Cengage learning can Apax Partners salvage this buyout Case Solution
The case sets out to examine the issues involved in the decision of a private equity firm to invest in the debt of the distressed leveraged buyout. Cengage Learning was the provider of the college textbooks as well as educational materials, which had filed for bankruptcy. Cengage was bought by Apax Partners for 7.1 billion dollars in the frothy buyout market for the year 2007, and had financed the deal of buyout with 5.6 billion dollars in debt. The company also invested 1.8 billion dollars in Cengage. Over the period of time; the profits of the Cengage started falling in the wake of the adverse effects of the global crises of 2007-2008. The libraries cut the educational budgets and students started buying used textbooks. Not only this, the rise of digital material necessitated sizable expenditures for the delivery channels and new content. Because of the deteriorated financial standing of the company;Apax was concerned about whether the company would be able to avoid bankruptcy and service its debts or not.
In November 2012, Apax is considering a sizeable purchase of Cengage’s debt; what are the pros and cons of this investment strategy
Apax contemplated to buyout Cengage, because Cengage was a US based second largest publisher, which has been engaged in selling digital curriculum solutions, e-books, print books, course ware and study aids. Despite the strong financial position of the company in market; the sales of the company decreased by 12.8 percent, resulting in the loss of 27 million dollars. The reason behind the company’s deteriorated financial performance was a decline in the government funding for the educational, in the aftermath of the global crises. Additionally, the decline in government funding resulted in sizeable increase in fees and tuition to close the funding gap. Additionally, the company’s performance was adversely affected by the competitor’s use of the creative and aggressive digital strategy. The decision of buying the debt of Cengage must be made after weighing the benefits as well as drawbacks of purchasing debt of Cengage. The advantages and disadvantages of purchasing Cengage’s debt, are discussed below:
Apax is considering the sizeable purchase of Cengage’s debt due to many benefits that the company has the potential to gain as a result of purchasing Cengage’s debt,such as:if the company purchases the considerable block of the Cengage’s debt, it would enable Apax to increase the possibility of retaining the ownership of Cengageafter the debt to equity swap. Furthermore, the company would be able to reserve its seat as a creditor at the negotiating table and to influence the progression of the restructuring of bankruptcy. Moreover, in case the plan of Hansen would be successful and the Cengage recovers from the bankruptcy; Apax would be able to enjoy the substantial return on its investment.
In contradiction to the benefits of purchasing the Cengage’s debt; there are some drawbacks of this investment strategy, such as:the restructuring of the Cengage’s debt would result in a considerable dilution of the Apax’s equity stake and the debt holders would demand equity in exchange for the significant reduction in the principle of debt. Furthermore, the investors of the company would be shaky about putting money on purchasing the debt of a company which has filed for bankruptcy and has lost its position in the market. Moreover, the creditors of Cengage Company would suspect the bargaining incentive of Apax Company because there would be a possibility that the position of Apax as anequity holder, would create conflict with the objectives, being a creditor. Moreover, it does not make sense for the company’s shareholders to purchase the debt of Cengage, which is not a sound organization and is gradually losing the market share that it has.
What issues are raised by buying only senior debt versus allocating some funds to purchase junior debt
Apax Partners is concerned about purchasing the senior debt and junior debt as it would give control of the bankruptcy process to the company,providing the greatest possibility of getting equity stake in the restructured organization. At the top of the capital structure; the company has intended to finance the leverage buyout with the senior debt totaling 4159 million dollars, which could be paid first in case of the default and the junior debt,totaling:1364 million dollars.
Despite the fact that the junior debt tends to be riskiness as compared to the senior debt as it carries higher interest rates than the senior debt, the company would have to pay high amount of money to pay the senior creditors with $4725 million, with an inclusion of a little extra amount that would be required to be paid to the junior creditors, i.e. $566 million. The decision of buying only senior debt would not be favorable for the company, due to the fact that the estimated recoveries to the senior and junior classes of creditors made by Apax, with the use of the Waterfall recovery model shows that only under the high range case; there would be enough vale to compensate the senior creditors in full and still have 566 million dollars to pay to the junior creditors. Under the low range case and mid-range case, the company would not have enough vale to compensate the senior creditors in full. Thus, the senior creditors would be able to get 100 percent of their claim value before any residual value could be shared with the equity holders. There is a likelihood that if the company defaults on its payments; it would lose the asset used as collateral. Since it is the type of liability; it would raise financial burden and expenses for the company.
On the other hand, the decision of allocating some funds to purchase the junior debt would not be favorable for the company, after taking under consideration the estimated recoveries to the senior and junior classes of creditors made by Apax, with the use of the Waterfall recovery model, which shows that only under the high range case; there would be enough vale to compensate the junior creditors with the recovery rate of 41.5 percent.Whereas, under the low range case and mid-range case; the company would not be left with enough money to compensate the junior creditors with 0 recovery rate, respectively. Furthermore, it can be seen that under each scenario, including: low range case, mid-range case and high range case, no value remained for the original equity holders of the company, which provides a strong basis that the company would lose the investment of 1.8 billion dollars in Cengage………………..
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