Breaking: 2U files for Chapter 11 Bankruptcy in Prepackaged Deal

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2U - once valued at nearly $5.5 billion as the dominant Online Program Management (OPM) provider - announced that it has filed for Chapter 11 bankruptcy with a voluntary prepackaged deal. What this means is that the company’s debt and ownership structure will be changed, but it will continue to operate and is likely to emerge from bankruptcy as soon as September 2024.

When I first started covering 2U’s balance sheet crisis last November, I noted that there was no way for the company to cover its debt maturity (hundreds of millions in loans due to be paid by early 2025). The simple math pointed to two choices for 2U:

• Work with debt holders and creditors to refinance the debt by Summer 2024; or

• Declare Chapter 11 bankruptcy under court protection to restructure debt holdings.

In a nutshell, what 2U has done appears to be a combination of these two options - the company has already worked out a deal with groups representing the vast majority of its debt holdings, but 2U will make this happen through an expedited Chapter 11 bankruptcy. This is probably the best case scenario for the company and its academic partners.

Background

2U was one of the highest EdTech flyers in the stock market, reaching a peak market capitalization of nearly $5.5 billion in May 2018 and a secondary peak of $3.7 billion in February 2021. But since its July 2021 announcement of a deal to buy edX (eventually paying Harvard and MIT $800 million in cash), the company’s value has collapsed to roughly $11.5 million yesterday.

There are multiple factors involved in this collapse - some external (interest rates, Covid pull back, regulatory activism) and some internal (declining core enrollments, disappointing bootcamp results).

Despite all the news stories about 2U, the biggest crisis for 2U over the past year has not come from government regulations, or class action lawsuits, or from the termination of the USC partnership. The crisis comes from 2U’s balance sheet, largely driven by 2U’s acquisition of Trilogy (bootcamps) and edX (MOOCs). As I shared in November, 2U had nearly $980 million in debt, with the biggest jumps (see the orange line) coming in Q1 2019 for Trilogy and Q1 2021 for edX at the same time that borrowing rates (driven by the federal funds rate in the red line) were very low.

That changed in Q2 2022 with a large increase in the federal funds rate, meaning that it was no longer cheap to borrow money. 2U faced a required $380 million payoff of term loans by early 2025, but it had no way to simply refinance debt to kick the can down the road. From November [emphasis added].

Company executives told me they were confident that they could do a straight refinance by Summer 2024, which I felt was optimistic due to continued inflation pressure on the cost to borrow.

The May Trigger

I believe that the situation changed in early May, when the Federal Reserve Bank announced its decisions to leave the federal funds rate unchanged. Essentially, a straightforward refinance solution was likely taken off the table.

At that point, bankruptcy seemed the only viable solution (at least to me). It is worth pointing out again that Chapter 11 bankruptcy does not mean that a company stops operating; rather it is typically a multi-year process where the courts figure out which debt and equity holders lose what amount of their holdings, with the idea of a healthier company exiting the process. Keep in mind that we have seen EdTech companies successfully manage bankruptcy, such as Cengage from 2013 / 14.

Furthermore, under bankruptcy there is a collateral waterfall that essentially sets the priority for who gets paid back first. Secured lien holders (term loans from big banks) first, then unsecured notes (i.e., publicly traded corporate bonds), and at the bottom equity holders (i.e., the stock market)

The Resolution

What has happened with 2U is that it was able to work out a deal with its creditors on the following terms. From the press release:

• The term loan holders will remain term loan holders, 2U will pay down approximately $30 million of the loans, and the holders will extend the maturity date by two years. 2U will have approximately $459 million in total debt coming out of bankruptcy, primarily with these term loans.

• The note holders will convert their loans into equity and become the primary owners of 2U (just under 90%), and creditors will put in $110 million in working capital - $64 million now and just over $45 million when 2U emerges out of bankruptcy, expected for September.

• The stock market equity holders are out of luck, and their shares become worthless. But note that there was only $11.5 million of equity as of yesterday.

• 2U becomes a private company, with a new board controlled by the new owners (formerly note holders).

Because this bankruptcy filing is being made as a voluntary prepackaged deal, with agreements from “lenders and noteholders holding approximately 87% of its outstanding debt,” this already passes the bankruptcy requirements (usually 75%), so there are no further votes needed. And the prepackaging is why 2U might exit bankruptcy by September instead of in a few years.

What This Means

2U still has a strategic turnaround to execute, and that includes the need to convince most academic partners to stay onboard. But there is no longer an unmanageable debt bomb set to go off in 2025. The company will have half the total debt and two extra years for the turnaround.

We need to cover the operational issues and customer feedback soon, but I’ll leave that for a separate post.

I was able to interview CEO Paul Lalljie for this story, and he views this as a reset, a second chance for 2U. As quoted in the press release:

To be honest, I did not see this level of an expedited bankruptcy option, and I had thought we would see forced sell offs (e.g., of Trilogy bootcamps) and a multi-year process. Cengage was able to exit bankruptcy in nine months, which had seemed aggressive, but here we’re talking about a two-month process. Assuming that 2U’s expectations are accurate.

I asked Lalljie about the bootcamps, as those offerings have been performing poorly and seem to be a drag on the company’s operations. He said that 2U needs to revamp how the bootcamps are designed, as they were originally intended as face-to-face offerings pre-pandemic, but that there are no immediate plans to get rid of them.

But now, operations continue as is, with no debt bomb and with $110 million of additional working capital. This is why I think this is probably the best case scenario for 2U and for its academic partners. Color me impressed with this near-term resolution to a financial crisis.

Update: Revised description of Andrew Hermalyn’s post. Fixed the details on paying down of $30 million of the term loans.

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