And that just marks the beginning of parent company McGraw-Hill’s (MHP) woes. Their other businesses include text book printing, which is under incredible pressure from the transition to digital, financial research and analytics, which is struggling due in part to investors running from volatile markets, and some television stations, which are struggling in the shift to online distribution.
And while all of those businesses might have some issues, they’re all asset-light businesses with relatively wide moats and a history of extremely attractive returns. No surprise then, that with all of the negativity surrounding their divisions, MHP has wound up on the magic formula list.
Let’s start by taking a look at how cheap MHP is.
Over the past 12 months, MHP has earned just under $1.5 billion in operating income. With a current enterprise value of $13.4 billion, they trade for about 9 times EBIT. While that’s not the cheapest valuation we’ve ever seen, it’s a cheap price for businesses as strong as these.
However, there’s reason to believe that these earnings actually understate just how much MHP’s business is earning. There’s almost no synergies between any of their units, and corporate overhead runs very high. If they were to split up, they could eliminate almost all of the overhead with limited to no effect on any of the businesses. As a matter of fact, that’s exactly what they seem to be doing with their recently announced plans to split into two units and sell off their radio divisions.
Returns on capital
So just how much does this business earn?
MHP employs under $4 billion in tangible capital. So with about $1.5 billion in operating income, the company is earning over 35% returns on tangible capital.
That’s awesome — and remember, it’s likely understated. Returns would be well over 40% if the company slashed the overhead costs by breaking up.
By now, you’ve probably picked up on the likely catalyst for MHP: a breakup. Doing so would eliminate all of the corporate overhead costs and reveal just how much the underlying businesses are earning and how much they’re worth.
There’s reason to believe it’s coming too. MHP has already announced plans to switch into two separate divisions, and they’ve sold off their radio stations.
They’re likely to follow up this plan by cutting costs and increasing share buybacks. How do we know this? Because they have an activist demanding it, and so far every play in their spin-off has come straight out of the activist's demands.
There you have it: McGraw-Hill, a hated business with a hard catalyst to unlocking value.