the group’s lenders take full ownership of the business. 

Despite the two struggling portfolio companies, Europe VII was generating a 1.11x return multiple and a 3.6 percent internal rate of return as of 30 September, 2012, according to the Oregon Investment Council. The fund exited a large part of its investment in Indian hospital chain Apollo Hospitals earlier in the year, according to a source, who said the investment is now held at 3.1x in constant currency.  

Funds held by the firm have realised a total of €4.4 billion since the beginning of 2011, generating an overall 2.1x return, the person said. This was topped by another €2.1 billion held in public securities as of December 2012, according to the source. New investments made by the firm since September 2011, it said, are currently held at a 1.5x multiple on invested capital. 

Last week, the firm announced a 10 percent cut in headcount, as well as the closure of its Southern European offices. It is raising its latest vehicle, which has a €9 billion target, after holding a €4.3 billion first close in March 2012. The firm is contractually required to hold a final close at the end of June 2013.