McGraw-Hill Minus Publishing?
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New York-based McGraw-Hill (NYSE: MHFI) has announced plans to sell its once-lucrative education-publishing business to private equity firm Apollo Global Management (NYSE: APO). News of the deal comes a little more than a year after the company signaled its intention to spin off its education arm into a separate company and continue on as a leaner financial provider of financial research and analysis. That move was made in response to a cratering stock price and widespread unease among investors who viewed the firm's education arm as a growing liability.
McGraw-Hill has long dominated the two industries in which it operates. Its education arm is a major distributor of textbooks and test-preparation materials. In recent years, the company has made significant investments in digital educational platforms designed to facilitate hands-on and distance learning. It has achieved penetration among virtually every age group and educational specialty.
However, the increasingly fragmented online-education market and lingering concerns about McGraw-Hill's ability to digitize its entire suite of products and services has raised some doubts among investors about its continued viability. In addition, there are signs that the proposed spin-off would have faced an uncertain future. Due largely to logistical issues surrounding the spin-off, McGraw-Hill reported an unexpected drop in income during the second half of 2012.
McGraw-Hill also runs a multifaceted financial information operation. It operates the venerable Standard & Poor's credit rating system and provides research services and in-depth reports for financial and investment professionals through its S&P Capital IQ department. A separate financial-services division known as Commodities & Commercial offers industry-specific market research and analysis for executives and business owners in competitive industries like energy, aerospace and automotive production.
Apollo's buyout values McGraw-Hill's publishing business at $2.5 billion. This represents a significant discount to the $3 billion at which the spin-off proposal valued the division in September 2011. The company expects to log a one-time write-down of up to $550 million due to this valuation discrepancy. Current McGraw-Hill shareholders are entitled to maintain their holdings. They are not entitled to receive Apollo shares or any cash payments.
In 2011, the company's education unit earned after-tax income of $260 million on about $2.3 billion in revenue. As such, McGraw-Hill expects to take a revenue hit of at least $2 billion per year as a result of the unit's sale. In addition to about $2.2 billion in cash, the company will receive a tranche of Apollo debt valued at about $250 million. This debt carries an annual yield of 8.5 percent.
McGraw-Hill plans to use its after-tax windfall of roughly $1.9 billion to repay high-interest short term debts and make acquisitions related to its core financial services division. Once the deal has gone through, the company will be re-branded as McGraw Hill Financial. No significant personnel changes are expected at the management level.
McGraw Hill Financial will be leaner and less leveraged than the old composite company. It will continue to perform all of the functions of the old company's financial services division. As such, it will receive the bulk of its revenue from institutional clients and well-funded investors. Historically, the performance of its Standard & Poor's unit has fluctuated in relation to market movements and the long-term business cycle.
By expanding its emphasis on customized "value-added" research and reports, the new company may be able to boost its margins and maintain long-term relationships with its existing clients. Additionally, credit-rating services are more important than ever in an increasingly fragmented financial industry. An uncertain economic outlook may prove beneficial for McGraw Hill Financial's bottom line.
In any event, the company stopped reporting results for its education arm after the third quarter of 2012. It expects McGraw Hill Financial to earn about $4.4 billion during 2013 and post steady revenue increases thereafter. It plans to use its fourth-quarter earnings release to discuss the new business's financial prospects and capital structure in greater detail.
The prospects for Apollo's new education unit are less clear. The private equity firm has not publicly announced its designs for the unit. In the face of growing threats to its business model and long-term weakness in state and local education budgets, Apollo shareholders may wonder whether the company will earn a reasonable return on its investment. Then again, a slimmer and fully digitized education unit may yet emerge from the deal.
McGraw-Hill does not anticipate any regulatory hurdles or shareholder disputes related to the buyout. It expects to execute the deal by the end of the first quarter of 2013.
mthiessen has no positions in the stocks mentioned above. The Motley Fool owns shares of The McGraw-Hill Companies. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!