AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'B+' Issuer Default Ratings (IDRs) of Houghton Mifflin Harcourt Publishers Inc. (HMH) and its subsidiaries. Fitch has also affirmed HMH's senior secured term loan at 'BB+/RR1'. The Rating Outlook is Stable. The affirmation reflects HMH's announced acquisition of Scholastic Corp.'s Educational Technology and Services (EdTech) business for $575 million in cash, HMH's upsized term loan, and an increase in share repurchase authorization. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
HMH announced that they had entered into an agreement to purchase the assets of the EdTech business for $575 million in cash, subject to regular working capital adjustments. The transaction is expected to close in the second quarter, and there is a $28.8 million termination fee payable to the seller under certain circumstances. Fitch believes the acquisition fits within HMH's operational and capital allocation strategies. The EdTech business focuses on intervention technologies, with READ 180 as its strongest offering.
Fitch's rating has consistently incorporated its belief that HMH's prior capital structure was not permanent, and that the company would increase leverage to fund an acquisition or capital returns.
HMH will fund a portion of the acquisition with proceeds from a new $500 million 6 year senior secured term loan. Fitch expects to rate the new term loan at the same rating as the current term loan. On April 23, HMH entered into an amendment to its revolver, allowing for aggregate indebtedness up to $500 million under the term loan (approximately $259 million in incremental debt from fiscal year end (FYE) 2014). Concurrently, HMH announced that its board had approved an incremental $100 million share repurchase, bringing the total authorization to $200 million.
HMH expects $10 million-$20 million in annual cost synergies (starting in 2016), $10 million-$20 million in transaction costs in 2015, and $200 million in tax savings over 10-15 years. During the LTM period ended Feb. 28, 2015, the EdTech business generated $232 million in revenues and $23.9 million of operating income. Fitch believes HMH can leverage EdTech's products across its larger salesforce to generate growth.
Strength in HMH's billings for FY2014, up 16%, drove a $229 million increase in deferred revenue, resulting in free cash flow (FCF) of $308 million for the year. Pro forma for the incremental debt and purchase price, Fitch calculates cash of approximately $138 million, providing for sufficient liquidity to fund the share repurchases over the next two years, within the context of the current rating.
HMH continues to be a leader in the K-12 educational material and services sector. Fitch believes investments made into digital products and services will position HMH to take a meaningful share of the rebound in the K-12 educational market. Fitch expects HMH will be able to, at a minimum, maintain its market share. Fitch's base case model assumes flat-to-up net revenue growth driven by new adoptions, and offset by increases in deferred revenue as digital sales become a larger proportion of the sales mix.
HMH continues to have financial flexibility to invest into digital content and new business initiatives. These investments into international markets and adjacent K-12 educational material markets may provide diversity away from highly cyclical state and local budgets.
Leverage and Liquidity
Fitch calculates pro forma post-plate unadjusted gross leverage of 2.9x (up from 1.7x at FYE 2014) and pro forma post-plate adjusted gross leverage of 3.2x (Pro forma liquidity is supported by approximately $140 million in cash and cash equivalents and $220 million in borrowing availability under the $250 million asset-backed revolver, due 2017. HMH also had $287 million in short-term investments as of FYE 2014.
Fitch calculates FCF of $308 million for 2014. Fitch expects HMH to continue to deploy cash (organically and through acquisitions) towards share repurchase, digital investments and adjacent K-12 educational material markets.
The Recovery Rating analysis reflects a restructuring scenario (going-concern) and an adjusted, distressed enterprise valuation of $1.4 billion using a 6x multiple. Given the strong recovery prospects, the $500 million senior secured term loan and the $250 million asset-backed credit facility are notched up to 'BB+/RR1'.
KEY ASSUMPTIONS
--Flat to slightly up GAAP revenues,
--Potential leveraging transactions to fund acquisitions or capital returns,
--Continued increase is the mix of digital sales.
RATING SENSITIVITIES
Negative Rating Actions: Revenue declines in the mid- to high-single digits and/or consistent negative FCF generation (which would be contrary to Fitch's expectations), and/or a leveraging return of capital to shareholders that increased leverage over the 4.0x-4.5x range (with some tolerance above that range for a leveraging strategic acquisition with a credible plan to delever) could result in rating pressures.
Positive Rating Actions: Long-term, meaningful diversification into international markets and into new business initiatives could lead to positive rating actions. Also, positive rating actions may be considered if a clear financial policy that is commensurate with a higher rating is communicated, which could include leverage below 3.5x and strategy around shareholder policy in terms of dividends and share buybacks.
Fitch has affirmed the following ratings:
HMH
--IDR at 'B+';
--Senior secured term loan at 'BB+/RR1';
--Senior secured asset backed revolver at 'BB+/RR1'.
Houghton Mifflin Harcourt Publishing Company
--IDR at 'B+'.
HMH Publishers LLC
--IDR at 'B+'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria & Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);
--'Credit Encyclo-Media: Fitch's Comprehensive Analysis of the U.S. Media & Entertainment Sector (Volume VII, 2014-2015)' (Oct. 2, 2014);
--'Media and Entertainment Handbook (Fitch's Comprehensive Credit Profile Analysis of Issuers within the Media & Entertainment Sector)' (Oct. 2, 2014).
Applicable Criteria and Related Research:
Media and Entertainment Handbook (Fitch's Comprehensive Credit Profile Analysis of Issuers within the Media & Entertainment Sector)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=787689
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=983712
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