The McGraw-Hill building in New York.Mark Lennihan/The Associated Press
The McGraw-Hill Companies began when a schoolteacher, James McGraw, bought the American Journal of Railway Appliances. More than a century later, it's a group of teachers that wants to break the company apart.
Ontario Teachers' Pension Plan, the investment manager that handles the retirement savings of nearly 300,000 teachers in the province, is one of McGraw-Hill's largest shareholders. It is also working with New York hedge fund, Jana Partners LLC, to push for a radical overhaul that would spell the end of the New York-based information giant as investors currently know it. And the pension fund's chief complaint has to do with, of all things, the company's education unit.
McGraw-Hill has come to own a collection of different businesses. The best known is credit rating agency Standard & Poor's, under fire for its role in the U.S. mortgage meltdown and for downgrading the United States. But the company also owns everything from television stations to Aviation Week magazine to research firm J.D. Power and Associates to a publisher of textbooks.
That, critics say, is exactly the problem. They argue that McGraw-Hill's stock price is too low because of a "conglomerate discount." Teachers and Jana want the company split up into four different units to raise the company's stock price.
According to the two shareholders, investors looking for high growth would be willing to pay more for Standard & Poor's if it wasn't coupled up with more sluggish businesses, such as education; similarly, investors who prefer stability and dividends might be willing to pay more for the education business than it's currently fetching as part of the broader company.
That's despite the fact that the ratings business, which made waves around the world this month by removing the United States' triple-A rating, is under siege on multiple fronts. Rating agencies are still being fingered for their role in the financial crisis and in recent days reports revealed that the U.S. Justice Department is probing S&P and Moody's over ratings of mortgage-backed securities.
McGraw-Hill is already adopting close to $100-million (U.S.) worth of new systems to ensure S&P can cope with a barrage of new regulations, such as the U.S. Dodd-Frank Bill, even as European politicians muse about creating a rating agency of their own. In the meantime, S&P and its rivals have been inundated with lawsuits launched by angry investors whose highly-rated investments tanked. The headwinds have taken a toll on McGraw-Hill's stock price.
But none of these challenges dent the enthusiasm that investors such as Teachers have for the ratings business, which has become ingrained in the global financial system and continues to be a big money maker. Last year S&P brought in $762.4-million (U.S.), nearly half of McGraw-Hill's profits, and its profit margin was triple that of the company's education arm.
And so some investors and analysts want to see S&P unleashed from McGraw-Hill's other units, such as its education business. It's an argument the company is studying carefully, in no small part due to the theory's most forceful champions: Jana, an activist hedge fund, and its unlikely collaborator - a Canadian pension plan that is little known in the corridors of midtown Manhattan. Together they own slightly more than 5 per cent of the firm, giving the duo a combined stake that makes them McGraw-Hill's second-largest shareholder.
In the process, Teachers is taking on one of the oldest and most storied companies in the United States, one that famously fended off a hostile takeover attempt by American Express in 1979.
Under pressure, McGraw-Hill's executives, led by Harold (Terry) McGraw III, the great-grandson of the schoolteacher founder, are reviewing the company's options and will hammer out a new vision in the months to come. They are well aware that if they don't take major actions, including hiving off the education business, a messy proxy fight will likely ensue.
From their offices in a Manhattan skyscraper that bears the company's name, McGraw executives and their investment bankers have been poring over an enterprise with more than 280 offices employing upwards of 21,000 people in 40 countries.
Executives agree that S&P, which McGraw-Hill bought in 1966, will remain the firm's engine despite the obstacles it faces, according to sources familiar with the matter. McGraw executives point out that more than 20 lawsuits against the rater have been dismissed, and another batch have been withdrawn, suggesting legal risks are diminishing. And there is a school of thought that the brouhaha over the U.S. downgrade has been a boon for the agency's brand outside of the U.S. McGraw-Hill also remains confident that investors will require trusted brands to make sense of credit markets, and the agency's services will become even more valuable as the markets become more complex.
To ensure that S&P and related businesses were each getting enough management attention, McGraw-Hill separated the division into two in November: one focused on ratings (S&P) and another, called McGraw-Hill Financial, focused financial information, data and analytics. The latter includes businesses such as S&P Indices and Capital IQ.
As a result, McGraw-Hill has four divisions, the other two being education and an information and media arm.
The education business, where the game is changing at a cheetah's pace because of technology, produces everything from standardized tests to textbooks and digital lecture tools. It earned an operating profit of $363.4-million last year, less than half S&P's, and its outlook has been further hurt by state and local government cutbacks of elementary and high school budgets in the U.S.
The information and media division, which includes brands such as Platts and Aviation Week as well as a stable of broadcasting assets, posted an operating profit of $160.4-million in 2010.
McGraw-Hill has already been making changes, but they've been too little, too late for the critics.
Mr. McGraw, 62, recently remade much of the executive team and announced a $2-billion stock buyback program. McGraw-Hill is also reviewing its general and administrative costs, and in June revealed that it's given Morgan Stanley a mandate to sell its broadcasting group.
None of this placated Teachers and Jana, who went public a few weeks ago by submitting Schedule 13D filings to U.S. regulators, notifying the market that they had spoken to the company and were keen to press for change. They made additional filings yesterday, outlining their vision to turn McGraw-Hill into four companies.
McGraw-Hill has said that it will make "significant" announcements shortly. Executives have determined that their priority is high-growth, global brands, according to sources. While no decision has been made, Aviation Week and McGraw-Hill Construction are contenders for the auction block.
But the real question is what to do with the education business. Executives are open to parcelling it off and have already had bankers exploring possibilities. An outright sale is one of those, but it's not currently the favoured option because it's unlikely to yield the highest financial gain for McGraw-Hill. An idea that's being given serious consideration is splitting McGraw-Hill into two.
Many competitors, such as Wolters Kluwer N.V. and Thomson Reuters, have already offloaded education businesses. A notable exception to the trend is London-based Pearson LLC, which effectively doubled down in education and is now stealing market share from McGraw-Hill in this space.
As McGraw-Hill evaluates the possibilities, it is out canvassing shareholders. So are Jana and Teachers. The duo has made it clear that if the pending changes aren't significant enough, they will take their case up at the company's annual meeting next year.