NEW YORK--(BUSINESS WIRE)--Fitch Ratings has maintained the Rating Watch Positive on the 'B+' Issuer Default Ratings (IDR) assigned to McGraw-Hill Global Education Holdings, LLC (MHGE), McGraw-Hill Global Education Finance, Inc. (MHGE Finance), MHGE Parent, LLC (HoldCo) and MHGE Parent Finance, Inc. (HoldCo Finance). MHGE, HoldCo and HoldCo Finance are all indirect wholly owned subsidiaries of McGraw-Hill Education, Inc. (MHE). Fitch is also withdrawing the ratings of McGraw-Hill School Education Holdings, LLC (MHSE) as associated issues were repaid in the first phase of the company's recapitalization. A full list of rating actions follows at the end of this release.
Fitch placed MHGE, HoldCo and HoldCo Finance on Rating Watch Positive on April 18, 2016 following the company's announcement it would undertake a recapitalization that would reduce debt, improve liquidity, diversify the company's operating and financial profile and strengthen the credit facilities' security package. The first phase of the recapitalization was completed on May 4, 2016 with the repayment of debt at MHGE and MHSE using proceeds from the issuance of new senior secured and unsecured debt. The second phase will involve MHE's previously announced IPO, which has not yet been completed.
Fitch would consider an upgrade if IPO proceeds are used to repay all existing HoldCo debt, which should result in Fitch-calculated funds from operations (FFO) adjusted total leverage declining below 4.5x. The recapitalization details include the expectation that MHE will use a portion of net proceeds from its IPO, announced in September 2015, to repay the senior unsecured notes issued by HoldCo and HoldCo Finance. Pro forma for the IPO and full repayment of the notes, FFO adjusted total leverage is expected to be 4.1x as of June 30, 2016.
Fitch could remove the Rating Watch Positive if the IPO does not occur before March 2017. If this occurs, Fitch expects to affirm the remaining ratings. The Rating Watch Positive would also be removed if the HoldCo notes are not repaid in an amount sufficient enough to reduce FFO adjusted total leverage below 4.5x. This could occur if MHE adjusts the expected uses of IPO proceeds or is unable to complete the IPO.
On May 4, 2016, MHE completed the first phase of its recapitalization with the refinance of all existing debt at both MHGE and MHSE using proceeds from new MHGE debt and cash on hand. The new debt is comprised of a $350 million senior secured revolver maturing in May 2021, a $1.6 billion senior secured term loan maturing in May 2022 and $400 million of senior unsecured notes maturing in May 2024. Additional use of proceeds included a $300 million cash dividend.
As part of the financing transactions, MHSE became a wholly owned subsidiary of MHGE and part of MHGE's security package. In addition, $400 million of secured debt at MHGE was replaced with unsecured debt. Fitch views these actions positively as they diversify MHGE's operating and financial profile while strengthening the credit facilities' security position.
Fitch expects to withdraw the IDRs and issuer ratings of HoldCo and HoldCo Finance once their senior unsecured notes have been repaid in full.
KEY RATING DRIVERS
Reorganization: With the repayment of its debt, MHSE became a subsidiary of MHGE, diversifying MHGE's operating and financial profile and contributing fresh collateral to the new credit facilities. MHGE's new business profile is as follows: approximately 40% of total billings are from higher education publishing/solutions, 39% from K-12 education content, 15% from international, which includes sales of higher education and professional education materials, and 6% from professional education content and services.
Defensible Market Shares: In the U.S. higher education publishing market, Fitch believes Pearson Education, Cengage Learning and MHGE collectively hold more than 75% market share. For the U.S. K-12 publishing market, Fitch believes Pearson Education, Houghton Mifflin Harcourt and MHSE collectively hold more than 80% market share. This scale provides meaningful advantages and creates barriers to entry for new publishers in both segments.
Long-term Digital Opportunity: Fitch believes the transition to digital will lead to a net benefit and expects MHE to continue investing in its digital products, including through small bolt-on acquisitions. Fitch expects print/digital margins to be roughly in line, as digital textbook price discounts (relative to print) and interactive user experience investments offset the elimination of the cost of manufacturing, warehousing and shipping printed textbooks. In addition, higher ed publishers will have the opportunity to disintermediate used/rental textbook sellers.
Education Spending Budgets: Fitch believes state and municipal revenues and education budgets will continue to improve at least through 2019 as a result of a strong adoption calendar, following several years of cyclical weakness. However, the potential for federal student aid cuts remain an issue for higher ed publishers. Long term, Fitch believes higher ed enrollment will continue to grow in the low single digits, as college degrees continue to be a necessity for many employers.
Fitch's Base Case Assumptions are pro forma for the transactions and include the operating results of MHSE Sub:
--Higher ed revenue is forecasted to grow low to mid-single digits annually as digital continues its positive growth trajectory driven by growing acceptance of adaptive learning solutions. School is expected to return to positive growth in 2017 with new adoption opportunities. Professional and International revenue is expected to grow by 2% and 3%, respectively.
--EBITDA margins are expected to grow driven by the continued implementation of cost savings that will more fully flow through the financial statements.
--Debt is repaid as required under amortization schedule, plus an additional $300 million of discretionary prepayments annually using excess cash flow.
--MHE's IPO proceeds are sufficient to repay HoldCo notes in 2017.
--No dividends or share repurchases are contemplated following the IPO.
Rating Upgrade: The Rating Watch will be resolved positively when MHE's planned IPO has been completed. Fitch will consider an upgrade if IPO proceeds are used to repay all existing HoldCo debt, which should result in Fitch-calculated FFO adjusted total leverage falling below 4.5x. Fitch may consider a multi notch upgrade if MHGE establishes a financial policy that results in a significant improvement in operating metrics, including FFO adjusted total leverage.
Rating Downgrade: The Rating Watch Positive could be removed if the IPO does not occur by March 2017. It would also be removed if the HoldCo notes are not repaid in an amount sufficient enough to reduce FFO adjusted total leverage below 4.5x. This could occur if MHE adjusts the expected use of IPO proceeds or is unable to complete the IPO.
As of June 30, 2016, MHGE had $96 million in cash and $290 million available under its $350 million revolver due 2021. Fitch-calculated FFO adjusted total leverage was 5.0x. Fitch's focus on FFO adjusted total leverage is driven by the contribution of MHSE into MHGE with the debt refinancing and the resultant increase in MHGE's exposure to deferred digital revenues. The calculation is in line with how Fitch calculates leverage across the El-Hi industry, with the change in deferred revenue included in the calculation of FFO to account for GAAP-driven revenue timing differentials. As digital revenues continue increasing, revenues realized in a given year will eventually match revenues recognized in that year, although Fitch does not expect that to occur within the rating horizon.
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 $1.63 billion, using a 6x multiple and a post restructuring EBITDA of approximately $273 million. After deducting Fitch's standard 10% administrative claim, Fitch estimates recovery for the senior secured instruments consisting of new senior secured instruments of 76%, which maps to the low end of its 71%-90% 'RR2' range. The HoldCo notes and new senior secured notes have no expected recovery, resulting in an 'RR6' rating.
FULL LIST OF RATING ACTIONS
Fitch has maintained the Rating Watch Positive on the following ratings:
McGraw-Hill Global Education Holdings, LLC (MHGE)
--Long-Term IDR 'B+';
--Senior secured credit facility 'BB/RR2';
--Senior unsecured notes 'B-/RR6'.
McGraw-Hill Global Education Finance, Inc. (MHGE Finance; co-issuer on MHGE's senior notes)
--Long-Term IDR 'B+';
--Senior unsecured notes 'B-/RR6'.
MHGE Parent, LLC (HoldCo)
--Long-Term IDR at 'B+';
--Senior unsecured notes 'B-/RR6'.
MHGE Parent Finance, Inc. (HoldCo Finance; co-issuer to HoldCo's senior unsecured notes)
--Long-Term IDR 'B+';
--Senior unsecured notes 'B-/RR6'.
Fitch has affirmed with a Stable Outlook and withdrawn the following ratings:
McGraw-Hill School Education Holdings, LLC (MHSE)
--IDR at 'B';
--Senior secured credit facility at 'BB/RR1'.
Date of Relevant Rating Committee: Oct. 14, 2016.
Additional information is available on www.fitchratings.com.
Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:
--Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation. In addition, pre-publication costs are netted from EBITDA calculations.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 05 Apr 2016)
Dodd-Frank Rating Information Disclosure Form
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