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CENGAGE LEARNING: Moody’s Lowers CFR to Caa2, Outlook Negative

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Moody’s Investors Service downgraded Cengage Learning, Inc.’s ratings, including its Corporate Family Rating to Caa2 from B3, and changed the outlook to negative from stable.

“The downgrades reflect the continued secular pressure and evolving social transformation in the higher education market with significant uncertainty around enrollment levels amid the coronavirus pandemic and Moody’s growing concerns over the longer-term sustainability of the company’s capital structure,” said Dilara Sukhov, Moody’s lead analyst on Cengage. “The negative outlook reflects heightened refinancing risk, including the renewal of the ABL revolver maturing in June 2021, and that revenue and earnings will diminish in an increasingly competitive environment.”

Moody’s took the following actions:

Issuer: Cengage Learning, Inc.

Ratings Downgraded:

Corporate Family Rating, downgraded to Caa2 from B3

Probability of Default Rating, downgraded to Caa2-PD from B3-PD

$1,710 million Senior Secured Term Loan due 2023, downgraded to Caa1 (LGD3) from B2 (LGD3)

$620 million Senior Unsecured Notes due 2024, downgraded to Caa3 (LGD5) from Caa2 (LGD5)

Outlook Action:

Outlook is changed to Negative from Stable

RATINGS RATIONALE

Cengage’s Caa2 CFR reflects continued secular challenges pressuring the higher education segment, including affordability-driven price compression, intensely competitive markets, rental and used textbooks and open educational resources. The company’s adjusted cash revenue declined roughly 7% in FYE 3/2020 from prior year and 17% in the first fiscal quarter ending June 30, 2021. Moody’s expects that the revenue decline will accelerate to 15 to 20% in FYE 3/2021 as secular headwinds in the higher education industry are further exacerbated by uncertainty in enrollment and the budgetary constraints and the likely deferrals of purchasing decisions in the school business amid the coronavirus pandemic.

As a result of anticipated decline in earnings and a heavy debt burden, the company’s debt-to-cash-EBITDA leverage, which was already high at 7.8x (including Moody’s standard adjustments and cash pre-publication costs as an expense) as of LTM 6/2020, will exceed 9x (Moody’s adjusted) over the next 12-18 months, raising concerns about sustainability of capital structure in the longer term.

Cengage’s rating continues to be supported by its well-established brand, good market position, longstanding relationship with education institutions, proprietary content developed through long-term exclusive relationships with leading authors and broad range of product offerings in higher education publishing. The company’s Cengage Unlimited and Cengage Unlimited eTextbooks products position it favorably to expand its share in the higher education market, as remote learning expands through the next academic year.

However, the anticipated acceleration in growth of digital revenue in the Higher Education business will be overshadowed by enrollment pressure, which Cengage estimates to decline 10%-15% in the fall semester in the US. While Cengage has been successful at implementing its cost-saving strategy in FYE 3/2020, it will need to reduce costs to be commensurate with the revenue decline.

Cengage faces multiple near-term operating headwinds from market and company-specific issues. The company’s earnings pressure and high leverage reduce flexibility to proactively address the $1.7 billion term loan maturity in June 2023, raising concerns about sustainability of the company’s capital structure. Moody’s is also concerned about the heightened risk of distressed exchange transactions given that the company has Board of Directors authorization for repurchase of up to $100 million debt.

ESG CONSIDERATIONS

The key social risks in the education publishing sector lies in evolving demographic and societal trends and particularly in the way students choose to study and consume learning materials. As affordability of textbooks and learning materials are important to students and higher education institutions, less expensive alternatives to print textbooks emerged. This social trend resulted in a multi-year precipitous decline in average spend per on learning materials. Publishers, including Cengage, are responding by growing digital offerings that provide extra value to students.

The coronavirus outbreak is accelerating the transformational social changes impacting textbook publishers. The spread of the coronavirus outbreak, deteriorating global economic outlook, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The media/publishing has been one of the sectors most significantly affected by the shock given its sensitivity to consumer demand and sentiment.

More specifically, the weaknesses in the company’s credit profile have left it vulnerable to shifts in market sentiment in these unprecedented operating conditions and the company remains vulnerable to the outbreak continuing to spread. The coronavirus outbreak has placed increased level of uncertainty regarding future enrollments and financial performance of courseware publishers, as current social distancing measures have moved many physical learning operations to online in the education sector.

The timing and format of reopening of learning institutions remains uncertain, as different jurisdictions evaluate potential public health implications of reopening. The closure of physical facilities has led to an accelerated transition to various forms of remote learning and to a broader adoption of digital courseware. Moody’s regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety.

LIQUIDITY & STRUCTURAL CONSIDERATIONS

Cengage currently has adequate liquidity, supported by a sizable $321 million cash balance as of June 30, 2020, but ABL maturity in June 2021 and the expectation of diminished internally generated cash flow will put pressure on the company’s liquidity. Moody’s projects that cash on hand and externally generated cash flow will be sufficient to fund the company’s highly seasonal cash needs and 1% (or $17 million) annual term loan amortization over the next 12-18 months. Cash flow needs are highly seasonal with working capital swings of roughly $100-$150 million as majority of sales occur in Q2 and Q4 driven by sales of digital product and courseware. The $250 million ABL revolver (which had a $50 million balance with a $55 million borrowing base as of June 30, 2020) provides adequate backup for unplanned needs but its near-term expiration raises concerns about the company’s ability to have uninterrupted access to the credit line over the next 12-18 months.

The $1.7 billion Senior Secured Term Loan benefits from the subordination of $620 million Senior Unsecured Notes, resulting in a one-notch uplift from CFR to Caa1 term loan instrument rating. The term loan is secured by a 1st lien on substantially all assets, including tangible and intangible assets of the borrower’s U.S. subsidiaries, 100% of the capital stock of U.S. subsidiaries, 65% of the stock of first-tier foreign subsidiaries, and a 2nd lien on the ABL revolver’s 1st lien collateral, principally certain current assets including receivables and inventory. The term loan does not have any financial covenants.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Heightened near-term risk of default including through distressed exchange transactions, or a reduction in the recovery assumption could lead to further downgrades. Cengage’s ratings could also be downgraded if the company is unable to make de-leveraging progress or generate and sustain positive free cash flow. A weakening of liquidity would also pressure the company’s ratings including through such factors as significant revolver usage, weaker or negative free cash flow, or erosion of the covenant cushion.

An upgrade or a shift to a stable rating outlook is unlikely unless the company is able to proactively address its 2021/2022 debt maturities at commercially viable terms. If that were to occur, Cengage could be upgraded if good operating execution leads to revenue and earnings growth, consistent free cash flow generation and reduced leverage or the company de-levers through asset sales, an equity offering or acquisitions such debt-to-cash EBITDA is sustained under 7x (including Moody’s standard adjustments and cash prepublication costs as an expense).

The principal methodology used in these ratings was Media Industry published in June 2017.

Cengage Learning, Inc. is a provider of learning solutions, software and educational services for the higher education, research, school, career, professional, and international markets. Cengage publishes college textbooks and reference materials, and supplements its print publications with digital solutions. Large shareholders currently include Apax Partners, KKR and Searchlight Capital as well as other creditors who became shareholders upon exit from the Chapter 11 bankruptcy in 2014. Revenue for the last twelve months ended June 30, 2020 totaled $1.3 billion.

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