PSO Pearson Plc

The McGraw-Hill Companies Inc. (MHP), a publisher and provider of financial information and media services, recently posted soft third-quarter 2011 results. The quarterly earnings of $1.21 a share missed the Zacks Consensus Estimate by couple of cents, and remained flat from the prior-year quarter’s earnings.

McGraw-Hill now expects to achieve earnings in the range of $2.81 to $2.86 in fiscal 2011 from its earlier earnings guidance range of $2.79 to $2.89 per share.

McGraw-Hill’s total revenue of $1908 million fell short of the Zacks Consensus Estimate of $2,041 million, and shrinked 2.5% from the prior-year quarter.

Sluggishness in global credit market and lower state new adoption sales dragged down the revenues at Standard & Poor's and McGraw-Hill Education, respectively. However, the revenue decline was offset by healthy performance across McGraw-Hill Financial and Information & Media segment.

Segment Details

McGraw-Hill Financial segment revenue grew 18.4% to $348.5 million, driven by an increase of 15.6% in subscription revenue to $251.8 million and 26.4% in non-subscription revenue to $96.7 million. Excluding, the acquisition of TheMarkets.com, revenue jumped 14.6% to $336.2 million.

The acquisition of TheMarkets.com by Capital IQ strengthened its position in the highly competitive financial data provider sector. The acquisition facilitates Capital IQ to provide a comprehensive research package to its buy-side clients, which not only include fundamental and quantitative research as well as analysis solutions but also cover equity and market research reports and earnings estimates with valuation models from leading brokers.

Capital IQ had a client base of over 3,800 at the end of the quarter, reflecting a growth of 17.7% from the prior-year.

The company also witnessed increase in the number of exchange-traded funds (ETFs) on S&P indices, which currently stands at 359, portraying a recovery in the worldwide market and fresh investments from investors. McGraw-Hill launched 11 new ETFs during the quarter under review.

Standard & Poor’s (S&P’s) segment revenue climbed 1.8% to $409.9 million during the quarter. Transaction revenue, which includes ratings of publicly issued debt and bank loan, and corporate credit estimates, came down 19.5% to $131.2 million, whereas non-transaction revenue, which includes annual contracts, surveillance fees and subscriptions, grew 9.5% to $278.7 million.

The European sovereign crisis, increasing credit spreads and waning economy dented S&P’s transaction revenue. On the contrary, McGraw-Hill notified that increase in new corporate credits under surveillance and revenue gains at its non-issue based analytical services and at CRISIL benefited the non-transaction revenue.

The Education segment experienced a drop of 11.1% in revenue to $937.3 million, reflecting revenue decline of 21.4% to $420.4 million at McGraw-Hill School Education Group. While, McGraw-Hill Higher Education, Professional and International Group’s revenue remained approximately flat at $516.9 million.

The higher education and professional market witnessed strong double-digit growth rate across digital products and services, and the increase in demand for online study tools (e.g. McGraw-Hill Connect series, McGraw-Hill Create).

Information & Media segment revenue rose 11.9% to $228.5 million driven by a 25% increase in Platts’ revenue. The company stated that the reported quarter reflects the reclassification of the Broadcasting Group as discontinued operation.

McGraw-Hill has decided to dispose its Broadcasting Group with an aim to re-evaluate its portfolio of businesses and concentrate more on global brands, and thereby enhance shareholder value through proper capital allocation. The company entered into $212 million cash conformity with The E. W. Scripps Company (SSP) on October 3, 2011 to sell its Broadcasting arm.

McGraw-Hill added that it expects to close the deal in 2012.

Unlocking the Value

With the intent of boosting the shareholders value McGraw-Hill announced extensive growth and value measures, including the separation of the company into two independent companies, McGraw-Hill Markets and McGraw-Hill Education.

Since last year, the company has been reviewing its business segments as the company lost a substantial market value in last 5 years and its rating agency was under fire for its latest U.S.downgrade.

Moreover, the New York-based hedge fund Jana Partners and the Ontario Teachers' Pension Plan, holding approximately 5.2% joint stake in the company, were pushing McGraw-Hill to split into four separate companies.

Going with its plan, the company aims to create two "focused companies”  with optimal-size capital and cost arrangement for amplifying client commitment and improving strategic and economic suppleness while increasing management’s focus and responsibility.

Further, the company added that it will focus on abridging costs by $100 million in coming 15 months to ensure competent operating channels and will also accelerate the pace of share buybacks to a total of $1 billion for the fiscal year 2011.

McGraw-Hill expects to complete the transaction by the end of 2012 through a tax-free spin-off while the separation plan is subject to the approval by the board of directors.

McGraw-Hill added that it has engaged The Goldman Sachs Group Inc. (GS) and Evercore Partners Inc. (EVR) as the financial advisors to guide the company during the evaluation period.

Financial Aspects

McGraw-Hill ended the quarter with cash and cash equivalents of $1,437.6 million, long-term debt of $1,198 million, and shareholders’ equity of $2,288.1 million. The company incurred capital expenditures of $69.6 million and generated free cash flow of $627.3 million during nine-month period.

During the quarter under review, McGraw-Hill repurchased 9.0 million shares for $355 million. Year-to-date, the company repurchased 16.7 million shares for approximately $655 million. The company plans to purchase the remaining of $1billion shares in the fourth quarter of 2011.

Currently, we have a long-term Neutral rating on McGraw-Hill, which competes with Pearson plc (PSO). Moreover, the company holds a Zacks #3 Rank, which translates into a short-term Hold recommendation.

 
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