Inside the Cengage Bankruptcy

July 2, 2013 by Thad McIlroy

Bankruptcy filings amount to hundreds of pages. If you’re interested in Cengage Learning’s bankruptcy and want to read the source documents start at the Cengage site on a page called “Information About Our Restructuring.” At the bottom of the page you’ll find a link to “Claims Information & Court Filings,” where many of the meaty documents reside, including a set of “Court Docket” filings. The first reveals that the Chapter 11 voluntary petition fee is $1213. Not bad, given that investors are facing a write-off of some $4 billion of the $7.75 billion spent to acquire Cengage from Thomson in 2007. (Three days later Thomson announced it would buy Reuters for $17.2 billion and it was then obvious that a grand plan had motivated the sale of the Thomson educational publishing division.)

Of greatest interest to players in the publishing industry is Exhibit A on Cengage’s Investor Relations/Announcements page, the oddly-named “Blowout Materials.pdf.” It’s a 76-slide presentation titled “Operating Plan.” The Executive Summary is unusually frank. It leads off with an admission that “the traditionally stable Higher Education publishing market…recently gone into decline.” Cengage, furthermore, “is underperforming the market primarily driven by its digital execution.” The “poor market conditions” will only slowly improve “as digital penetration increases” but this will result in only “modest industry growth going forward.” After these admissions the Summary goes on to the usual reassurances that the problems at Cengage have been identified and are already being addressed. The new plan “has achieved significant early traction.” Sure. Why not.

The Cengage Learning operating plan is not likely to excite investors. The company will continue to shrink through 2015, and then begin to slowly grow into FY 2018, with sales five years from now just 5% higher than FY 2013. The earnings are projected to grow slightly faster, moving the company from losses over the next two years to an EBITDA in 2018 11.4% higher than in FY 2013. The foundation somehow feels shaky.

OperatingProjections-2013-18

Up next is another speculative financial analysis, this one trying to pin down where the savings are going to come from in the next three years that will return Cengage to profitability. A third of the $100 million in targeting savings are TBD. The only number that you can be sure will be achieved is the staffing reduction of over $50 million. Companies are good at that. The reductions in contracts, facilities and travel/entertainment are so low as to be uncontroversial.

CengageCostReductions

A slide that startled me reveals the core problem faced by Cengage and (perhaps to a slightly lesser extent) by its competitors. Print sales of new books have dived some 50% from their mid-90s levels, and after a pause in the early 2000s, have resumed their downward march. Print sell-through is now less than a third of total units in schools. Also, growing significantly faster than ebook sales, are the rentals of used textbooks which are hitting both rentals of new titles and new print sales. Yikes.

Print-Sell-Through-Declines

There’s lots of additional market and competitive information in the slide deck: well worth a gander for those who care about these things.

Online at Claims Information & Court Filings you’ll find a section called Voluntary Petitions. Click any of the four links on that page to see the hit list of “Creditors Holding the Top 30 Largest Unsecured Claims,” the banks, the vendors and the authors that will likely be taking a bath in this Chapter 11 reorg. Amounts range from $292 million owed to Wilmington Trust, a division of M&T Bank (“$83 billion in assets as of December 31, 2012”) to Silverbull Software, facing a loss of $389,951 (“Silverbull Software provides number of technology solutions and support services for Global Clients looking to add a competitive advantage in our clients target industry”). Just slightly less, at $392,748, is Globus Printing Company, “family owned and operated since 1957.”

The filing also suggests that Cengage has exposed its bestselling authors to credit risk. The hit list includes six very high grossing individual textbook authors, all male, owed a total of $4.1 million in royalties (aspiring self-published authors take note!).

N.Gregory Mankiw        $1,618,249
Jackson J. Spielvogel     $626,676
Carl S. Warren            $489,509
Eugene F. Brigham         $473,918
David Nunan               $472,856
John C. Kotz              $428,352

One of the numerous documents filed by Cengage today seeks to restore these royalty payments: it’s very much in Cengage’s interest to retain its top earners. Still I’m surprised that the agreements reached in preparation for today’s filing would not have already addressed this embarrassment. I went back through the files to Houghton Mifflin Harcourt’s May 2012 filing and none of its authors were similarly exposed.

I’m not sufficiently expert in the machinations of bond holders to understand exactly what’s going on behind the scenes at Billionaire Central. In April the Wall Street Journal reported that Apax Partners had purchased more than $800 million of Cengage’s discounted debt. This puts Apax into the position of being both the major owner of Cengage, about to take a big bath, but also a senior secured creditor of Cengage, which would potentially restore its powers to direct Cengage’s corporate destiny. Perhaps unsurprisingly the report notes that “the strategy, while legal, is somewhat controversial.”

Last December the New York Daily News revealed that Apollo Global Management, while forging a deal to buy McGraw-Hill’s education business for $2.5 billion, also purchased a “significant debt position in cash-strapped Cengage Learning.” The Daily News speculates that the long-term play is to merge McGraw-Hill and Cengage. With the final merger of Random House and Penguin only 48 hours old this scenario is certainly plausible.

Stay tuned.

July 4, 2013: There’s a revealing article in today’s Financial Times (UK): “Debt investment in Cengage backfires on Apax Partners.” According to journalist Henry Sender, “it is clear that buying (the Cengage debt) has only amplified the buyout group’s (Apax) losses. In addition… Apax has opened itself up to the charge of conflict of interest by purchasing the debt of a company it already controls.”

 

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Comments

  • W

    Jul 3rd, 2013 : 7:05 AM

    Thanks for posting this analysis, Thad. I’ll be watching this space!

  • Bob

    Jul 10th, 2013 : 5:48 AM

    What a mess

  • Leslie Fitch

    Jul 3rd, 2013 : 10:48 AM

    Gregory Mankiw writes about how great the free market economy is so this development should be fine with him.

  • Thad McIlroy

    Jul 3rd, 2013 : 12:48 PM

    Good point 🙂

  • L. Bebe

    Jul 3rd, 2013 : 12:30 PM

    With print sell-through is now less than a third, Cengage and others in the industry are just sitting ducks. How can they have a sustainable model when e-books are not particularly good learning tools for topics of a complex nature (IE: it is easier to read and learn from an actual printed book which features diagrams, schematics and such). I am be old fashioned, but I’d rather by my chemistry, physics, mathematic, biology, economic, etc books in print. Jeez, even e-cook books suck. Is it a reasonable projection to go from 24% digital in 2013 to 40% by 2018?

  • Thad McIlroy

    Jul 3rd, 2013 : 12:56 PM

    My sense is that by 2018 –more– than 40% of the market will be digital, but –not– with digitized versions of existing textbooks, as is the predominant digital form today. Startups like Inkling and Knewton are rethinking how the curriculum is presented, adapting it to the digital medium rather than aping print. The question for Cengage and its large-scale competitors is whether they can out-innovate the startups, or, as Pearson is doing, follow a coherent acquisition path. I’m not placing any bets.

  • L. Bebe

    Jul 3rd, 2013 : 5:59 PM

    I took a brief look at Inkling and they give away some free chapters for sampling. From the ones that I looked at (cooking, economics), are nicely formatted and hyperlinked and so on but are still really just text with graphics. My question is: to truly take advantage of technology and to revolutionize the textbook market, do you see a trend in the future where textbooks have much more interactive features embedded in the book (similar to a multi-media website)? In my mind, a textbook of the future would be text, with multi-media content, and interactive “apps” that are like micro lesson plans within the book. For example, one can “practice” a dissection of a dead rat using the textbook “app” before coming to class and performing the actual dissection. Can ONIX handle such tasks? Presumably, it would be very costly to produce such textbooks as the author needs to work with programmers, probably making such a scenario too prohibitive for now. Or is this already happening?

  • Thad McIlroy

    Jul 4th, 2013 : 12:31 AM

    It is happening, slowly. As you point out, it is “very costly to produce such textbooks” and the software still falls short in many cases as do the necessary skills in the publishing companies. There’s a great opportunity for startups, but literally thousand of texts are in use today so it will be many years till these are re-thought, re-authored, re-designed and re-published. Apps provide somewhat more power than ebooks, but marketing them is an added challenge.

    One for instance I was looking at this other day is:

    Leonardo da Vinci: Anatomy http://www.royalcollection.org.uk/exhibitions/leonardo-da-vinci-anatomist/buy-the-app

  • L. Bebe

    Jul 4th, 2013 : 12:41 PM

    Thanks for your insight and replies. As your comprehensive website points out, readership is on a decline, especially amongst the younger generation. You also point out that even college graduates often become non-readers because textbooks are not particularly interesting and turns them off from reading when there are other forms of more interesting entertainment. If e-textbooks or app-books can function in a more interactive way that lifts the staid books and textbooks into a much more functional, interesting reading or learning tool, then perhaps the general decline in readership might eventually reverse. This implies that there is a large, untapped number of non-readers that could become readers again. As you point out, Facebook and twitter are forms of publishing and reading. Young people actually do read quite a bit, but in a different format. The consolidation within the publishing industry is the failure of the stalwart publishers to adapt to understanding the psyche of the younger generation, IMO. Whoever designed ONIX, did not do so with an eye to the future of having a software platform that could embrace multimedia interactivity within an e-book. So maybe the app-book wins in the end and good-bye to Kindle. Thanks for putting together a comprehensive website on the publishing industry, Thad.

  • Thad McIlroy

    Jul 4th, 2013 : 12:57 PM

    Thanks for your comments.

  • L. Bebe

    Jul 4th, 2013 : 5:26 PM

    I just realized that I made a typo above as ONIX is used for handling Metadata and meant to say epub and mobi in my above comments.

  • alfarocat

    Aug 23rd, 2013 : 11:10 PM

    Yes, there are those who prefer print. I do as well for certain things. But in the field of education, material can come alive if technology brings an approach that a print book cannot. As someone mentions below, seeing the dissection of an animal for a biology class surpasses merely reading about it. In auto mechanics, seeing how a repair is done is better than merely reading about the procedure. (Believe me, I know, when I tried to do a car repair merely from book illustrations.) A mention or print version of Martin Luther King’s “I have a dream” speech pales in comparison to hearing him deliver it.

  • L. Bebe

    Aug 24th, 2013 : 11:27 AM

    Perhaps, in the long term, there needs to be a tighter collaboration between the actual educators (K-12 and Higher Ed) with textbook authors. (Correct me if I am mistaken if this is already happening.) As alfarocat points out, the appropriate use of multimedia or interactive apps with a textbook can potentially replace a portion of the teaching normally done by the teaching staff.

    In other words, a well-designed interactive multimedia textbook could replace some of the simpler tasks of the educator, resulting a more efficient, streamlined method of education, therefore allowing the educator, particularly in Higher Ed, to concentrate on the more complex or difficult areas of the curriculum. Instead of textbook authors writing according to what they believe should be taught, the learning institutions could “commission” textbook authors to produce material according to the specific curriculum of that particular field of study. This might be one feasible model that would help defray the cost of producing expensive multimedia textbooks. The mere print only books are already expensive as is; paying for programming multimedia content would only work if the author and textbook publishing company knows arranges ahead of time a commission payment. If others (universities or students) wish to purchase or rent the commissioned textbook, then the profit can be shared between the original commissioning institution and the publisher.

    This might be a win-win situation that could benefit all parties: students, educators, universities, textbook authors, and textbook publishers.

  • Rakesh

    Jul 4th, 2013 : 3:42 AM

    I guess Cengage and McGraw Hill would become a single entity soon!!

  • Larry Molmud

    Jul 11th, 2013 : 5:50 AM

    This all warms my black heart so much.

  • Thad McIlroy

    Jul 13th, 2013 : 1:52 PM

    I do understand.

  • Kev148

    Jul 17th, 2013 : 2:02 PM

    Thanks for writing this piece Thad. I hope you continue to follow these Cengage proceedings as I’m curious to see what happens. The Greg Mankiw element is hilarious. What I find most comical is the total unawareness and disruption taking place in higher education right now.

  • Thad McIlroy

    Jul 18th, 2013 : 4:35 PM

    Thanks: I intend to continue to report on each of the larger textbook publishers.

  • ed2go Instructor

    Jul 24th, 2013 : 10:30 AM

    Thad – did you see any information on the lesser known ed2go online education business entity that is within Cengage? I am an instructor and cannot find any info about ed2go within the filings.

  • Thad McIlroy

    Jul 24th, 2013 : 10:50 AM

    As far as I can see it’s business as usual at ed2go. But it has not been discussed in any filing or news story.

  • alfarocat

    Aug 23rd, 2013 : 11:03 PM

    I’m a Cengage author. I’ve been with the company through many iterations and changes in ownership. I’ve always remarked that Cengage is a follower, not a leader. It’s been obvious for years that they’ve been behind the 8-ball regarding technology. That they’ve done as well as they have is in spite of themselves, not because of good management and innovation. How sad that it’s come to this.

  • Thad McIlroy

    Aug 23rd, 2013 : 11:11 PM

    I think that I understand your frustration, but I’m not sure singling out Cengage can be supported by the facts. All of the large textbook publishers, whether K-12 or Higher Ed, have been challenged in the last decade (with the certain exception of Pearson). The one inescapable fact behind the Cengage bankruptcy was that the company was acquired from Thomson in 2007 for far too high a price. And the bulk of the acquisition cost should not have landed on the Cengage balance sheet as debt. That has crippled the operation of the company since day 1, and now has pummeled it over the cliff. It is sad that it’s come to this.

  • alfarocat

    Aug 24th, 2013 : 7:15 AM

    Thanks for your reply, Thad. How does Cengage’s situation compare to that of other publishers?

  • Thad McIlroy

    Aug 24th, 2013 : 4:06 PM

    McGraw-Hill was just split in two, Houghton-Mifflin Harcourt emerged from its own Chapter 11, profits are down across the board. Cengage would have been profitable if it wasn’t paying interest on such a huge debt.

  • DJSetay

    Oct 1st, 2013 : 10:54 PM

    Cengage’s problems are far worse than the “market trends”. I’ve been in the wholesale textbook business since 1979, and I have certainly seen a lot of things… but nothing can hold a candle to how out of touch Cengage has been with their customers.

    Recently passed legislation, requires schools to have a “hard date” by which faculty must turn in their adoptions to the bookstore manager, or distributor (depending on the schools distribution model). In 2013, Cengage didn’t even get their sample books to faculty before the deadline, in a great many cases.

    Last year, in 2012, they decided they didn’t like having their books scavenged by book recyclers buying desk copies… in their mind, if a professor sells books, they don’t honestly look at them for adoption. MOST professors, even the ones who sell their books to used book dealers, will NOT sell books they haven’t at least looked at. You would think Cengage would at least understand their own vertical market. Nope. Not even.

    Because of Cengage’s twisted perception of their customers, they decided to significantly limit the number of unsolicited desk copies sent to faculty. Their adoptions in 2012 tanked quite dramatically as a result.

    E-book sales have certainly had some impact, but campus rentals, as well as a proliferation of online rentals have definitely had an impact on sales, as well as severe price fatigue from students and faculty alike.

    The majority of students are NOT fans of e-books. Part of this is because of the horrible experience early student adopters had with absurdly restrictive DRM schemes… but also, they just have a more difficult time cognitively, with that format of the material.

    Cengage needs to clean house, and flush all the “geniuses” who have had great difficulty finding their posteriors with both hands.

    Cengage’s problems, far more than changing market conditions, are more a result of their extraordinary disconnect with their primary customers. They really SHOULD be used as a case study for how not to run a company, and how not to treat their customers. They define “customer no service”.

    There’s no time or space to list all the things Cengage does wrong. A lot of faculty are pretty bright folks… the opinion most of them have of Cengage, was certainly earned by Cengage.

  • Thad McIlroy

    Oct 6th, 2013 : 12:39 PM

    Thanks, DJSetay, for the informed commentary. I tend to think of the big 5 as each having similar operating problems, but clearly that’s not your perspective and you speak from experience. Thanks for the comment.