Citing nearly $6 billion of debt, Cengage Learning filed a Chapter 11 bankruptcy petition in federal court last week. The bankruptcy petition is part of an effort to restructure its outstanding debt, with a goal of eliminating as much as $4 billion of debt. The petition includes all of Cengage Learning’s wholly owned U.S. subsidiaries, although not its non-U.S. subsidiaries. By filing the Chapter 11 bankruptcy, Cengage will remain in business during the bankruptcy process, with day-to-day operations and personnel largely unchanged, and it expects to continue with product development and innovation.
Cengage employs 5,500-plus people in more than 25 countries worldwide, with annual revenues of more than $2 billion per year. Cengage describes itself as “a leading provider of innovative teaching, learning and research solutions for the academic, professional and library markets.” Although it has been primarily known as a publisher of college textbooks, it has been expanding into digital publishing and databases. Its brands include Brooks/Cole in mathematics and physical sciences; Delmar in healthcare, technology, and trades; Gale, which covers both K–12 and higher education markets, with textbook and database resources; Wadsworth in the humanities and social sciences; and South-Western in business and economics.
Cengage’s path to its current situation dates from 2007 when a private equity group purchased the company from the Thomson Corp. (now Thomson Reuters) for $7.75 billion. The purchase was funded with about $5 billion in debt financing in a leveraged buyout. A leveraged buyout such as this generally involves the buyer funding the purchase with a mixture of cash and/or equity, with the bulk of the purchase price coming from funds borrowed from banks or investors. The intention is that the cash flow generated by the new purchase will be enough to pay off the loans used to purchase the company, as well as run day-to-day operations.
In 2008, Cengage made several acquisitions, including PAL Publications, Houghton Mifflin’s College Division, and Gatlin Education Services. By 2009, Publishers Weekly ranked it as the 11th-largest publisher worldwide, based on its revenues, and Cengage describes itself as the second-largest publisher of higher education materials in the U.S.
Notably, Cengage’s purchase in 2007 occurred just prior to the 2008 economic downturn. As a privately held company, it is not required to file detailed financial reports with the Securities and Exchange Commission. However, earlier this year, the Wall Street Journal reported that the company had “disappointing earnings” and a “drop in profit” in 2012. Bloomberg reported that the company lost more than $2 billion in the first 3 months of 2013, with only $353 million in sales for the quarter.
Matters began to come to a head earlier this year when Cengage began discussions with its creditors about restructuring its debt. Debt restructuring typically takes place when a company has a large debt, but when it also has significant assets and cash flow. Among the options the company and its creditors can consider are rescheduling the debt to allow for payments over a longer term, canceling some of the debt, swapping one form of debt for another, or swapping the debt for additional equity in the company. In the spring, Cengage hired several banking and legal specialists to advise it on restructuring options.
Over the course of the spring, a number of investors purchased Cengage’s debt in what the Wall Street Journal reported was an effort to “control (the) company’s fate.” (Same Wall Street Journal source as above.) Creditors of a company in financial distress may often “sell their debt” to other investors as a way of getting a guaranteed, albeit smaller, return for their investment. For example, a creditor may be owed $250 million of its original investment of $300 million. If the creditor is concerned about losing the remaining investment if the company were to fail, it may choose to “sell” the $250 million “debt” to a new investor for $100 million (or 40 cents on the dollar) to minimize its loss. The debt still shows up on the company’s books for $250 million, but the new creditor only needs $100 million to break even and can influence the company’s operations and financial fate.
While the restructuring talks continued through the spring, Cengage reportedly was continuing to tap into its credit lines in order to fund day-to-day operations. By May 2013, both the Wall Street Journal and Bloomberg reported that Cengage was considering filing a “negotiated” bankruptcy to achieve “a fast and efficient debt restructuring with minimal disruption to the business.” (Same Bloomberg source as above). By late June, the Wall Street Journal was reporting that Cengage was preparing to file a “prearranged bankruptcy” by early July, in part because of upcoming debt payments that it was expecting to “skip.”
By filing its bankruptcy under Chapter 11 of the Bankruptcy Code (Title 11, Sections 1101–1174 of the U.S. Code), Cengage will be able to remain in business and continue its day-to-day operations, albeit under the supervision of the bankruptcy court. The court may appoint a trustee to supervise the running of the business, although that does not appear to apply to Cengage’s bankruptcy. Companies operating under a Chapter 11 bankruptcy can also reject or renegotiate existing contracts, labor agreements, liens, and other business activities. Recent Chapter 11 bankruptcies in the U.S. have included Chrysler and General Motors, as well as several airlines such as American Airlines and US Airways.
In contrast, a Chapter 7 bankruptcy is where the company ceases to operate as a going concern, and the remaining assets are liquidated and sold to pay off the liabilities. Electronics retailer Circuit City and file-sharing pioneer Napster both disappeared after Chapter 7 bankruptcies.
Typically, while a company is operating under a Chapter 11 bankruptcy, it will negotiate a reorganization plan with its creditors. The plan may include restructuring some debt while eliminating others and “classifying” the creditor’s claims on the company, which specifies the order in which creditors are paid. Plans must meet certain legal requirements, and they must be approved by both the creditors and the bankruptcy court. Creditors are motivated to develop and support the reorganization plan as it often provides the best chance for receiving the most return on their investments. Based on published reports, Cengage’s restructuring talks through the spring essentially amounted to a “pre-negotiated” reorganization plan, to be implemented through the Chapter 11 bankruptcy process.
In a statement, Cengage CEO Michael Hansen indicated that the company expects to continue its “normal business operations, with no expected disruptions to our relationships with our employees, customers, business partners, or vendors.” The statement goes on to note that Cengage expects to make “timely payment(s)” to its vendors and that employees will continue to receive their “usual pay and health and welfare benefits.” Cengage Learning’s Frank Menchaca, senior vice president of global product management, research, school and professional, recently told Barbara Brynko, editor-in-chief of Information Today, that his department is expanding and continuing to conceive new products. “So any rumor that we’re getting squeezed, it’s not happening,” he says. “And any sense that we’re scaling back, we’re not. It hasn’t changed what we’re doing at all. We’re not going anywhere.”
But not every company successfully emerges from Chapter 11 bankruptcy, nor does emerging from Chapter 11 guarantee that the company can continue as a going concern. Cengage is attempting to transition “from traditional print models to digital educational and research materials.” (Source is the Cengage statement above.) However, the traditional educational textbook model is shifting to digital and open source content and to textbook rentals rather than sales, which generate lower revenues. Cengage’s bankruptcy filing is positioned as part of a “long-term business strategy” to improve its financial foundation while it continues its transition from print to digital. While the bankruptcy filing is a necessary step in that strategy, its future will depend on its success in managing its transition in a larger marketplace for educational resources.