Proceeds from the note issuance will be used to pay a dividend to Apollo Global Management (Apollo), the sponsor. Funds affiliated with Apollo acquired McGraw-Hill Companies Inc.s' education business for
While Fitch did not previously model the proposed debt-funded dividend, the transaction is consistent with Fitch's expectations for private-equity-owned issuers. Following the proposed transaction, there is limited- to-no head-room within the current ratings for additional leveraging transactions.
MHGE's operating results have performed in line with Fitch expectations. As of
Fitch views the credit on a consolidated basis, since MHGE Parent has no operations and its only material asset is the indirect equity interest in MHGE. MHGE will be the primary source of funds to service MHGE Parent's debt. Pro forma for this transaction, Fitch calculates consolidated post-plate leverage to be 6.1x, up from 4.8x at
Fitch expects consolidated leverage to decline over the next few years, driven by EBITDA growth (supported by low single-digit revenue growth and the benefits from efficiencies/cost reduction initiatives) and mandatory debt reduction at MHGE. Fitch expects gross leverage (based on Fitch's calculation) to be under 6x by year-end 2014. Any future leveraging transactions that drove Fitch calculated gross leverage to over 6x would pressure the ratings.
MHGE Parent's new senior unsecured notes are not guaranteed by MHGE or any of its subsidiaries (MHGE's debt benefits from subsidiary guarantees), and are structurally subordinated to MHGE's debt. The notes contain a contingent pay-in-kind (PIK) option. The PIK may be exercised in the event that there is not sufficient cash available to MHGE Parent to cover interest payments (except for the first and last interest payment).
Fitch notes that the PIK feature provides flexibility for the company in the event of weak cash flows. Cash flows to fund interest will be governed by the restricted payment (RP) covenants within the MHGE secured debt documents. However, based on Fitch's base case projection, there is sufficient liquidity and room within the RP basket to fund cash interest payments on the MHGE Parent notes. The MHGE RP basket provisions within the bond indentures include a cumulative 50% of net income basket (which includes various adjustments) and a general RP basket of
KEY RATING DRIVERS
The ratings reflect MHGE's business profile: 63% of revenues from higher education publishing/solutions, 10% of revenues from professional education content and services, and 27% from international 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 that 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 pricing increases are expected to materially slow down and will likely be in the low single digits. 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 adoption at the K-12 education level. Fitch believes that the transition will lead to a net benefit for the publishers over time. Publishers will have the opportunity to dis-intermediate used/rental textbook sellers, recapturing market share from these segments. 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 the age demographic of higher education, the current data speeds available on the internet, and the relative ease of finding a pirated text book. A mitigant to piracy risk is the development and selling of digital education solutions. The digital solutions incorporate homework and other supplemental materials that require a user's authentication. The company's strategy is to 'sell' these products to the professors, who then adopt this as required material for the course. Students then purchase the digital solution. This strategy has also been adopted by MHGE's peers. It will be vital for the industry to steer professors towards these digital solutions rather than a stand-alone eBook in order to defend against piracy. Fitch believes that this strategy is sound and can be successful. Fitch notes that adoption will be slow due to the slow to change nature of many professors.
Fitch expects traditional print revenues to continue to decline due to growth in eBooks, near-term cyclical pressures in enrollment, and delays by professors in adopting new editions.
The ratings reflect cost savings identified by MHGE, approximately
LIQUIDITY, FCF AND LEVERAGE
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.
As of LTM ended
MHGE's credit facility and its senior secured notes are pari passu with one another 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
Both the bank facility and the secured notes are guaranteed by existing and future wholly-owned domestic subsidiaries of MHGE (subject to certain exceptions).
RECOVERY RATINGS ANALYSIS
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
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Continued growth in digital revenues coupled with a financial policy that may include leverage of 4x or less (on Fitch-calculated basis), along with a clear rationale for such a policy, would likely lead to positive rating actions.
Negative: Future developments that may, individually or collectively, lead to a negative rating action:
--In the near term, further leveraging transactions;
--Annual Fitch calculated FCF of less than
--Gross post-plate leverage exceeding 6x, whether driven by operating results or a leveraging transaction;
--Mid-single-digit revenue declines, which may be driven by declines or no growth in digital products (caused by a lack of execution or adoption by professors).
Fitch has taken the following rating actions:
--Long-term IDR affirmed at 'B+';
--Senior secured credit facility (term loan and revolver) affirmed at 'BB/RR2';
--Senior secured notes affirmed at 'BB/RR2'.
MHGE Finance (co-issuer to MHGE's secured term loan, revolver and notes listed above)
--Long-term IDR affirmed at 'B+';
--Long-term IDR assigned at 'B+';
--Senior unsecured notes assigned at 'B-/RR6';
--Long-term IDR assigned at 'B+'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Source: Fitch Ratings
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