New York, August 17, 2020 — Moody’s Investors Service, (“Moody’s”) downgraded McGraw Hill LLC’s (“McGraw”) ratings, including its Corporate Family Rating (CFR) to Caa2 from B3 and changed the outlook to negative from stable.
The downgrades and the change in outlook to negative reflect Moody’s view that the company’s operating challenges stemming from the continued secular pressure in the higher education market will be further exacerbated by the significant uncertainty around enrollment levels amid the coronavirus pandemic. Moody’s believes that the earnings deterioration will make it difficult for the company to materially reduce its high leverage and address its significant $2.1 billion of 2021/2022 maturities (including revolver), thereby elevating default risk. Given near-term maturities, the expectation of high leverage, and negative pressure on earnings, sustainability of the capital structure has become a greater concern, including the likelihood of a distressed debt exchange.
The company’s $350 million revolver (undrawn as of March 31, 2020) is now current, expiring in May 2021. McGraw’s $1.6 billion term loan’s and MHGE Parent, LLC’s $180 million term loan (unrated) mature in May 2022 and April 2022, respectively. In addition, $100 million out of $150 million McGraw’s ABL revolver expires in September 2020 and the remainder in October 2021.
…. Probability of Default Rating, Downgraded to Caa2-PD from B3-PD
…. Corporate Family Rating, Downgraded to Caa2 from B3
….Senior Secured Bank Credit Facility, Downgraded to Caa1 (LGD3) from B2 (LGD3)
….Senior Unsecured Regular Bond/Debenture, Downgraded to Caa3 (LGD5) from Caa2 (LGD5)
McGraw’s Caa2 CFR reflects the company’s persistently high financial leverage, its debt-heavy capital structure that Moody’s deems unsustainable, and Moody’s expectation the revenue and free cash flow will decline further amid the coronavirus pandemic. It also reflects continued secular pressure within the company’s higher education segment, including affordability-driven price compression, intensely competitive markets, rental and used textbooks and open educational resources. McGraw Hill’s K-12 school business is exposed to pricing pressure and adoption cycles of its end markets. Moody’s expects that the company’s FY2021 revenue will decline, pressured by the reduced enrollments/attendance in the higher education and international segments, budgetary constraints and the likely deferrals of purchasing decisions in the company’s K-12 segment, and the overall climate of increased unemployment and decreased household incomes favoring lower-priced learning products. Assuming a decline in earnings in the mid-teen range and a heavy debt burden, Moody’s projects that the company’s debt-to-cash-EBITDA, which was 6.3x (including Moody’s standard adjustments and cash pre-publication costs as an expense) as of FYE 3/31/20, will increase closer to mid 8x (Moody’s adjusted) over the next 12-18 months.
McGraw’s rating continues to garner support from its strong brand, good market position, longstanding relationships with education institutions, proprietary content developed through long-term exclusive relationships with leading authors and broad range of product offerings in higher education publishing. The company’s emerging digital platforms position it favorably to expand its product offerings within the education market, as remote learning is expected to grow significantly through the next academic year. The company currently generates more than 50% of its revenue from digital solutions, with higher education revenue being more than 75% digital. McGraw continues to experience material growth in its Inclusive Access offering.
The negative rating outlook reflects the elevated risk of default unless the company can refinance debt maturities on commercially viable terms, ensure uninterrupted access to a revolving line of credit and reverse its weak operating performance.
The key social risks in the education publishing sector lies in evolving demographic and societal trends, particularly in the way students choose to study. As affordability of textbooks and learning materials are increasingly important to students and higher education institutions, less expensive alternatives to print textbooks emerged. This social trend has resulted in a precipitous decline in average spend per student on learning materials. Publishers, including McGraw, are responding by growing digital offerings that provide extra value to students.
The coronavirus outbreak is accelerating the transformational social changes impacting McGraw and its peers. The spread of the coronavirus outbreak, deteriorating global economic outlook, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The media/publishing has been one of the sectors most significantly affected by the shock given its sensitivity to consumer demand and sentiment. More specifically, the weaknesses in McGraw’s credit profile have left it vulnerable to shifts in market sentiment in these unprecedented operating conditions and the company remains vulnerable to the outbreak continuing to spread. The coronavirus outbreak has placed an increased level of uncertainty regarding future enrollment and financial performance of courseware publishers, as current social distancing measures have moved many physical learning operations to online in the education sector. The timing and format of reopening of learning institutions remains uncertain, as different jurisdictions evaluate potential public health implications of reopening. The closure of physical facilities has led to an accelerated transition to various forms of remote learning and to a broader adoption of digital courseware. Moody’s regards the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety.
Moody’s views McGraw’s financial strategy as aggressive. The company has historically raised debt to fund shareholder returns, while increasing leverage in a highly cyclical industry.
LIQUIDITY AND STRUCTURAL CONSIDERATIONS
McGraw currently has adequate liquidity, supported by its sizable cash balance (approximately $179 million available as of May 31, 2020) but the reduction in the ABL commitment to $50 million (unless extended) next month from $150 million currently, $350 million undrawn revolver expiration in May 2021, anticipated pressures on receivable collections during the coronavirus outbreak and the expectation of diminished internally generated cash flow will strain the company’s liquidity. Moody’s projects that the company’s cash on hand and internally generated cash flow will be sufficient to fund the company’s highly seasonal cash flow and the 1% required annual term loan amortization, but not the 2021/2022 debt maturities. The term loan does not have financial covenants and revolver has a springing net leverage covenant, to be tested at 30% or greater draw. Moody’s estimated the company will have adequate cushion over the covenant requirement should the covenant be tested.
The $2 billion Senior Secured Credit facilities benefit from the subordination of $400 million Senior Unsecured Notes and $180 million MHGE Parent, LLC (HoldCo) Term Loan (unrated), resulting in a 1-notch tranche uplift from CFR to Caa1 instrument rating. The $400 million Senior Unsecured Notes are rated Caa3, due to their subordination to the Senior Secured Credit Facilities, but ranking in higher priority to $180 million HoldCo Term Loan.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Heightened near-term risk of default including through distressed exchange transactions, or a reduction in the recovery assumption could lead to further downgrades. McGraw’s ratings could also be downgraded if the company is unable to make de-leveraging progress or generate and sustain positive free cash flow. A weakening of liquidity would also pressure the company’s ratings including through such factors as significant revolver usage, weaker or negative free cash flow, or erosion of the covenant cushion.
An upgrade or a shift to a stable rating outlook is unlikely unless the company is able to proactively address its 2021/2022 debt maturities at commercially viable terms. If that were to occur, McGraw could be upgraded if good operating execution leads to revenue and earnings growth, consistent free cash flow generation and reduced leverage or the company de-levers through asset sales, an equity offering or acquisitions such debt-to-cash EBITDA is sustained under 7x (including Moody’s standard adjustments and cash prepublication costs as an expense)
The principal methodology used in these ratings was Media Industry published in June 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1077538. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
McGraw Hill LLC is a global provider of educational materials and learning services targeting the higher education, K-12, professional learning and information markets with content, tools and services delivered via digital, print and hybrid offerings. McGraw Hill LLC revenue for the fiscal year ended March 31, 2020 was $1.6 billion.
For further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
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These ratings are solicited. Please refer to Moody’s Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
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Dilara Sukhov, CFA Asst Vice President - Analyst Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Lenny J. Ajzenman Associate Managing Director Corporate Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653
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