TABLE OF CONTENTS
I. COMPANY OVERVIEW
II. CAPITALIZATION
III. HISTORICAL OPERATING RESULTS
IV. PROJECTIONS
V. CONCLUSION
I. COMPANY OVERVIEW
The McGraw-Hill Companies, Inc., incorporated in December 1925, is a global information services provider serving the financial, education and business information markets, such as energy, automotive, construction, aerospace and defense, broadcasting and marketing/research information services. The Company serves its global customers through a range of products and distribution channels, including digital data and information, integrated digital platforms, printed books, magazines and newsletters, online through Internet Websites and through wireless and traditional on-air broadcasting, as well as through a range of conferences and trade shows. The Company has four segments: Standard & Poor’s (S&P), McGraw-Hill Financial (MH Financial), McGraw-Hill Education (MHE) and McGraw-Hill Information & Media (I&M).
- S&P is the provider of credit ratings. The key constituents S&P serves are investors; corporations, governments, and municipalities; commercial and investment banks; insurance companies; asset managers, and other debt issuers. S&P differentiates its revenue between transaction and non-transaction, where transaction revenue includes new issuance of corporate, public finance, structured finance debt instruments, bank loans and corporate credit estimates, and non-transaction revenue includes annual fees for customer relationship-based pricing programs, surveillance fees and ratings fees earned relating to cancelled transactions (breakage fees).
- MH Financial is a global provider of digital and traditional research and analytical tools for investment advisors, wealth managers and institutional investors. It deploys the technology strategies to deliver to customers an integrated portfolio of cross-asset analytics, desktop services, valuation and index benchmarks and investment recommendations in the financial information, data and analytics market. The key constituents MH Financial serves are asset managers; investment banks; investors; brokers; financial advisors; investment sponsors, and companies’ back-office functions, including compliance, operations, risk, clearance and settlement. MH Financial differentiates its revenue between subscription and non-subscription, where subscription revenue includes credit ratings-related information products, the Capital IQ platform, investment research products and other data subscriptions, and non-subscription revenue includes fees based on assets underlying exchange-traded funds, as well as certain advisory, pricing and analytical services.
- MHE is a global educational publishers and consists of two operating groups: the School Education Group (SEG), which is serving the elementary and high school (el-hi) markets, and the Higher Education, Professional and International Group (HPI), which is serving the college and university, professional, international and adult education markets. SEG sells textbooks (print and digital versions), digital and hybrid supplemental materials and provides online and traditional assessment and reporting services. The key markets are pre-kindergarten, elementary, secondary, testing, supplemental, vocational and post-secondary fields in the United States. In the college and university market, and the international market, the Company sells integrated digital e-Learning platforms, textbooks and other resources to higher education institutions.
- I&M consists of two operating groups: the Business-to-Business Group (B2B), including such brands as Platts, J.D. Power and Associates, McGraw-Hill Construction and Aviation Week; and the Broadcasting Group, which operates nine television stations, four ABC affiliated stations located in Denver (KMGH-TV), Indianapolis (WRTV), San Diego (KGTV), and Bakersfield, California (KERO-TV), and five Azteca America affiliated stations in Denver (KZCO-TV), Fort Collins (KZFC-TV), Colorado Springs (KZCS-TV), San Diego (KZSD-TV) and Bakersfield, California (KZKC-TV). Key markets served by B2B include professionals and corporate executives in automotive, aerospace and defense, construction, and energy, and global business and financial professionals, traders, investors, marketers, advertisers, and consumers worldwide.
II. CAPITALIZATION
MHP is well capitalized (and over equitized) with leverage of 0.7x TTM EBITDA that is fully covered by cash on hand. The Company supports an enterprise value of 7.6x TTM EBITDA. Ideally, the Company would incur a little bit of low cost debt to leverage their equity returns. Even with moderate leverage the Company would have a low cost of debt and maintain significant financial flexibility.
| Market / Par Value | EBITDA Multiple | |
|---|---|---|
| Based on TTM EBITDA of $1,634.3MM as of 6/30/2011 | ||
| Market Cap based on 301.3MM Shares Outstanding and a $41.41 Market Price as of 8/1/2011 | ||
| All figures are MM’s (except per share data) unless noted otherwise | ||
| - Cash and Equivalents | $1,325.0 | 0.8x |
| + Total Debt | $1,198.0 | 0.7x |
| + Preferred Equity | $0.0 | 0.0x |
| + Minority Interest | $80.8 | 0.0x |
| + Market Capitalization | $12,476.83 | 7.6x |
| Total Enterprise Value | $12,430.63 | 7.6x |
III. HISTORICAL OPERATING RESULTS
| 2006 | 2007 | 2008 | 2009 | 2010 | |
|---|---|---|---|---|---|
| All figures are MM’s (except per share data) unless noted otherwise | |||||
| Revenue | $6,255.1 | $6,772.3 | $6,355.1 | $5,951.8 | $6,168.3 |
| % Growth | n/a | 8.3% | -6.2% | -6.3% | 3.6% |
| Gross Profit | 3,867.9 | 4,244.7 | 3,836.6 | 3,565.8 | 3,822.3 |
| % Margin | 61.8% | 62.7% | 60.4% | 59.9% | 62.0% |
| EBITDA | 1,611.5 | 1,864.3 | 1,656.3 | 1,464.3 | 1,581.0 |
| % Margin | 25.8% | 27.5% | 26.1% | 24.6% | 25.6% |
| Net Income | 882.2 | 1,013.6 | 799.5 | 730.5 | 828.1 |
| % Margin | 14.1% | 15.0% | 12.6% | 12.3% | 13.4% |
| Weighted Avg Diluted Shares | 366.9 | 344.8 | 318.7 | 313.3 | 312.2 |
| % Growth | n/a | -6.0% | -7.6% | -1.7% | -0.3% |
Historically, McGraw-Hill has performed well right up until the financial meltdown starting in 2008 and continuing through 2009. The Company cycled fairly moderately in 2008 and 2009 with top line performance decreasing a little over 6% in each year. In 2010, MHP saw the beginning of a financial recovery with revenues expanding over 3%. The Company’s profitability (gross margin) has remained relatively constant expanding slightly from 61.8% in 2006 to 62.0% in 2010. EBITDA performance is a similar story with margins contracting slightly from 25.8% in 2006 to 25.6% in 2010 resulting in EBITDA compression from $1.612B to $1.581B (2% contraction).
| 2006 | 2007 | 2008 | 2009 | 2010 | |
|---|---|---|---|---|---|
| Per share data based on weighted average diluted shares outstanding | |||||
| Revenue | $17.05 | $19.64 | $19.94 | $19.00 | $19.76 |
| % Growth | n/a | 15.2% | 1.5% | -4.7% | 4.0% |
| Gross Profit | 10.54 | 12.31 | 12.04 | 11.38 | 12.24 |
| EBITDA | 4.39 | 5.41 | 5.20 | 4.67 | 5.06 |
| Net Income | 2.40 | 2.94 | 2.51 | 2.33 | 2.65 |
| Dividends | 0.73 | 0.82 | 0.88 | 0.90 | 0.94 |
| Payout Ratio | 30.2% | 27.9% | 35.1% | 38.6% | 35.4% |
| Dividend Growth | n/a | 12.9% | 7.3% | 2.3% | 4.4% |
McGraw-Hill has also been pursuing a share redemption program to offset the dilution caused by stock grants/awards to management. In excess of the shares awarded, the Company has redeemed shares sufficient to reduce the number of share outstanding from 367MM to 312MM in the past five years (a 15% reduction). Performance on a per share basis has swung from a slight contraction in EBITDA to a reasonable expansion due to the reduced number shares outstanding. EBITDA per share has grown from $4.39 to $5.06 (a 15% increase as compared to a 2% contraction at the company level). The Company’s dividends per share have been growing as well from $0.73 per share in 2006 to $0.94 in 2010 (29% increase) with a modest increase in the payout ratio from 30% to 35%.
IV. PROJECTIONS
| 2011 | 2012 | 2013 | 2014 | 2015 | |
|---|---|---|---|---|---|
| All figures are MM’s (except per share data) unless noted otherwise, Consensus Estimates only relate to EBITDA (provided by Capital IQ) all other assumptions are based on unadjusted LTM actuals | |||||
| EBITDA | $1,731.2 | $1,831.8 | $1,925.6 | $2,206.0 | $2,395.0 |
| % Growth | 9.5% | 5.8% | 5.1% | 14.6% | 8.6% |
| Interest Expense | 77.3 | 77.3 | 77.3 | 77.3 | 77.3 |
| Taxes | 532.3 | 564.8 | 595.2 | 686.0 | 747.1 |
| Capital Expenditures | 128.2 | 135.7 | 142.6 | 163.4 | 177.4 |
| Dividends | 301.3 | 301.3 | 301.3 | 301.3 | 301.3 |
| Addl’ FCF | $692.1 | $752.6 | $809.2 | $978.0 | $1,091.8 |
The consensus estimates for MHP are moderate/aggressive and achievable projecting the growth rate between 5% and 15% annually through 2015 at the EBITDA line. Under the consensus case the Company is projected to have significant additional free cash flow available to reinvest in the business, repurchase shares (always assumed for ease in modeling), or increase their dividend.
| 2011 | 2012 | 2013 | 2014 | 2015 | |
|---|---|---|---|---|---|
| All figures are MM’s (except per share data) unless noted otherwise; average share redemption price assumes 15% annual increase (compounded each year) in stock price for conservatism’s sake | |||||
| Addl’ FCF | $692.1 | $752.6 | $809.2 | $978.0 | $1,091.8 |
| Avg Share Redemption Price | $47.62 | $54.76 | $62.98 | $72.43 | $83.29 |
| Shares Redeemed | 14.5 | 13.7 | 12.8 | 13.5 | 13.1 |
| Wtd Avg Diluted Shares | 297.7 | 283.9 | 271.1 | 257.6 | 244.5 |
| Dividends Per Share | $1.01 | $1.06 | $1.11 | $1.17 | $1.23 |
| Dividend Growth | 7.7% | 4.8% | 4.7% | 5.2% | 5.4% |
The share redemptions are assumed to be at a 15% annually compounded price. I believe that this is structured very conservatively. If the weighted average redemption price exceeded this threshold, the investor would have ample opportunity and time to re-evaluate their position and consider selling off their position for a gain from today’s price. The Company’s share redemptions would allow for an increase of approximately 5% annually in the dividend by the share redemptions alone. Additionally, the Company’s payout ratio would decline as the dollar amount of dividends paid would not be increasing while the Company earnings (using EBITDA as a proxy) would be increasing.
If the Company performs inline with the consensus estimates and pays dividends / redeems shares as outlined above, the Company would achieve the IRR / Cash on Cash returns below based on the outlined Terminal EBITDA Multiples.
| Terminal EBITDA Multiple | ||||||
| 5.1x | 5.6x | 6.1x | 6.6x | 7.1x | 7.6x | |
|---|---|---|---|---|---|---|
| IRR | 6.3% | 8.5% | 10.5% | 12.5% | 14.3% | 16.4% |
| Cash on Cash | 1.30x | 1.42x | 1.54x | 1.65x | 1.77x | 1.92x |
| 2011 | 2012 | 2013 | 2014 | 2015 | |
|---|---|---|---|---|---|
| All figures are MM’s (except per share data) unless noted otherwise | |||||
| EBITDA | $1,581.0 | $1,581.0 | $1,581.0 | $1,581.0 | $1,581.0 |
| % Growth | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% |
| Interest Expense | 77.3 | 77.3 | 77.3 | 77.3 | 77.3 |
| Taxes | 483.6 | 483.6 | 483.6 | 483.6 | 483.6 |
| Capital Expenditures | 117.1 | 117.1 | 117.1 | 117.1 | 117.1 |
| Dividends | 301.3 | 301.3 | 301.3 | 301.3 | 301.3 |
| Addl’ FCF | $601.7 | $601.7 | $601.7 | $601.7 | $601.7 |
The flat case for the Company assumes that there is no growth in EBITDA over the next five years. Under this case the Company is projected to have a flat $602MM of additional free cash flow available to reinvest in the business, repurchase shares (always assumed for ease in modeling), or increase their dividend.
| 2011 | 2012 | 2013 | 2014 | 2015 | |
|---|---|---|---|---|---|
| All figures are MM’s (except per share data) unless noted otherwise; average share redemption price assumes 15% annual increase (compounded each year) in stock price for conservatism’s sake | |||||
| Addl’ FCF | $601.7 | $601.7 | $601.7 | $601.7 | $601.7 |
| Avg Share Redemption Price | $47.62 | $47.62 | $47.62 | $47.62 | $47.62 |
| Shares Redeemed | 12.6 | 12.6 | 12.6 | 12.6 | 12.6 |
| Wtd Avg Diluted Shares | 299.6 | 287.0 | 274.3 | 261.7 | 249.0 |
| Dividends Per Share | $1.01 | $1.05 | $1.10 | $1.15 | $1.21 |
| Dividend Growth | 7.0% | 4.4% | 4.6% | 4.8% | 5.1% |
The share redemptions are assumed to be at a 15% increased price to the Company’s current price. I believe that this is fairly conservative given that if there is no growth in the business, it is unlikely that the stock price would appreciate and if it did, an investor would have ample opportunity and time to re-evaluate their position and consider selling off their position for a gain from today’s price. The Company’s share redemptions would allow for an increase of approximately 4%-5% annually in the dividend by the share redemptions alone. Additionally, the Company’s payout ratio would not be increasing as the dollar amount of dividends and the Company earnings (using EBITDA as a proxy) would be flat.
If the Company performs flat to their current levels as outlined above, the Company would be able to achieve the IRR / Cash on Cash returns below based on the outlined Terminal EBITDA Multiples.
| Terminal EBITDA Multiple | ||||||
| 5.1x | 5.6x | 6.1x | 6.6x | 7.1x | 7.6x | |
|---|---|---|---|---|---|---|
| IRR | -3.2% | -1.2% | 0.6% | 2.3% | 4.0% | 6.1% |
| Cash on Cash | 0.87x | 0.95x | 1.03x | 1.10x | 1.18x | 1.29x |
| 2011 | 2012 | 2013 | 2014 | 2015 | |
|---|---|---|---|---|---|
| All figures are MM’s (except per share data) unless noted otherwise | |||||
| EBITDA | $1,533.6 | $1,487.6 | $1,443.0 | $1,399.7 | $1,357.7 |
| % Growth | -3.0% | -3.0% | -3.0% | -3.0% | -3.0% |
| Interest Expense | 77.3 | 77.3 | 77.3 | 77.3 | 77.3 |
| Taxes | 468.3 | 453.4 | 439.0 | 424.9 | 411.3 |
| Capital Expenditures | 113.6 | 110.2 | 106.9 | 103.7 | 100.6 |
| Dividends | 301.3 | 301.3 | 301.3 | 301.3 | 301.3 |
| Addl’ FCF | $573.1 | $545.4 | $518.5 | $492.4 | $467.2 |
The downside case for the Company assumes that there is a 3% annual decrease in EBITDA through 2015. Under this case the Company is projected to have $467MM of additional free cash flow available to reinvest in the business, repurchase shares (always assumed for ease in modeling), or increase their dividend at the end of 2015.
| 2011 | 2012 | 2013 | 2014 | 2015 | |
|---|---|---|---|---|---|
| All figures are MM’s (except per share data) unless noted otherwise; average share redemption price assumes a one-time 15% in stock price for conservatism’s sake | |||||
| Addl’ FCF | $573.1 | $545.4 | $518.5 | $492.4 | $467.2 |
| Avg Share Redemption Price | $47.62 | $47.62 | $47.62 | $47.62 | $47.62 |
| Shares Redeemed | 12.0 | 11.5 | 10.9 | 10.3 | 9.8 |
| Wtd Avg Diluted Shares | 300.2 | 288.7 | 277.8 | 267.5 | 257.7 |
| Dividends Per Share | $1.00 | $1.04 | $1.08 | $1.13 | $1.17 |
| Dividend Growth | 6.8% | 4.0% | 3.9% | 3.9% | 3.8% |
The share redemptions are assumed to be at a 15% increased price to the Company’s current price. I believe that this is fairly conservative given that if there is a contraction in the business, it is unlikely that the stock price would appreciate and if it did an investor would have ample opportunity and time to re-evaluate their position and consider selling off their position for a gain from today’s price. The Company’s share redemptions would allow for an increase of approximately 4% annually in the dividend by the share redemptions alone.
If the Company performs to their downside case as outlined above, the Company would be able to achieve the IRR / Cash on Cash returns below based on the outlined Terminal EBITDA Multiples.
| Terminal EBITDA Multiple | ||||||
| 5.1x | 5.6x | 6.1x | 6.6x | 7.1x | 7.6x | |
|---|---|---|---|---|---|---|
| IRR | -7.0% | -5.1% | -3.4% | -1.7% | -0.2% | 1.9% |
| Cash on Cash | 0.74x | 0.80x | 0.87x | 0.93x | 0.99x | 1.08x |
VI. CONCLUSION
BUY:
McGraw-Hill is a Buy given the Company’s 2.4% yield, a low payout ratio under 40% of earnings, a strong (albeit slowing) history of dividend growth, and a high IRR assuming an achievable consensus case with no expansion in the valuation multiple. I also feel that the Company’s ratings business has an opportunity to pick up in the near term and will face little competition from new entrants.