The editors of Honi Soit did attempt to compromise with the school before this falling-out: After seeing the original uncensored image (perhaps not surprisingly) shut down, the paper added black bars that covered the offending parts. The bars still didn't leave much to the imagination—it's still, uh, a pretty hairy situation—and University administrators, which operate the publication, pulled the issue.
From the Huffington Post:
“The cover was meant to be an empowering message to women that they don’t need to be ashamed of their bodies,” Editor-in-Chief Hannah Ryan told Jezebel. “This response, and the fact that it is possibly criminal, is therefore incredibly disappointing.”
In an essay titled “The Vagina Dialogues” on Honi Soit's website and Facebook page, the editors wrote: “We are tired of vaginas being either artificially sexualised (see: porn) or stigmatised (see: censorship and airbrushing). We are tired of being pressured to be sexual, and then being shamed for being sexual.”
And it concludes: “We hereby present to you the censored vaginas of 18 Sydney University Students. We present them, tarnished, enraged, and enlarged. And we ask you, the reasonable person, are you seriously offended by a body part half the population has?”
If you'd like to see the original image, the Huff Po has it. The editors weren't kidding about the whole “non-sexualized” thing. Whew.