Fitch Affirms McGraw-Hill Global Education's IDR at 'B+'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the Issuer Default Ratings (IDR) of McGraw-Hill Global Education Holding LLC (MHGE) and McGraw-Hill Global Education Finance, Inc. (MHGE Finance) at 'B+', and the senior secured debt ratings at 'BB/RR2'. Fitch has also affirmed the IDRs of MHGE Parent, LLC (HoldCo) and MHGE Parent Finance, Inc. at 'B+', and the senior unsecured debt rating at 'B-/RR6'. The Rating Outlook is Stable. A full list of rating actions can be found at the end of this release.

On Sept. 4, 2015, McGraw-Hill Education Inc. (MHEI), the indirect parent of MHGE, filed an S-1 for a proposed initial public offering. The company expects to use IPO net proceeds to repay debt and for general corporate purposes. Fitch would consider a positive rating action if MHGE or HoldCo debt is repaid.

KEY RATING DRIVERS

The ratings reflect MHGE's business profile: 66% of fiscal year (FY) 2015 cash revenues from higher education publishing/solutions, 10% from professional education content and services, and 25% from international, which includes sales of higher education and professional education materials. The higher education publishing market is dominated by Pearson, Cengage and MHGE. Fitch believes that collectively these three publishers make up approximately 75% market share. This scale provides meaningful advantages to these three publishers and creates barriers to entry for new publishers.

Fitch believes there could be some near-term enrollment pressures due to continued enrollment declines at for-profit universities and the potential for federal student aid cuts. Long term, Fitch believes enrollment will continue to grow in the low single digits, as higher education degrees continue to be a necessity for many employers.

MHGE and its peers have continued to demonstrate pricing power over their products. Fitch believes this will continue, albeit at lower levels than historically. Textbook price increases are expected to materially slow and will likely be in the low single digits. Cash revenue growth will primarily come from the continued growth in volume of digital solution products sold and pricing increases associated with these digital products as they gain traction with professors.

The transition from physical education materials to digital products has been advancing at a materially faster pace relative to the K-12 education level. Fitch believes the transition will lead to a net benefit for the publishers over time. Within the Higher Ed segment, for the year ended Dec. 31, 2015, digital adjusted cash revenues grew 16%, which offset print adjusted cash revenue declines of 13%. Publishers have the opportunity to disintermediate used/rental textbook sellers as revision cycles are extended and updates can be made every semester. Fitch expects print/digital margins to remain roughly the same, as both the discount of the digital textbook (relative to the print textbook) and the investments made in the interactive user experience offset the elimination of the cost associated with manufacturing, warehousing, and shipping printed textbooks.

Fitch recognizes the risk of digital piracy, given higher education's age demographic, current Internet data speeds, and the relative ease of finding a pirated text book. A mitigant to this risk involves the distribution of digital education solutions that incorporate homework and other supplemental materials and require a user's authentication. The industry's strategy is to 'sell' these materials, referred to as integrated digital learning solutions, to the professors who adopt them as required course materials, thereby requiring students to purchase the digital solution instead of just the eBook. It will be vital for the industry to continue to steer professors towards these digital solutions rather than stand-alone eBooks in order to defend against piracy. Fitch believes this strategy is sound and can be successful.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

Higher Ed revenue is forecasted to grow 2.5% annually as digital continues its positive growth trajectory driven by growing acceptance of adaptive learning processes, while professional and International revenue is expected to grow by 2% and 3%. EBITDA margins are expected to grow driven by the continued implementation of cost savings that will more fully flow through the financial statements. Annual free cash flow (FCF) is expected to be in the range of $100 million to $150 million.

RATING SENSITIVITIES

Positive: Continued growth in digital cash revenues coupled with a financial policy that may include Fitch-calculated post-plate leverage of 4x or less, along with a clear rationale for such a policy, would likely lead to positive rating actions. Fitch would also consider a positive rating action if a sizeable amount of MHGE or HoldCo debt is repaid with IPO proceeds.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include: Annual Fitch-calculated FCF of less than $50 million; gross Fitch-calculated post-plate leverage exceeding 6x on a sustained basis, whether driven by operating results or a leveraging transaction; and mid-single-digit cash revenue declines, which may be driven by declines or no growth in digital products (caused by a lack of execution or adoption by professors).

LIQUIDITY

As of Dec. 31, 2015, the company had $311 million in cash and an undrawn $240 million revolver due 2018. Fitch calculates FY 2015 FCF of $128 million and expects FCF to remain healthy, exceeding $150 million over the rating horizon. Fitch also expects EBITDA-to-FCF conversion to continue to exceed 25% annually (38% at Dec. 31, 2015). The ratings reflect Fitch's expectation that FCF will be dedicated towards debt reduction at MHGE and to acquisitions. Fitch believes most acquisitions will be small tuck-in acquisitions.

Fitch calculates post plate EBITDA of $337 million as of Dec. 31, 2015, resulting in pro forma gross leverage of 5.7x (pro forma for the $72.5 million term loan prepayment to be made in April 2016). Fitch post plate EBITDA does not add back certain adjustments made by the company, including adjusting for deferred cash revenue and expected cost savings. Fitch expects leverage to continue to decline for the rating horizon.

MHGE's credit facility and senior secured notes are pari passu and benefit from a first priority lien on all material assets, including a pledge of the equity of domestic guarantor subsidiaries and 65% of the voting equity interest of first-tier foreign subsidiaries, subject to certain exceptions.

MHGE's credit facility is further secured by a pledge of the equity interest of MHGE held by its parent McGraw-Hill Global Education Intermediate Holding LLC (Holdings). While the secured notes do not benefit from the pledge of MHGE's equity by Holdings, Fitch believes the value of the security comes from the assets of MHGE and its subsidiaries (including the equity pledge of MHGE's subsidiaries).

MHGE's Recovery Ratings reflect Fitch's expectation that the enterprise value of the company and, thus, recovery rates for its creditors, will be maximized in a restructuring scenario (as a going concern) rather than a liquidation. Fitch estimates a distressed enterprise valuation of $1.6 billion, using a 6.0x multiple and a post-restructuring EBITDA of approximately $270 million. After deducting Fitch's standard 10% administrative claim, Fitch estimates recovery for MHGE's senior secured instruments of 88%, which maps to the 71%-90% 'RR2' range. The MHGE Parent notes have no expected recovery, resulting in an 'RR6' and a rating two notches down from the IDR to 'B-'.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

MHGE

--Long-term IDR at 'B+';

--Senior secured credit facility (term loan and revolver) at 'BB/RR2';

--Senior secured notes at 'BB/RR2'.

MHGE Finance (co-issuer to MHGE's secured term loan, revolver and notes listed above)

--Long-term IDR at 'B+';

--Senior secured credit facility (term loan and revolver) at 'BB/RR2';

--Senior secured notes at 'BB/RR2'.

MHGE Parent

--Long-term IDR at 'B+';

--Senior unsecured notes at 'B-/RR6'.

MHGE Parent Finance, Inc. (co-issuer to MHGE Parent's senior unsecured notes)

--Long-term IDR at 'B+';

--Senior unsecured notes at 'B-/RR6'.

The Rating Outlook is Stable.

Date of Relevant Rating Committee: March 29, 2016.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

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Contacts

Fitch Ratings
Primary Analyst
Jack Kranefuss
Senior Director
+1-212-908-0791
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Rachael Shanker
+1-212-908-0649
or
Committee Chairperson
David Peterson
Senior Director
+1-312-368-3177
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
Email: alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jack Kranefuss
Senior Director
+1-212-908-0791
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Rachael Shanker
+1-212-908-0649
or
Committee Chairperson
David Peterson
Senior Director
+1-312-368-3177
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
Email: alyssa.castelli@fitchratings.com