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Investing in Cengage Debt - Case Study Q&A

Reasons to Invest in Cengage Debt

Read the case study and answer all the questions below using the exhibits in the excel sheets attached. You have to read the case study and refer to and calculate the numbers using the exhibit in the excel sheet. Answers do not need to be in full sentences but should be as complete and specific to information in the case as possible. In November 2012, Apax is considering a sizeable purchase of Cengage’s debt. At this time, Cengage has $4,159 senior debt outstanding, trading at 78% of par value (i.e. each $100 face amount of bonds costs $78), and $1,364 junior debt outstanding, trading at 21% of par value (see Exhibit 8).

1. As of November 2012, what (in your opinion) are the three most important reasons why Apax SHOULD invest in Cengage debt [no more than 15 words each]?

2. As of November 2012, what (in your opinion) are the three most important reasons why Apax SHOULD NOT invest in Cengage debt [no more than 15 words each]? Apax expects Cengage to file for Chapter 11 bankruptcy, and emerge from bankruptcy in June 2013 with an estimated enterprise value (TEV) of $3,438 million. Assume that Apax has decided to invest $750 million of its funds to purchase senior debt. Also assume that the Chapter 11 plan of reorganization follows absolute priority in determining the distributions to prebankruptcy debt and equity owners (as described in paragraphs 3 and 4 of the case), and is based on the assumed $3,438 TEV for Cengage. Lastly, assume that any equity in the restructured company that Apax receives under the plan of reorganization will be sold in 2018, when Apax will exit its investment in Cengage at [7× (projected 2018 adjusted EBITDA)].

3. What are the cash flows to Apax from its investment strategy in Cengage’s senior debt? Please list the cash flow (in $ millions) followed by the date of the cash flow (month, yr) : for example, enter your answer as $xx , MMM YY ; $xx , MMM YY ; etc.

4. What is the return to Apax from this investment in Cengage’s senior debt (you can use the excel XIRR function; enter your answer here in percent, xx.x%). The owners of Cengage’s junior debt are unhappy with this potential outcome, because they believe the company will benefit more quickly from its move to digital products. They have prepared their own set of projections for the firm, which are provided in your additional excel spreadsheet on canvas (“Cengage junior debtholders projections.xlsx”). The debt structure at exit from bankruptcy would not be changed. Based on this information, they have hired you as their financial advisor to produce a discounted cash flow valuation of Cengage.

5a. What is the 2014 cash flow that you would discount in your DCF valuation, and briefly describe how it is calculated? Enter your value in $ millions, with one decimal place, followed by your explanation (enter as $xxx.x million ; “explanation” ).

5b. What is the 2015 cash flow that you would discount?

5c. What is the 2016 cash flow that you would discount?

5d. What is the 2017 cash flow that you would discount?

5e. What is the 2018 cash flow that you would discount?

5f. What is your terminal value of cash flows, stated as of 2018?

5g. What discount rate would you use to discount these cash flows, and briefly what inputs did you use to calculate that discount rate (enter as x.xx% ; “explanation”)

5h. What is the TEV (at of June 30, 2013) from your DCF valuation?

6. Continue to assume that Apax had invested $750 million in the Cengage’s senior debt in Nov 2012, and held this investment as described in

3. Assuming the same exit multiple for any equity received in the bankruptcy restructuring (but using the revised projection for 2018), what would Apax’s realized return be if the court had instead agreed with the junior creditors’ valuation, and confirmed a reorganization plan following absolute priority but assuming the junior creditors’ estimated TEV of the firm at exit from bankruptcy? Would this outcome suggest a different 2012 investment strategy for Apax? Why?

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