Buyout firms double down as lender to make money on failed investments- report

By Nicel Jane Avellana

Jan 01, 2014 08:52 PM EST

Textbook publisher Cengage Learning Inc lost money when students and local governments reduced their textbook purchases, putting the investment of its private equity owner Apax Partners at risk. The London-based buyout firm, however, did not walk away but doubled down as a lender, amassing over $1.2 billion of the textbook firm's debt before it finally filed for bankruptcy protection in July 2013, The Wall Street Journal reported. As Cengage's biggest lender, it was now in a position to negotiate a restructuring plan so that it will continue to become an owner after Cengage gets out from bankruptcy.

The report said that more private equity firms are employing the same strategy that Apax used. When buyouts don't go as planned, they buy the debt of the firms that they are owners in, placing them in a position to utilize restructurings or bankruptcies to layoff workers, reduce pensions or large debts so they have another chance at profiting from the deal.

The strategy, however, are becoming a hot topic of debate among the private equity community, the report said. According to New York-based Loan Syndications and Trading Association General Counsel Elliot Ganz said they are developing guidelines that buyout companies can follow when buying the debt of the firms they own to prevent legal battles. However, he said it might take about a year to implement the guidelines. The report quoted him as saying, "The market isn't waiting for us. They're doing the deals the way they're doing the deals." The association is a trade group that backs banks and other secured lenders.

The report said possible conflicts stem from the fact that the private equity firm is both the owner and lender of the company. When that company seeks bankruptcy protection, the private equity owner manages the process even if its investment is most probably going to be rendered worthless. However, since creditors are paid back first in a bankruptcy process, the private equity owner ultimately loses control of the company. Yet when the private equity firm becomes a creditor, it holds more sway on the result of the bankruptcy and still remains in control after the process is completed, the report said.

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