In response to Jana Partners proposal McGraw-Hill is not planning on splitting into four publicly traded companies.  Instead it is moving towards a spin-off of its education business in September as it continues a wholesale restructuring of the company and tries to reinvigorate its Standard & Poor’s ratings business, according to people familiar with the matter.

The disposal of the education business would mark the most dramatic move yet as McGraw-Hill reacts to shareholder pressure and moves to accelerate growth of the disparate businesses owned by the publishing and financial services conglomerate.

Jana Partners have published details of its proposals for the company in a regulatory filing on August 22nd, after presenting its ideas to McGraw-Hill’s management. Jana argues that a four-way split would improve the allocation of capital and result in more focused management at the individual businesses.

Source:  Financial Times

In its Lex Column of August 24th, the Financial Times (FT)scrutinized Jana Partners six part case to break-up McGraw-Hill.  The FT judged that of the six arguments three where unfair.  It no longer matters how the company performed in the past, what matters most is how McGraw-Hill will perform in the future.

1. It historically has traded at a discount to competitors in its various markets. Fair: until very recently Moody’s, McGraw-Hill’s pure-play competitor in credit ratings, traded at a modest premium to McGraw, and peers in the financial, media and information business are much more richly valued (in education, everything depends on the comparator).

2. There are minimal synergies between most of the businesses. Fair: except for some shared customers, the credit ratings, media and information, and education businesses hardly overlap at all.

3. Its stock has underperformed peers. Unfair: it depends on the time period. Actually, investors have little to complain about: over 15-years McGraw-Hill has outperformed the S&P 500 index by 280 per cent.

4. High returns in the ratings business has meant underinvestment elsewhere, especially education. Unfair: of course a standalone business faces less competition for internal capital, but that does not necessarily mean more capital per se, nor that a break-up improves returns.

5. Because it looks bad for a debt ratings outfit to be leveraged, McGraw-Hill’s other businesses do not have the appropriate amounts of debt financing. Fair (especially, in this political climate).

6. The conglomerate structure of the company has made McGraw-Hill hard to manage and prone to excess costs. Unfair: certainly, big firms have a tendency to bloat, but both these accusations relate to management ability, not structure.

Faced with this mixed scorecard, investors must focus on the first, and by far the strongest argument of the six.  What matters is not how McGraw-Hill has performed historically, but how to maximize its value tomorrow.

Source:  Lex column of the Financial Times