THE ISSUE: McGraw-Hill Cos Inc. is planning to split itself
into two public companies with one focusing on its credit
rating business and the other on textbooks and educational
products. Which company will be the better investment?
By Katya Wachtel
NEW YORK, Sept 12 McGraw-Hill MHP.N, the
publishing and information services conglomerate, is betting
that two companies is better than one.
But investors, including some of the activist shareholders
who are pushing for a break-up, should be aware that the
earnings potential of two new companies being created by
McGraw-Hill could be quite different.
Wall Street analysts and money managers say the company's
markets group, which will include the Standard & Poor's ratings
business, will tend to be the more consistent performer.
The markets business, with about $4 billion in revenue in
2011, won't be weighed down by costs associated with
McGraw-Hill's more sleepy textbook and educational products
The education business, meanwhile, will have about $2.4
billion in revenue.
STANDARD & POOR'S UNIT:
Following the split, the expectation is that the
newly-minted markets company will garner new investor interest
after shedding its weaker performing education unit. The
markets company will be closer to a pureplay ratings agency,
much like Moody's Investors Service.
"We're big believers in global growth so the financial
piece looks like a real opportunity here," said Timothy
Ghriskey, chief investment officer at Solaris Asset Management,
a investment firm that does not currently own any McGraw-Hill
stock. Even before the split announcement, Ghriskey said his
firm was looking at McGraw-Hill because of the strength of the
Investors, for today at least, are certainly warming to the
prospect of McGraw-Hill splitting up. In early afternoon
trading on the New York Stock Exchange, the company's shares
rose 2.22 percent to $39.58, even as the broader market was
trading in the red.
Douglas Arthur, an analyst at Evercore Partners in New
York, which is advising on the deal, said the new markets
business will have much stronger cash flow and operating
margins than the education business.
"I've written for a long time that the education business
has held back the growth profile of the company," Arthur said.
The education business also could offer some opportunity to
investors, but with a lot more risk. Analysts and investors
said the challenge for the new education business will be
finding ways to cut costs and increase revenues.
The new company's big challenge will be finding a way for
its textbook division to thrive in the age of electronic
learning software and also deal with reduced spending state
McGraw-Hill's digital strategy trails its competitors,
according to an August research report from analysts at Stifel
But if the new company can make the transition to the
digital frontier, it may offer better upside returns than the
new markets business.
"There aren't many pureplay, publicly traded education
companies, so there's an opportunity for an investor or anyone
in looking for exposure in that space," said JPMorgan & Chase
analyst Michael Meltz. "This [split] will free it up to spend
capital however they want to."
Terry McGraw, CEO of the company, said in an interview that
the split will be good for recruiting a new chief executive for
the education business.
"As a public company, the opportunity to get a very strong
CEO to come in is going to be very good," McGraw said.
BOTH ATTRACTIVE PLAYS:
Peter Appert, senior research analyst at Piper Jaffray &
Co. and a long-time follower of McGraw-Hill, said both the
markets group and education unit are both attractive investment
"We believe there is opportunity for margin upside in both
units although the market will likely take a 'show-me' attitude
until we get more detail on cost reduction initiatives," he
wrote in a research note.
As an indication of potential margin leverage, Appert notes
that S&P ratings' 2010 actual margin -- before corporate
overhead -- of 44.5 percent compares with Moody's 46.2 percent
and McGraw Hill's Education's margin of 14.8 percent compares
with Pearson's North American education margin of 17.8
All told, Appert said the steps the company outlined,
including more aggressive stock buybacks and cost reduction
efforts, "make strategic sense and will ultimately help close
the gap between the current share price and our estimated $46
sum-of-parts asset value and $48 fundamental valuation."
(Reported by Katya Wachtel with additional reporting by
David Henry and Sam Forgione; edited by Matthew Goldstein,
Jennifer Ablan and Walden Siew)