The Backstory

Cengage filed for bankruptcy in late June 2013, when it became unable to restructure nearly $6 billion in debt. The debt was primarily leftover from the $7.75 billion 2007 sale of Cengage by the Thomson Corp. (now Thomson Reuters) to Apax Partners, a private equity group. About $5 billion of the purchase price was borrowed from banks and investors. This type of purchase is known as a leveraged buyout, with the expectation that the revenues and cash flow of the newly purchased company will be adequate to cover normal operations as well as to pay of the loans used to purchase the company.

Primarily known as a publisher of college textbooks, Cengage describes itself as “a leading provider of innovative teaching, learning and research solutions for the academic, professional and library markets worldwide.” In the first few years under its new ownership, Cengage made several acquisitions including PAL Publications and Gatlin Education Services, and its brands include Brooks/Cole, Delmar, Gale, Wadsworth, and South-Western imprints.

The Downturn

However, the 2008 economic downturn, along with dramatic changes in Cengage’s core textbook publishing business, resulted in sharp revenue downturns by 2012. Published reports from The Wall Street Journal and Bloomberg indicated there were significant drops in revenue and losses of up to $2 billion. By early 2013, Cengage was in talks with its creditors about restructuring its debt. Debt restructuring can take place when a company has a large debt but also significant assets and cash flow. Additional published reports had a number of investors purchasing Cengage’s debt in what The Wall Street Journal reported to be an effort to “control [the] company’s fate.” Investors often buy the debt of a troubled company for less than the balance due. In this situation, the original creditor is guaranteed some return on its investment, and the new investor has a smaller risk and an increased say in the company and its operations.

Notwithstanding the debt purchases and debt restructuring efforts, Cengage opted to pursue a Chapter 11 bankruptcy in order to continue its efforts to restructure its finances while also continuing to engage in day-to-day operations. Chapter 11 bankruptcy allows a company to continue its day-to-day operations but also to renegotiate contracts, labor agreements, and liens.

The 9-month bankruptcy process was not without conflict and complexity. In any bankruptcy process, the various creditors can be either secured or unsecured, with secured creditors being “first-in-line” to receive any payments from the company or its assets, and unsecured creditors being “last-in-line” to receive payments. In addition, in Cengage’s bankruptcy, there were “first-lien” secured creditors that held the majority of the debt, just over $4 billion, and “second-lien” creditors, who along with the unsecured creditors, were owed an additional $1.3 billion.

The Complications

It is not uncommon for squabbles to develop among the creditors. With Cengage, two particular factors emerged to complicate the case. First is that one of the first-lien creditors was Apax Partners, the original private equity firm that owned Cengage. In the months leading up to the bankruptcy filing, Apax Partners purchased $1.2 billion of Cengage’s debt. This essentially put Apax Partners on both sides of the bankruptcy lawsuit, as the corporate entity charged with ensuring a balanced plan of reorganization and as a major first-in-line creditor with an interest in receiving the highest return on their investment. But by hiring an independent investment bank to represent it as a creditor, and then designating an independent member of Cengage’s board of directors to represent to corporation in the bankruptcy negotiations, the major difficulties were resolved.

The other complication was the value and ownership of more than 15,000 copyrights controlled by Cengage. As assets, they had value that could be applied to either the first-lien creditors or the junior and unsecured creditors. Cengage had reserved those copyrights, along with other assets for the unsecured creditors. Separate lawsuits were filed by the first-in-line creditors and Cengage over the right to the copyrights as an asset, but they were resolved when a federal mediator stepped in and negotiated a settlement.

The Outcome

Cengage will not emerge debt-free, but it will emerge with substantially less debt than at the beginning. The first-lien creditors will be considered the equity owners of the company, controlling most of the equity and holding responsibility for about $1.75 billion in new financing. The second-lien and unsecured creditors will receive about $225 million in cash or stock in the company.

In a statement, Cengage CEO Michael Hansen said that the company expects to be “an even more competitive and well-capitalized company, with … greater financial flexibility to accelerate our growth and continue to meet the evolving needs of our users and customers. We are continuing to execute our strategy of transforming Cengage Learning into the educational technology leader with the best selection of high quality educational and research content, digital solutions and personalized services.”

Emerging successfully from bankruptcy is only the first step for Cengage. It must now continue to strengthen its overall operations, in particular its evolution from print to digital in its core textbook-oriented businesses. Already some cautionary notes are being raised. Standard & Poor’s credit rating service gave a B+ rating to the company’s debt, but it also cautioned that Cengage’s business risk profile was “weak” as it fought challenges from digital textbooks, the growing rental and resale textbook markets, declining enrollments, and declining spending by libraries and public schools.

But the company is emerging as leaner without the burden of a $4 billion debt to repay. If the company is able to utilize its resources effectively, it could be—again in Hansen’s words—“well-positioned to have a profound impact on the learning experience, creating long-term growth and profitability.”