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.
KEY ASSUMPTIONS
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 SENSITIVITIES
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.
LIQUIDITY
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.
Applicable Criteria
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
https://www.fitchratings.com/site/re/885629
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 05 Apr 2016)
https://www.fitchratings.com/site/re/879564
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013251
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013251
Endorsement Policy
https://www.fitchratings.com/regulatory
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.
Copyright © 2016 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch's factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch's ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.
The information in this report is provided "as is" without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.
For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001