Pluralsight, the Restructuring Deal of 2024 (Special 100th Edition)

Ladies and gentlemen, welcome to the 100th Pari Passu Newsletter.

Before diving in, I just wanted to take a second to thank all of you. Working in Private Equity and keeping the lights on at Pari Passu is not always easy, but I am so grateful for every single one of you reading (to thank you, scroll to the bottom of this email to grab a small gift).

Today, we have a special post to celebrate this amazing milestone: a Deep Dive on Pluralsight, the restructuring deal of 2024. This write-up will be the first in-depth look at the Pluralsight transaction. Below, we will look at the landscape of the private credit market, how the Pluralsight situation came to be, what Vista underwrote in their buyout, what we believe went wrong, and what the implications of the deal are for the private credit market.

At this point, liability management transactions have become a household name for anybody who works in restructuring. While the LMT landscape is constantly evolving, there is one thing that has always been constant about these maneuvers: they all involve public debt. That was at least true until earlier this year, when Pluralsight, a company that was taken private in 2021 by Vista Equity Partners, engaged in a drop-down maneuver that involved stripping assets from private credit lenders. Up until Pluralsight, there had never been a LMT that involved private credit, and the Pluralsight deal will forever shape the landscape of private credit LMTs. Let’s dive in.

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What is Private Credit?

We have covered this topic in previous articles, but to best understand the Pluralsight situation, we must quickly dive into Private Credit (PC) and how this asset class arose. Private Credit broadly falls under the asset class of leveraged credit (a bucket for corporate bonds and loans that hold a below investment grade credit rating). The corporate bonds consist of High Yield bonds, while the loans consist of broadly syndicated loans and, as of recent, Private Credit.

Focusing on leveraged loans, the broadly syndicated loan market has been a primary growth driver of the leveraged credit market. These loans are provided by banks, with an emphasis on securitization and ensuring returns. It arguably offers the ‘safest’ returns in the leveraged credit market. This is for a few reasons. First, the banks that provide leveraged capital do so with the intention of holding it to maturity and thus have stringent covenants that ensure their returns are maintained even if a company deteriorates during the loan period. Additionally, leveraged loans are usually secured, meaning that they will typically sit above their high-yield bond counterparts [14]. 

Private Credit / Direct Lending arose as an alternative to leveraged loans. There are 2 stark differences between PC and broadly syndicated loans that explain the rapid growth in popularity [14]. First, Private Credit is not publicly traded, while loans are considered public debt. This means that broadly syndicated loans are subject to more price volatility, which inherently makes them ‘riskier’. Secondly, following the Great Financial Crisis, banks were given very stringent lending requirements, which disincentivized lending towards riskier / over-leveraged companies. These two factors have curbed bank’s appetite to lend in riskier situations, leaving companies in need of capital in a precarious situation. The solution - Private Credit. By not trading on the public markets, private credit lenders became willing to offer capital with ‘looser’ credit terms as access to credit terms was privileged knowledge. Additionally, various private funds had significant dry powder (stored capital that could be used). In the past two years, we have seen a record high in the number of companies that need capital and a record low in the number of banks willing to provide loans. With excess dry powder, private credit filled this gap and has been able to charge higher than normal rates for doing so, making it a very attractive asset class to investors.

Overview of Pluralsight

Pluralsight is a cloud-based platform focused on providing scalable, on-demand technology learning solutions for individuals and businesses, specifically in the IT sector. Pluralsight is meant to revolutionize the traditional in-person, instructor-led training models, which suffer from a lack of scalability and inability to quickly meet consumer’s changing preferences. Pluralsight’s offerings particularly benefit companies, as companies currently suffer from the dilemma of either hiring new talent or training existing employees to meet the skills required in a certain industry. Given the rapid advancements in many industries, companies are now training employees as it is a more cost-effective solution when compared to hiring new employees. So how is this done?

Pluralsight abandons the traditional in-person teaching model by crowdsourcing digital content, vetting that content by professionals, and providing it to customers globally. Specifically, Pluralsight has crowdsourced this content to IT professionals, with over 85% of their revenue coming from Business-to-Business services [3]. As of 2020, Pluralsight had over 18,000 business customers, with a customer base located in over 180 countries [2]. Pluralsight’s products are broadly broken up into 2 categories: Pluralsight Skills and Pluralsight Flows [2],[3]:

1. Pluralsight Skills: Pluralsight uses machine learning-driven assessments to provide users with Skill IQ, which measures skill proficiency in various technologies (e.g. Java). Additionally, Pluralsight provides a course library hosting thousands of on-demand courses across various technological skill sets such as cloud, IT, etc. Consumers can take personalized learning paths that are tailored to their respective skill levels and goals. Businesses can additionally use this service to track their employees’ skills and usage of the platform.

2. Pluralsight Flows: Pluralsight’s second product helps aggregate historical data to provide reports to companies on their team’s productivity measures. It studies a team’s software code and works with other tools that a team might use (such as Github). This provides a broad view of what a given team is working on, where they face challenges, and where they are excelling to allow for maximum efficiency and software code quality. 

Pluralsight grew in popularity for its user-friendly interface and adaptive features like skill assessments and interactive practice problems that adjust to each user’s skill level and role. This tailored learning experience is unique among platforms. Compared to its competitors, Pluralsight’s offerings are niche enough to attract IT professionals, and consistently updates its database of information to ensure it is up to date. These competitive advantages led to partnerships with firms like Google and Microsoft [3].

Leveraged Buyout and the Downturn

In early 2021, Vista Equity Partners agreed to purchase Pluralsight in a take-private deal for $22.50 per share (approximately a 25-30% premium) and an estimated value of $3.5bn. This transaction included $1.5bn of debt financing (~40% LTV), with over $1bn coming from direct lenders ($1.175bn recurring revenue term loan and a $100mm revolver) for an implied $2bn equity check [1],[4].

As a useful side note, the $1.175bn recurring revenue term loan emphasizes the benefits the private credit can offer. A recurring revenue term loan has covenants that are based on the company's annual recurring revenue. For example, a leverage covenant would be based on its ARR rather than its EBITDA. This effectively ignores the company's operating expenses, providing ‘freedom’ for companies within the credit documents as a company borders a distressed situation [4].

Since the buyout, Pluralsights’ growth slowed as it started to move from a growth to a mature stage company. Over the past three years, the company has undergone a variety of cost-cutting measures to be able to support its annual interest payments. Although the company's revenue has grown, it has not done so at the pace to be able to support this large debt obligation, requiring Vista Equity Partners to request lenders for an amendment of the underlying credit covenants. Specifically, in Q1 2023, the private equity firm requested private credit lenders to loosen their loan covenants (specific terms on the types of covenants have not been disclosed given the private credit documents are kept between lender / issuer) [4],[5].

Although Pluralsight is a private company, we can do some rough calculations to understand how the company has ended up in a distressed situation. When Vista bought out Pluralsight, it was reported that the company was generating $390mm in annual recurring revenue. Assuming a 10% CAGR, this leads to $472mm of ARR in 2023. In 2023, it was reported that Pluralsight had a 26% EBITDA margin, meaning it would generate $123mm in annual EBITDA (scroll down to see summary financials). It was estimated that the private credit debt had an interest rate of SOFR + 800. Given that SOFR was approximately 5.5% in June 2024, this means the company had to pay interest expense of $159mm annually ($1,175mm of debt * 13.5%). The remaining $325mm was not issued by private lenders. The specific interest rates on those pieces of debt were not publicly disclosed. However, as stated early on, private credit can charge a greater rate because it is not publicly traded and is thus less risky. Assuming the public loan rates were 200bps cheaper than the private credit rates (SOFR + 600), the interest expense on the old debt is $37mm (325mm of debt * 11.5%). This total interest expense would be $196mm given these assumptions. With an EBITDA of $123mm in 2023, this would lead to a cash burn of $73mm per year. For simplicity, we are ignoring CapEx and Working Capital given these were pretty minimal based on its financials before the take-private.

Let's look at the specific points that drive this cash burn analysis:

1. Margin Effect: Keeping interest rates and top-line growth constant for Pluralsight, the company would need to increase its EBITDA margins to approximately 43% just to break even. Even for a software company, a margin this high is difficult to obtain. Given that it is unrealistic to obtain EBITDA margins exceeding 43%, Vista Equity Partners likely underwrote some growth in ARR. Pre-take-out, Pluralsight’s topline growth exceeded a CAGR of 20% from 2015-2019. Vista Equity Partners likely underwrote a similar growth rate when completing the deal, but as we will shortly discuss, a small deviation from expectations led to their distressed situation.

2. Interest Rate Effect: Interest expense is arguably the biggest issue for Pluralsight. In 2021, when the private credit was issued, SOFR was at 0.05%. Thus, direct lenders were able to charge S+800bps (for a total interest rate of ~8% in 2021) and in nominal terms, the total interest seemed reasonable (and very accretive as the equity was likely underwritten at ~20% IRR). Things started to change as rates increased in 2022 and with a ~5% SOFR, the new interest rate of 13.5% started to inflict some serious pain. From a monetary perspective, interest expense only on the private credit tranche (the $1,175mm) increased from $94mm to $159mm (even with the same amount of debt outstanding).

Given this information, let’s try to put ourselves in Vista’s shoes when underwriting this deal. We can distill three key drivers: 1) ARR Growth, 2) EBITDA Margin, and 3) Cost of Debt. We can visualize each of these drivers in Figure 1 below. 

On the left side of the image, we can see what underwriters and Vista Equity Partners likely forecasted or anticipated when underwriting the buyout. In the left side assumptions, we can see substantial but reasonable growth for this type of business (CAGR of 18% which was already a haircut on the historical figure), EBITDA margin expansion which we would expect from operating leverage and cost-cutting initiatives (from 26% to 32%), and some sort of rate hikes (50bps rate increase per year) that flow through the cost of debt. Under these assumptions, we can see how the buffer between EBITDA and interest for Vista would be $69mm in 2024.

Now let’s take a look at what we believe happened (right side of the image, please note that these numbers are solely our assumptions). Here, we see that ARR still grows (although more moderately at a CAGR of 10%). Additionally, we are assuming no EBITDA margin expansion (26% from 2021-2024) given the commentary that has circulated about the restructuring. Finally, we illustrate the true outcome of rate hikes, where interest rates increased 5.5% over the 4 years. These small changes led to a year 4 buffer of negative $61mm in 2024. Although none of these changes were dramatic (check out our Envision Deep Dive to see an LBO where things really went south), this is a fascinating ‘case’ as it emphasizes how a moderate change beyond a PE’s underwriting for a given company can completely affect the outcomes of a transaction. 

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