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Rating Action:

Moody's downgrades Cengage's CFR to Caa3 from Caa1; rating outlook is negative

Global Credit Research - 13 Nov 2012

Approximately $5.9 billion of debt instruments affected

New York, November 13, 2012 -- Moody's Investors Service downgraded Cengage Learning Acquisitions, Inc.'s (Cengage) Corporate Family Rating (CFR) to Caa3 from Caa1, Probability of Default Rating (PDR) to Caa3 from Caa2, speculative-grade liquidity rating to SGL-4 from SGL-3, and instrument ratings as detailed in the debt list below. The downgrades reflects Moody's view that the sharp revenue and EBITDA declines in Cengage's fiscal 2013 first quarter further complicate the company's already difficult tasks of materially reducing its very high leverage and addressing its significant $2.7 billion of 2014/2015 maturities, thereby elevating default risk. The rating outlook is negative.

Cengage attributed the significant revenue and EBITDA decline to a combination of market (continued textbook rental market inroads, soft higher education enrollment particularly at career colleges, adoption deferrals, and pressure on library funding) and company-specific factors. Moody's believes the actions Cengage is implementing to mitigate marketplace pressures and address company-specific factors (such as improving channel partner management and adjusting sales force incentives and training to increase adoption of products that require students to utilize digital solutions) will take time to implement and involve execution risk. However, Cengage's approaching maturities and near-term pressures on the higher education market provide limited flexibility to execute a turnaround and materially reduce leverage.

An increase in Cengage's secured debt-to-EBITDA ratio to 6.8x also currently eliminates the company's capacity within the secured debt ratio incurrence limits in its various debt agreements (although some secured debt capacity remains within lien baskets) and reduces cushion within the maximum 7.75x net secured debt maintenance covenant in its credit facility. This along with provisions such as the most favored nation pricing clause in Cengage's credit facility will also make it difficult to address maturities and maintain positive free cash flow after factoring in the likely significant increase in cash interest costs.

Cengage is reportedly a bidder for McGraw-Hill Education (MHE), although there are reportedly other potential bidders for the company. A transaction with MHE would increase Cengage's scale in the higher education business and likely be de-leveraging when factoring in synergies. However, Moody's believes Cengage would need to resolve its maturities issues as part of any proposed financing for a MHE transaction, and this would be challenging given the pressure on its business and its high secured and total leverage.

Downgrades:

..Issuer: Cengage Learning Acquisitions, Inc.

.... Corporate Family Rating, Downgraded to Caa3 from Caa1

.... Probability of Default Rating, Downgraded to Caa3 from Caa2

.... Speculative Grade Liquidity Rating, Downgraded to SGL-4 from SGL-3

.... Senior Secured Bank Credit Facility, Downgraded to Caa2, LGD3 - 37% from B2, LGD2 - 21%

.... Senior Secured Regular Bond/Debenture (First Lien Notes), Downgraded to Caa2, LGD3 - 37% from B2, LGD4 - 65%

.... Senior Secured Regular Bond/Debenture (Second Lien Notes), Downgraded to Ca, LGD5 - 85% from Caa3, LGD4 - 65%

.... Senior Unsecured Regular Bond/Debenture, Downgraded to Ca, LGD6 - 92% from Caa3, LGD5 - 78%

Loss Given Default Updates:

.... Senior Subordinated Regular Bond/Debenture, Changed to LGD6 - 95% from LGD5 - 85% (no change to Ca rating)

RATINGS RATIONALE

Cengage's Caa3 CFR reflects its very high debt-to-EBITDA leverage (11.1x LTM 9/30/12 incorporating Moody's standard adjustments and cash pre-publication costs as an expense), limited free cash flow generation and elevated default risk due to the significant refinancing risk associated with its 2014/2015 maturities. Cengage has a good market position and broad range of product offerings in higher education publishing. Moody's believe the company has moderate growth prospects over the intermediate term and is reasonably positioned to transition its revenue as higher education publishing continues to shift to digital from print formats. Cengage nevertheless faces multiple near-term operating headwinds from market and company-specific issues. Moody's believes earnings pressure and Cengage's high leverage reduce flexibility to address the sizable $2.7 billion of remaining 2014/2015 maturities, creating elevated default risk. The maturity on Cengage's $300 million 2017 revolver springs to April 2014 if more than $400 million of the approximate $2.1 billion of 2014 term loans are outstanding as of that date and the maturity of the company's $1.3 billion 2017 term loan springs to October 2014 if more than $350 million of the remaining $404 million of 10.5% senior unsecured notes are outstanding as of that date.

Moody's is reverting to a 50% mean family recovery rate assumption given the sharp jump in debt-to-EBITDA leverage to 11.1x from 9.3x (incorporating Moody's standard adjustments and cash pre-publication costs as an expense) in the first quarter. This results in a two-notch reduction in the CFR to the same Caa3 level at which the PDR is placed.

The downgrade of Cengage's liquidity rating to SGL-4 from SGL-3 reflects weaker cash flow generation and higher risk of a covenant violation over the next 12-15 months. Moody's believes cash (approximately $57 million as of 9/30/12) and unused capacity under the $300 million April 2017 revolver commitment provide modest coverage of the approximate $36 million of required annual term loan amortization, seasonal cash needs, and potentially limited to negative free cash flow generation. The breadth of the operating challenges contributing to the significant first quarter earnings decline, as well as the time required and execution risks associated with the company's turnaround plans make positive free cash flow generation questionable over the next 12-15 months. Moody's estimates that Cengage has an approximate 13% EBITDA cushion within the maximum 7.75x net senior secured leverage covenant in its credit facility (there are no step downs in the covenant). However, there is greater uncertainty regarding Cengage's ability to comply with the covenant over the next 12-15 months given the operating pressures and the company's possible use of incremental secured debt to at least partially address its unsecured debt maturities.

The negative rating outlook reflects the elevated risk of default unless the company can reverse its weak operating performance and refinance maturities.

Heightened near-term risk of default including through distressed exchange transactions, or a reduction in the recovery assumption could lead to downward pressure on the CFR, instrument ratings and/or the PDR rating. Cengage's ratings could also be downgraded if the company is unable to make de-leveraging progress or generate and sustain comfortably positive free cash flow. A weakening of liquidity would also pressure Cengage's ratings including through such factors as significant revolver usage, weaker or negative free cash flow, erosion of the covenant cushion, or changes in the likely cost of refinancing.

An upgrade or a shift to a stable rating outlook is unlikely unless the company is able to address its 2014/2015 maturities at a manageable cost. 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.

Please see the credit opinion on the issuer page on www.Moodys.com for additional information on Cengage's ratings.

The principal methodology used in rating Cengage was the Global Publishing Industry Methodology published in December 2011. Other methodologies used include Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

Cengage, headquartered in Stamford, CT, is a provider of learning solutions to colleges, universities, professors, students, libraries, reference centers, government agencies, corporations and professionals. Cengage publishes college textbooks and reference materials, and supplements its print publications with digital solutions. The company was acquired by funds managed by Apax Partners and OMERS Capital Partners in a $7.3 billion leveraged buy-out from Thomson Reuters Corporation in July 2007. Revenue for the LTM ended September 30, 2012 was approximately $1.8 billion.

REGULATORY DISCLOSURES

The Global Scale Credit Ratings on this press release that are issued by one of Moody's affiliates outside the EU are endorsed by Moody's Investors Service Ltd., One Canada Square, Canary Wharf, London E 14 5FA, UK, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that has issued a particular Credit Rating is available on www.moodys.com.

For ratings issued on a program, series or category/class of debt, this announcement provides relevant regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides relevant regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides relevant regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Information sources used to prepare the rating are the following : parties involved in the ratings, parties not involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

Moody's considers the quality of information available on the rated entity, obligation or credit satisfactory for the purposes of issuing a rating.

Moody's adopts all necessary measures so that the information it uses in assigning a rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see the ratings disclosure page on www.moodys.com for general disclosure on potential conflicts of interests.

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Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

Please see ratings tab on the issuer/entity page on www.moodys.com for the last rating action and the rating history.

The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

John E. Puchalla
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

John Diaz
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's downgrades Cengage's CFR to Caa3 from Caa1; rating outlook is negative
No Related Data.
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