Wednesday, September 14, 2011

McGraw-Hill's Split Up

Only last month I wrote this post concerning outside pressure on McGraw-Hill to break itself up. Two years ago, this post discussed the fallout from Terry McGraw's push for growth on the cheap at his company's S&P Ratings unit.

It doesn't look like David Einhorn made money shorting McGraw-Hill's stock back then.

However, a glance at the firm's equity price since 1985 shows the McGraw's have created no value premium for shareholders, despite exposing them to the risk of owning just one equity.

The company, awkwardly diversified as it is between educational and other publishing, and financial services information, probably reached its zenith of value creation back in 2001. But since roughly 2007, the firm has pretty much tracked its own iconic S&P500 Index performance.

As I wrote in an earlier post, McGraw-Hill's current instantiation is the product of a bygone era in which the commonality among businesses was the physical printing and distribution of information. The planned split finally addresses this now-awkward fact by separating what is referred to as the company's education businesses from its financial information ones.

A decade or more ago, this may well have caused the value of the latter, which CEO Terry McGraw plans to lead, to soar. Now, with S&P's reputation tainted from its inept performance during the mortgage securitization boom/bust which led to the 2008 financial crisis, that may not be true.

I'll have more on that point in a later post.

Terry McGraw was cited in yesterday's Wall Street Journal as insisting this split is the fruit of a year-long effort inside the company, and that it is emphatically not in response to pressure from Jana Partners, an institutional investor in the company, or any other outside pressure.

That's hard to believe. Very few CEOs voluntarily engage in wholesale cuts in the size of their empire without heavy market pressure, e.g., Brian Moynihan at BofA and Jeff Immelt at the struggling GE.

Perhaps the more interesting question is whether the firm's rating business will ever be floated off on its own, if for no other reason than to firewall the other pieces of the firm from legal and reputational backlashes.

In any case, while it's possible the pieces of McGraw-Hill could do worse, going forward separately, than the whole, I suspect they won't. As separate and public companies, a really bad performance would probably led to acquisition by a competitor, while the focused nature of each resulting business group will give each the opportunity to be managed more appropriately to its needs, without distractions from resource allocation across such different types of businesses.

The nature of capital markets for the past 30 years has been to de-conglomerate, and McGraw-Hill is finally about to allow investors to do for themselves what this remaining conglomerate has unsuccessfully attempted to do for them for so long, i.e., diversify and allocate resources as they see fit, rather than pay a family management to do it badly.

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