Distressed Debt News: McGraw-Hill Financing Creates Company at Different Comp, Cengage-Watchers Note

Details about the upcoming financing for McGraw-Hill Education’s buyout by Apollo Global Management could place pressure on Cengage’s capital structure, according to sources.

The financing, which consists of a $1 billion bond, a $560 million term loan and a $240 million revolver – and now $950 million in equity – now completely excludes the K-12 business, according to sources. There is no claim on that business, multiple sources said, and also the purchase price will solely be based on the higher education business. The pricing on the TL is L+650-800 with a 1.25% LIBOR floor and a 98 OID, and the revolver has a 99 OID, according to details presented on the call.

The K-12 portion will have its own cap structure, according to sources that were on the bank meeting call yesterday, which might be some asset-backed revolver, and new investors could possibly purchase equity in that separate business along with Apollo.

Cengage was mentioned frequently on the bank call from a competition standpoint, though there was nothing explicitly mentioned about any partnership or acquisition that could happen with the businesses - and idea debt investors have floated because Apollo also owns a portion of Cengage’s 12% notes. Cengage’s fate remains closely followed by distressed debt investors, and not without some head-scratching of late. The company’s bank debt took a dive prior to earnings being released as market participants feared poor results for the quarter ending Dec. 31. And those results were indeed poor as the company disclosed decreasing cash and cash equivalents of $33.5 million as of Dec. 31, down from $137 million at the same point year-prior, and adjusted EBITDA of $145.1 million for quarter, down 17% compared with the same quarter year-prior.

Yet some of the developments were positive, which resulted in a relief rally in both the bank debt and 144A paper. Shortly after the Wall Street Journal reported last week that the company was going to hire – but had not yet hired – Alvarez & Marsal for restructuring options.

Financial sponsors Apax Partners have been snapping up the company’s first-lien debt, the company disclosed in its latest results: during the “three and six months ended December 31, 2012, funds advised by Apax that had previously invested in our equity made substantial purchases of our outstanding debt at a discount,” according to the note. But it’s not certain if Apax has been doing this in order to retain control in an in-court or out-of-court restructuring.

Apax, along with OMERS, purchased Cengage in July 2007 for $7.3 billion from Thomson Reuters, a deal that included about $5.6 billion in debt. Yet the owners have not been able to make any money on the acquisition except management fees, not being able to take out a dividend since that time.

It appeared the backers were trying to extend their optionality in July, when JP Morgan ran an exchange for Cengage in a deal privately negotiated between the company and some of the larger notholders including Apollo. The exchange put in new 12% 144A secured notes due 2019, effectively subordinating the remaining 10.5% notes due 2015, and leaving the company with no ability under its senior secured leverage ratio to incur any additional first- or second-lien debt. Sources at the time noted those who got left out of the exchange were left with less valuable debt. This allowed Apax to keep their options open to address the remaining maturities while hoping for an improvement. However, since that improvement did not materialize, both notes have become severely discounted with the 10.5% notes quoted in the 23 context and the 12% notes at 33.5.

The non-extended term loan was last quoted in a 78/79 context according to sources, while the extended portion is in the low to mid-70s.

The cap structure includes $1.527 billion on the 2014 term loan at L+225, $1.29 billion on the extended portion due 2017 at L+550; $551.2  million on the incremental term loan; $725 million in 11.5% senior secured First Lien Notes due 2020 725 million, $710 million in 12% Senior Secured Second Lien Notes due 2019, $328.8 million in 10.5% unsecured notes due 2015; $132 million in 13.25% subordinated discount notes due 2015; and $66.2 million 13.75% PIK notes due 2015 for a total of $5.36 billion, as of Dec. 31, according to the company.



hunter [at] distressed-debt-investing [dot] com

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I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.