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McGraw-Hill’s Legacy of Information & the Divergent Business Model
It may well have been the common ground of engineering, particularly as it applied to railroads, that initially brought pioneers James H. McGraw and Jonah A. Hill together. Since the dawn of their partnership in 1909, The McGraw-Hill Companies (MHP) have established a long-standing record of publishing educational and informative periodicals, texts, etc., across myriad fields of interest and subject matter. For several decades, the company produced publications that mostly served the education and industrial sectors. Although there had been some business and economic-related titles, McGraw-Hill made its definitive foray into the realm of financial analysis with the acquisition of Standard & Poor’s in 1966. From that point on, it is fair to argue that the company gradually began to operate as two separate entities under the same umbrella, leading up to the recent announcement of a formal separation into two independent publicly traded businesses.
Over time, McGraw-Hill has augmented its scale and market exposure through several acquisitions. However, perhaps the most pivotal purchase was its acquisition of Standard & Poor’s (S&P). This company, much like its parent corporation, had its roots in railroad publications. In 1941, Henry Varnum Poor merged his publishing outfit with Luther Lee Blake’s Standard Statistics Bureau to form Standard & Poor’s. In the ensuing years, especially after its merger with McGraw-Hill, the business grew to become one of the premier credit rating agencies and a highly touted resource of financial data, worldwide. And, in the past decade, McGraw-Hill’s financial services segment, the bulk of which refers to S&P’s operations (and other data services that support S&P’s business), has risen to account for the lion’s share of the whole business’ profits, in spite of generally generating somewhat lower revenues than the education segment. Indeed, the higher-margined S&P business has been essentially driving performance for some time. In fact, as this business became more complex and diverse, the potential for income generation expanded considerably, and on a global level. Moreover, given that the bulk of the services and products offered are information-oriented, costs have been more manageable for S&P. This progression likely set the tone for a company divided.
Over the decades following the acquisition of S&P, McGraw-Hill’s traditional publishing segment reinforced its already renowned reputation and leading brand by establishing dominance in the education market. The company’s textbooks gradually became an industry standard and the business gained considerable market share across the education categories (from kindergarten through 12th Grade, as well as the tertiary higher learning group). However, in spite of generating more revenue than the financial segment, profitability in the education division has become less consistent over the past several years, particularly as the adoption rates of new textbook titles and educational materials have fluctuated quite a bit at the state and local levels. The ebb and flow of government funding in schools have considerably influenced performance at the K – 12 levels. In addition, the rising costs of publishing and the increase in demand for digital content have hampered the publishing industry as a whole.
The information and media segment (dwarfed by the other two units) consisted of various magazines and television broadcasting networks that contributed a mere fraction of operating profits and was essentially an offshoot of the education segment that attempted to diversify the revenue base by tapping into the media space. This segment was hurt by the volatility of advertising revenue over the past several years as the Internet age and increasing popularity of digital content began to erode its customer base.
These factors combined, eventually prompted some large shareholders to begin calling for a complete separation of the two divisions into independent publicly traded companies. This sentiment had been building on Wall Street for some time and back in August, two of the company’s largest shareholders, hedge fund Jana Partners and the Ontario Teachers’ Pension upped their joint stake in McGraw-Hill, a move that many believed was an attempt to gain leverage in persuading management to split up the company. The consensus opinion was that the separation would unlock value for shareholders, as the operational model of the two segments had already become considerably polarized. A breakup would allow new management teams to focus more diligently on the contrasting needs of each respective business and reevaluate the independent cost structures accordingly. Most important, the separation would allow the new shares of the financial business to trade on the merit of its performance, rather than be held back by the inconsistency of the education segment. Moreover, this move would compel the new management team of the education outfit to work harder at improving operations in order to lift the price of its new shares.
Perhaps it was the media scrutiny that ensued following the move by McGraw-Hill’s large shareholders or the bad press that followed S&P’s downgrade of the United States debt rating that tipped the scales, but not long after these events transpired in early August, the announcement was made in mid-September that the company was splitting up into two independent publicly traded entities. The two new corporations will be called McGraw-Hill Markets, which would consist of all the financial services operations (including S&P) and McGraw-Hill Education, which would focus on the education and digital learning business. Although transaction details were limited, the separation is expected to take the form of a tax-free spinoff of the education business to existing shareholders, pending final board and regulatory approval. Management stated that the split will likely be completed by the end of 2012. On a side note, the company intends to sell its television broadcasting unit to diversified publisher and media conglomerate E.W. Scripps (SSP) for $212 million in cash.
All in all, looking back, it seems apparent that this outcome was inevitable. Although the process may have been sped up by the economic malaise that has unfolded over the past three years, the divergence of the respective business models and growth potentials of the units would have probably led to this fork in the road at some point in the near future. McGraw-Hill’s stock ran up some 20% in the week following the announcement and has been somewhat range-bound ever since (approximately between $40 and $45 a share). However, this was more a recovery of previously lost ground. Moreover, though the actual separation date is quite far off, we have not seen any definitive signs that investors are particularly moved by this news, which indicates that the company’s stock is likely trading on the merits of S&P’s performance, which has stood out over the past five years, despite the declines experienced during the recession.
It seems likely that once the individual segments become separate companies, they will probably continue on their respective trajectories. The challenges that are currently hampering the broader global economy will probably weigh on performance in the near term, but by the time the split occurs, the likelihood of more stable macroeconomic conditions ought to unlock pent-up demand for S&P’s financial services, thereby propelling profitability for McGraw-Hill Markets. McGraw-Hill Education on the other hand, may continue to face headwinds along with the rest of the publishing industry. In addition, the future of education spending on the federal level, as well as at the state and local tiers, remains a cause for concern. A stronger economy probably augurs well for profits in this business as well, but the new management team will likely have to adjust more rapidly to the shifting tide in digital content and technological enhancements in order to accelerate profit growth.
At the time when this article was written, the author did not have positions in any of the companies mentioned.