|[December 03, 2013]
Fitch Rates McGraw-Hill School Education Initial IDR 'B' and Term Loans 'BB/RR1'
NEW YORK --(Business Wire)--
Fitch Ratings has assigned an initial Issuer Default Rating (IDR) of 'B'
for McGraw-Hill School Education Holdings, LLC (MHSE) and assigned a
'BB/RR1' rating to the proposed senior secured term loans. The Rating
Outlook is Stable. MHSE is the K-12 educational content and test
assessment business of McGraw-Hill Education (MHE). A complete list of
ratings follows at the end of this release.
Proceeds of the term loans, along with cash on the balance sheet, will
be used to fund a $395 million dividend to the shareholders and cover
transaction costs. Funds affiliated with Apollo Global Management
(Apollo) acquired MHE for $2.4 billion in March of 2013. Apollo
contributed $1 billion in cash to complete the acquisition,
approximately 40% of the transaction value. The dividend would reduce
the overall equity outlay by Apollo to approximately 25% (based on the
$2.4 billion transaction value). The ratings reflect Fitch's belief that
the current capital structure is not permanent and over the long term
MHSE would carry higher levels of debt on its balance sheet, which may
be used for further equity returns or acquisitions. However, Fitch does
not expect additional leveraging transactions in the near to mid-term.
The term loans will benefit from a first priority lien on all non-ABL
collateral assets and have a second lien on the ABL collateral assets.
Between the two collateral groups, materially all the assets of MHSE
secure the term loans and the $150 million ABL facility in either a
first lien or second lien position. The term loans will also be
guaranteed by the same subsidiaries that guarantee the ABL facility. The
guarantors are the domestic wholly-owned subsidiaries of MHSE, which
make up a material portion of the company's operations. McGraw-Hill
School Education Intermediate Holdings will also provide a guarantee.
The term loans will amortize 1% per annum and mature in six years. There
is no mandatory excess cash flow sweep. MHSE expects to have an
uncommitted option to increase the term loans by $75 million and may
increase the term loans for a higher amount, limited by a Net First Lien
Leverage ratio of 2.5x for parity debt and a 4x limit for term loans
junior to the proposed term loans.
KEY RATING DRIVERS
McGraw-Hill School Education Group (MHSE) is one of three leading K-12
educational content providers. Fitch believes that Pearson, Houghton
Mifflin Harcourt (HMH) and MHSE hold more than 80% of the US K-12 text
book publishing market.
Fitch believes MHSE and its peers have endured a period of cyclical
weakness. State and municipal revenues and education budgets are
improving. In addition, the adoption of Common Core State Standards
(CCSS) for English language arts and math will drive demand for new
textbook, educational materials and digital learning solutions. Fitch
believes that the educational content providers will grow revenues
organically starting in 2013/2014.
Fitch expects MHSE to continue investing in its digital products,
including through acquisitions. In addition, the company has refocused
its sales force to place it in a position to better sell its digital
products. These investments and sales force initiatives should position
MHSE to benefit in the rebound in the K-12 eucational market. Fitch
expects MHSE to at least defend its existing market share. Fitch's base
case model assumes revenues growth in the low-single digits in 2014 and
2015. Fitch recognizes that there could be upside in 2015 revenue
growth, supported by the expected California and Texas adoptions.
Fitch's base case demonstrates that the company can deliver lower
revenue growth and maintain current ratings.
Based on Fitch's base case, MHSE is expected to generate $75 to $100
million in FCF in 2013 and $50 to $75 million in 2014. The lower FCF in
2014 is driven by working capital swings and investments in product
development due to the increased adoption/sale expectations. The ratings
reflect Fitch's expectation that FCF will be dedicated towards
acquisitions and organic investments. Fitch believes most acquisitions
will be small tuck in acquisitions. Investments into adjacent K-12
educational markets may provide diversity away from highly cyclical
state and local budgets.
MHSE did not provide audited financial statements. Audited combined
financial statements for McGraw-Hill Education LLC were provided, which
combined MHSE and McGraw-Hill's Global Education Holdings (MHGE).
Unaudited break out of these two divisions were provided by management
and used by Fitch to assign ratings. Upon the acquisition of MHE by
Apollo, MHSE and MHGE were separated into two sister non-recourse
subsidiaries of MHE.
LIQUIDITY, FCF AND LEVERAGE
Based on Fitch's base case, Fitch calculated FFO adjusted leverage is
expected to be approximately 2.3x at the end of 2013, exceed 3x in 2014
and decline below 3x by 2015. Adjusting EBITDA for deferred revenue,
one-time items and deducting plate expenditures, gross leverage is
expected to range from 1.8x to 2.3x in 2013 and 2014.
As of Sept. 30, 2013, liquidity was supported by $269 million in cash
(prior to the proposed dividend). The company also has its undrawn $150
million ABL facility due in 2018. Fitch expects 2013 year end cash
balances of approximately $100 million (following the proposed
dividend). Fitch believes MHSE will have sufficient liquidity to fund
seasonal cash flow needs.
RECOVERY RATINGS ANALYSIS
MHSE'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. Given the strong recovery prospects, the $200
million senior secured term loan is notched up to 'BB/RR1'.
Rating Upgrade: Long-term, meaningful diversification into international
markets (through its royalty received from MHGE) and into new business
initiatives could lead to positive rating actions. Also, growth of
EBITDA and FCF ahead of Fitch's expectations, which would likely
demonstrate the company's ability to drive digital revenue growth and/or
retake market share from its competitors, could lead to positive rating
Rating Downgrade: Revenue declines in the low to mid-single digits could
result in rating pressures.
Fitch has assigned the following ratings:
--Long-term IDR at 'B';
--Proposed senior secured term loans at 'BB/RR1';
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria & Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent
and Subsidiary Linkage
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