Jack Callahan – EVP, CFO
Manav Patnaik – Barclays Capital
McGraw Hill Financial Inc (MHFI) McGraw Hill Financial at the Barclays Global Financial Services Conference September 9, 2013 10:00 AM ET
Manav Patnaik – Barclays Capital
Okay. All right. Good morning, everybody. Thank you all for coming. My name is Manav Patnaik. I'm with Barclays Capital. I‘m the research analyst covering McGraw Hill. I am just going to introduce our speakers today. We have Jack Callahan, who is the CFO, and we also have Chip Merritt, who is the Investor Relations Head, sitting; will probably answer some questions as well. So, I am going to stop talking; and Jack, just let you take it away.
Thank you, Manav. It's a pleasure to be here this morning. I was just commenting to him that maybe it's a testament that we've made some progress in the evolution of – from McGraw Hill Companies to McGraw Hill Financial – that we actually got invited to this conference, because I don't think we ever would have been in the past. So it's wonderful to have this opportunity to talk about the new Company.
Before I do start the presentation, I need to make a few opening required comments. On a couple of the slides, we will use some adjusted numbers, very consistent with our most recent practice of isolating the one-time costs that are associated with the separation of the companies. This is the same perspective that we use internally to manage the business. And then, secondly, I will make a couple of forward-looking statements. There are some risks that clearly will impact those possible – actual results, and you can refer to our SEC filings to give you more specifics on that.
So, let me start. 2013 is, without question, a year of transition for us at McGraw Hill Financial; perhaps, arguably, one of the greatest years of transition in the 125-year history of the Company. We are becoming a new Company, a new Company that I know personally; I am very excited to have an opportunity to be part of, and to shape going forward.
And so what I would like to do this morning is just to give you a little bit of an update about what some of the major drivers are of the creation of this new Company; spend a few moments telling you why we believe we are very well positioned in terms of our ability to drive sustained, profitable growth going into the future. And then, I would like to spend the remaining time just to dive into the portfolio to give you a little bit more detail on our first-half performance, and a few comments on balance-of-year outlook.
Let me start by summarizing a couple of points on how we are becoming a new Company. First, the significant realignment of our portfolio is largely complete. Earlier in the third quarter, we announced the sale of Aviation Week to Penton Media. Aviation Week represents the last sort of pure publishing asset that we had in the portfolio.
But if you look back all the way to 2010, and before we announced the Growth and Value Plan, and the goal to set up two separate, independent companies – McGraw Hill Education and McGraw Hill Financial. You can see that we have divested well over 40% of our portfolio. And these asset sales – and I'll talk more about how they strengthen us strategically, in terms of focus and then relationship – they have also used divestitures. They've also done some very nice things to strengthening our balance sheet. It has supported a step up return of capital to shareholders, but we are really excited about what now we can do as McGraw Hill Financial.
Now that the separation is complete, and this Growth and Value Plan is largely complete, we are now intent on building out the promise of McGraw Hill Financial, which is based on our vision of building the leading brands in ratings, benchmarks, and analytics, providing essential intelligence to the markets. We are introducing some more of a common look and feel, brand architecture, to the Company, that I think better communicates the similarities of inner relationships across the portfolio.
And we will have more to talk about in the future, and I'll make a few statements on it today. If you like – if you don't – I'd love your feedback on the branding. Our Head of Corporate Communications is here, Ted Smyth. He is in the middle of the room. So, you can pass along your thoughts on the new look as we end today's program.
The other thing that is underway is not just the portfolio has changed, and we have a new look. We are also on the verge of new leadership. Doug Peterson joined the Board of Directors earlier in July. He joined as the President of S&P Ratings back in the summer of 2011. He assumes the CEO position as of November 1. And I, personally, from what I already can see, is I think this transition from Terry McGraw to Doug is going to be seamless.
I personally am very excited to have this opportunity to work with Doug. He brings a great background in global leadership. He spent a good deal of his time outside of the United States. He obviously has a very deep expertise in financial services, which is the more focused company we have become. And I can tell you, he has been a wonderful steward to the S&P Ratings business, through some challenging times over the last two-plus years, and is going to be a very engaging and personable leader to work with.
And so, while this Company has been around 125 years, I think you can see our portfolio has changed. Our look has changed. And right now, our leadership is about to change. And I am quite confident, as we get into the early part of 2014, Doug will be here to give you more thoughts and more insights about how he wants to go and manage the business as we move forward.
With that, let me spend a few of the foundational elements that Doug and I and the rest the management team are building off of that give us some confidence about what we are trying to build at McGraw Hill Financial is well positioned for sustained growth. So, what I would like to do is maybe just kind of work through some key drivers of things that give us excitement and confidence about what we are building.
One of the reasons we went down the path of the Growth and Value Plan was really to unlock the growth potential of the financial and commodity-oriented assets. And you can already see, in the growth of what we have delivered, that there is great potential. There is also more a focus in our portfolio, and there is more a degree of interrelatedness in terms of what we do across the businesses. And I will comment a bit more on that, in terms of we also have some great brands and benchmarks; we have leading positions globally that give us some great opportunity to grow off that base. And it's also nice when you compete in markets that we believe have some nice winds behind us. That the markets in which we compete, we believe, have some great prospects for future growth that should position us for sustained revenue growth moving forward.
We also are beginning to shift our focus in productivity. We, in the past, have been much more focused on driving cost to enable separation to variablize what had been fixed costs across the P&L. You can see – and I will come back in a little more detail in this – we are beginning to shift our thinking about how we can start to build more enterprise-wide capabilities that can better support future growth on a global basis moving forward.
And throughout all of this, and me as the CFO particularly, we generate a ton of cash. You all asked me about that when we have opportunities to talk about it. And that cash, that strong balance sheet, is going to give us great opportunities to continue to invest to broaden out our portfolio, while continuing to return a significant amount of cash to shareholders. So, in aggregate, if you look across what these multiple levers here – feel really good about our ability drive sustainable growth.
Let me give you a little more detail on a couple of them.
First of all, top-line growth. As we closed out 2012, for the first time we stripped out McGraw Hill Financial to lay out. Historically these businesses that now constitute the portfolio had grown 8%, 9%, 13%, in 2012, aided a bit by the formation of the JV with CME in our index business. But also I think what's really exciting is from in first half of 2013, that growth rate has continued. In fact, in the first half, we have grown at 15%.
Now, I do think the overlaps for the balance of the year are going to be a bit more challenging than we saw in the first half. But we initially gave full-year guidance at high-single-digit revenue growth. And we where we sit today we feel very comfortable with high-single-digit revenue growth for the full year, maybe a tad better. But we feel very good about the sustained growth, the business that we currently have in place that we have to work with going forward.
From a bottom-line point of view, and a free cash flow point of view, I think the growth trajectory is equally as robust. Again, for the first time last year, we had a chance to strip out all the moving pieces as we have pulled out Education. So McGraw Hill Financial, the base on which we are all growing this year is off of $2 and 75% earnings per share in 2012. Our current guidance for the year is $3.15 to $3.25. That implies mid-teens to high-teens EPS growth going forward. So, we feel very good about where we are, relative to our outlook for 2013. And we feel very good about sustaining this type of EPS growth moving forward.
And free cash flow, one of the greatest strengths we have going forward, we have the benefit of business that are growing nice high margins, limited reinvestment requirements. We have a fair amount of free cash to decide how to deploy on an annual basis. Our free cash flow has been depressed a bit in the 2012-2013 timeframe, as we have had one-time cash costs that related to the separation of the Company into two. But as we get into 2014, our free cash flow should return to exceed the levels that we saw back in 2011, more in the $800 million-plus range, which gives us a lot of flexibility in how we manage the P&L going forward.
We just have a great portfolio of brands. This is the more, now common, look and feel that we have from our branding and architecture across the portfolio. But you can see in each one of the discrete brands that we have a great position. In ratings, we have a leadership position. With Cap IQ, we provide high-quality information, analytical tools; and, importantly, it is the vehicle by which we monetize a great deal of the ratings information that is created by S&P Ratings Services.
Our index now, an index with our joint venture with CME, one of the foremost index providers. In Platts, we are the leader in providing price assessments for commodity markets. We have a great strength in oil and petroleum. And over the last few years, we have been investing to broaden the number of commodities that we cover. J.D. Power is the primary benchmark in many quality benchmarks in many markets, most notably automotive. I can say it's nice to be benefiting from the rebound in the auto markets globally. And then lastly, McGraw Hill Construction, a business that is becoming much more based on analytics and facts, much like the rest of our portfolio.
And across all of these businesses, there's things that link them together in terms of the common brands, common customers; increasing needs for unique data sets, analytic tools, information technology, and the build out of our global network. We actually see the build out of our global position as one of the leading growth opportunities we have going forward. If we were just to divide the world into three right now, across North America and South America we have about two-thirds of the businesses today. We see a great opportunity to build and extend our position across Europe and Asia-Pacific, which now represents about one-third of the business. And here, working together across the businesses, we see there's a good opportunity to accelerate this moving forward.
I mentioned earlier that we feel good about the market, the basic market drivers in the areas in which we compete. Let me comment on just a few of these, and I will come back with some more detail on one or two of them before I close today. If we just look about the aggregate amount of debt, the debt matures in the coming years, there is a significant amount to continue to drive the growth and the needs for our ratings business and the monetization of ratings information.
Banks, particularly in Europe, are continuing to deleverage their balance sheet, further increasing the dependence on capital markets. We are also laying the seeds to build out our positions in emerging markets that will give us future opportunities for growth down the line, as those credit markets move to a more sophisticated debt financing in the future.
In our Platts business, commodities are increasingly being linked to daily price assessments. One thing we have seen that is certainly true over the last few years across most commodities is increased volatility. The ability to link your long-term contracts to long-term price is really difficult without a daily price assessment. We have benefited from that. And we think it's a great growth vehicle for the future.
Our JV with CME is well positioned to continue to benefit from the growth in index-related investing. And through Cap IQ, we continue to increase the level of sophistication and analytics and information we provide the market. And as I mentioned earlier, our J.D. Power business is benefiting nicely from a rebound in the car markets in North America, but most notably in Asia. So that gives us great confidence, if you would, both in the strength of our businesses and but also the core secular market drivers for the next few years.
But we are also reminding – we are also working on productivity. As part of the Growth and Value Plan, we had set some aggressive cost targets. The goal of the Growth and Value Plan, which is largely coming to a close, was to enable separation and to reduce our cost footprint for two what would be smaller business. That had a lot to do with outsourcing and some targeted restructuring, de-layering of the business. We delivered, for the MHF side of the business, over $60 million in net cost saves. And that is after – that is despite $25 million in stranded costs.
We are starting to shift our focus on productivity. And this is an area where we will be back and talk about move into 2014, where we are trying to align ourselves around enterprise-wide capabilities that should allow us to do things smarter, more effectively, but also cheaper, more growth-capable in the future.
Let me give you a few examples.
One is in the area of how we aggregate data. We have thousands of resources around the world that frankly just collect and aggregate data.
How can we begin to better use that across the corporation?
Over the last 18 months, we have been doing a lot more in the area of information technology, pulling together a central view of how we manage those investments going forward. We are continuing to look at how to realign our various different functions to support a new McGraw Hill Financial that is more of an operating company versus a decentralized holding company, and we are doing more in the build out of our global network.
This is just some examples, and we will have more as we continue to build this out as we move into 2014. But I will point out, already we have started to see some nice margin realization from what we accomplished in the Growth and Value Plan, and our intention is to continue to balance both top-line growth and productivity going forward.
The other thing that gives us great confidence in our future is this strong balance sheet, and cash flow I mentioned earlier. We, after investing organically to build out our businesses, the next place where we'd like to deploy capital are tuck-in acquisitions that continue to expand our global footprint and build us – and add new capability. If you just look back, what we've done over the last just 2.5 years, in Dow Jones Indices, we formed the JV with CME. And last year, in 2012, we did three acquisitions to support Capital IQ; CMA, QuantHouse, and R2. All of them outside of the United States, so not a drain on US cash to build out needed capability for our Cap IQ platform.
In the area of Platts, we have made a number of acquisitions to kind of broaden the commodities, which we have expertise in. In 2011, we acquired BENTEK, which gave us capabilities in North America natural gas.
Last year, we bought a company called Kingsman, which gives us our first foray into agriculture, more specifically sugar and ethanol. And in 2011, we bought Steel Business Briefing, which brings us capability in steel and iron ore. But what we want to do is continue to build out the commodities that we have deep expertise in.
And, more recently, within S&Poor rating services they one that I would comment on, is we have been able to successfully increase our ownership of CRISIL, which is an independent company trading in India that is the leading provider of ratings-like information within India, but also has significant global operations. And we've been able to increase our ownership from about 53% to 68%, which we were thrilled with. We look for CRISIL to be a great asset, as it already has been, but even more so as we move forward into the future.
And lastly, what gives us confidence of growth, at least from the shareholders' perspective and returning value to you, we have been – where we have not been able to find tuck-in acquisitions, also aided by some of the asset divestitures that I referenced earlier – we have been, and will continue to, return a substantial amount of cash to shareholders. I would – in our second-quarter earnings call, by that point in time we had returned a little over $650 million to shareholders through both combination of an accelerated share repurchase and our common dividend.
We do anticipate completing the remainder of our share authorization that currently is out there. We have begun to repurchase shares on the open market. We have, I think, 7.3 million shares left under the existing authorization as of the end of Q2, and we do anticipate finishing that by the end of the year. One we do that, combined with the annual – combined with the common dividend that is yet to be paid – that would bring our return of capital for 2013, just with those assumptions, very much in line with what we did last year in 2012.
So, just bringing it all together, we think we have a virtuous cycle of sustained growth that we can go and continue to leverage as we move to the next chapter of development within McGraw Hill Financial. We have great brands and benchmarks with already leading global positions. I discussed specific secular drivers of market growth that give us confidence that we can continue to sustain the top-line growth moving forward.
We are starting to build enterprise-wide capabilities that may save us some money; but, more importantly, help us do things more effectively that generates a ton of cash. But we have very limited reinvestment needs in terms of CapEx. Our CapEx spending this year is only $125 million, and that will provide us a great deal of flexibility of balancing the pace of tuck-in acquisitions with returning cash to shareholders.
It's a great story, and it is one that we'll be back to give more detail around early next year, as Doug has an opportunity to shape the leadership team of the Company that he wants to move forward with next year.
So with the time that is left, I would just like to quickly spin through the portfolio, just to give you a quick update on first-half performance, and some thoughts on balance of the year. Just a reminder, the first half of the year was great. Top-line growth, as I mentioned earlier, was 15%, strong operating margin expansion. Our earnings per share was up 30%.
By line of business, S&P Ratings is almost 50% of revenue, and over half the operating profits. Dow Jones Indices certainly benefited from the formation of the JV. As a reminder though, 27% of the operating – or what we report as operating profits do represent the CME share of those profits that flows over to them in non controlling interests. S&P Capital IQ was a significant component of revenue for the first half of the year. Its profit contribution has been a bit muted by some investments that we're making, and I will comment on that, and Commodities and Commercial continued to make a significant revenue contribution in the first half of the year. It was really nice to see its margins tick up.
Let me give you more detail on some of the pieces here.
As I said earlier, I'd like to start with Ratings. Obviously, it's the mother ship. It's the largest, most profitable business. We feel great, as I mentioned earlier, about the structural drivers of future demand. What we have seen so far this year has been pretty broad-based drivers of growth in both corporates, extension at the bank loan ratings. Europe has had better growth this year than last. So, it's a bit more balanced this year than what we saw last year between US and North America. But I do want to caution that I do think some of the year-on-year comparisons, as we get into the back half the year, may be a little bit more challenging.
Just in terms of the numbers, Ratings last year finished the year a little bit over $2 billion. We are well on track to exceed it this year; at midyear, the business was up 22%. What has also been nice is we have seen a nice jump up in operating margin through the course of the year, up nicely – 46% for the first half.
Ratings is going to have a more challenging third quarter then the first half; still some growth. I think the overlap in the fourth quarter is going to be a bit challenging, given the great finish to the year it had last year. And I would like to be able to predict 46% margins for the full year, but I suspect they will be somewhere between last year's margins of 42% and 46% by the time we reach the end of the year.
And just one example of why we feel so good about the long-term prospects for our Rating business, we just recently updated our view a couple of months ago about our view of corporate debt that is maturing globally around the world. This is from the beginning of April 1 to the end of 2017. It's over $8 trillion dollars. And this is just one of many. This combined with bank deleveraging; combined with our broadening our position in developing markets that give us confidence about the future growth of this business. There's going to be a bit of volatility with interest rates, but we feel good about the long-term prospects.
Jumping to Dow Jones Indices, we are just now completed the first year of the JV. It was formed in July 1 of 2012. We generate revenue a wide variety of ways. It has been really exciting to add the Dow Jones brand. As we see areas of our marketplace continue to grow, most notably assets under management and ETFs continues to grow, it is contributing nicely to the overall prospects for the business.
Just give you a sense of what the numbers look like right now. As I mentioned, the joint venture was formed midyear last year. So, there was a half-year impact of the JV in the 2012 numbers. This year, we will have – is the first year we will have a full-year impact. I think as you start to get into the third quarter, it will be a little bit easier to read performance because we will be sort of comparing apples to apples to apples, in terms of revenue growth.
But we feel really good about the growth projections of this business. And next year it should be well over $0.5 billion. And you can see, you don't want to push a business too hard on margin expansion when its starting point is close to 60%. But it has been nice to get a couple of points of margin improvement from the integration with Dow Jones.
Let me turn to S&P Capital IQ. And, admittedly, this can sometimes be a tough portfolio to really understand, because there's a lot of different businesses that are contained, and is within this platform. Many of you may use Cap IQ. That fits in our desktop solutions part of this portfolio. It's about one-third of the overall business. But it's more than we have in this business unit than just Cap IQ. We also have a fair amount of information that we sell through direct feeds. That's been our enterprise solutions business.
The Cap IQ business also has responsibility for the commercialization of all our ratings IP, and that is also a significant driver of revenue and profit growth in this business. And we also have a small equity research capability sitting within Cap IQ. It has been a bit challenged lately, and it has been a bit dilutive to the overall growth rate.
We are making some investments this year to build out capability, most notably leveraging some of the acquisitions we did last year. We're trying to build out our portfolio analytics capability. Cap IQ was very good as a single security analysis tool. We are adding, with the acquisition of R2, some ability to better serve portfolio managers.
The growth rate is – for the year so far – has only been 4%. Again, there is a lot of different mix impacts within the portfolio. Cap IQ, the desktop portfolio, is growing a bit better than that. We have lost some business in our equity research business, so there's a little bit of couple different business trends within it. And as I mentioned, margins are a tad depressed as we cycle through some investments around adding capability for Cap IQ. But we do anticipate slightly improved margins as we approach the end of the year.
And, lastly, I'm just going to make a few comments on Commodities and Commercial before wrapping up. As a reminder, our Platts business provides over 12,000 price assessments on a daily basis. It provides information that is critical to both the functioning of commodity markets, but also provides deep expertise to a variety of different industry sectors. We make money both off subscription, and from trading off derivatives.
And it's a great market position. It's an area that you should expect us to continue to aggressively invest in to build out our capability in this area. And not to forget, we also have J.D. Power and McGraw Hill Construction. J.D. Power particularly is benefiting from the rebound in the auto markets globally. 30% of the revenue of J.D. Power now comes from across Asia-Pacific, the world's largest car market. And it's very well positioned to continued growth there.
And our Construction business has done a really good job of shifting from what had been largely a media-based model five or six years ago, to one that is more based on data analytics. And just as a modest reminder, some of the go-forward comparisons may be impacted a bit here, because we did sell Aviation Weekly earlier in the third quarter. But it was a relatively small business, a little less than $50 million.
In terms of the financials on Commodities and Commercial, we've had nice growth over the last few years, 9% on a compound basis. This year has been a bit less – the Commercial businesses have got off to a bit of a slow start. It seems to be improving, but you can see that Platts continues to have double-digit earnings revenue growth. And from a margin point of view, it was really nice this year, with the step-up in margins. They've done a nice job of combination of cost control, also with a rebound of some of the commercial businesses have really generated a nice lift overall margins. So, that was a quick spin, an update on the portfolio.
In closing, I hope you see us as a bit of a new company; a company certainly in the middle of a transition. And very soon, we will have a new leadership team in front of you to talk about the business. We feel this leadership transition is very much on track. And we are doing this transition in a period of great strength in the business. We look – 2013 looks to be a good year for us, and we continue to believe we are very well positioned for sustained growth moving forward, and our balance sheet and cash flow give us a lot of choices on how we can drive value creation, both through acquisitions and return of capital to you as shareholders, moving forward.
So, a quick update; hope that was helpful. And for the time remaining, open it for questions.
Manav Patnaik – Barclays Capital
So, we do have a breakout session at the Gibson Suite after that. But, obviously, if you guys have any questions – and I can ask a few – but anybody in the audience wants to ask anything first up, well, right here.
All right. I’ll just speak loudly. You talked about an upcoming productivity focus. What are you going to have – do you have any guess as to the magnitude of that? How it’s going to change? Or how was that? Can you talk about can you operate in data management and technology, none of which come cheap. And I could – can you talk about that?
[Indiscernible]. We’re – we have already started the work in identifying where these areas of enterprise capability sit. We’re working through the plans to understand what the benefits could be. So, it's a little too early to be very discrete, and to say how much would a cost save program over the next 18 months would deliver. That's – combine that with some changes in our leadership, we have some work to finalize that. But we are quite confident that, as we start to do things in a more coordinated, interrelated way across the portfolio, it’s going to give us an opportunity not just to do things cheaper but to actually end up with better solutions.
You know one example, information technology; we have – because of our historical decentralized area, we have far too many applications, many of which are based on not necessarily the most current technology. So, we have an opportunity, as we thoughtfully, carefully, over a period of years, start to upgrade that, to do that in a more effective and more cost-effective way.
Right now, not anticipating a big jump-up in any capital spending right now, while I do think there may be places we may choose to invest in some software development. At the same time, we have made some other decisions to move away, from a less capital-intensive way in which we manage IT assets, like servers and things like that, which I think shouldn't – and I am not anticipating, right now, any big change in our reinvestment requirements as we stand right now.
Manav Patnaik – Barclays Capital
I have one quick one. You mentioned in the beginning that most of the significant portfolio realignments have been done. And just in context of your financial – the name being a financial company – just curious, more specific to the Commodities and Commercials division, like J.D. Power, Construction – how do you see those over time fitting in? Do those – how core are those assets to the overall strategy you guys are going with?
Well, I’ll just add one more. Platts is a financial – is as much financial as Ratings, in terms of how it operates in the markets. Within J.D. Power and Construction, if you think beyond just the name, but back to capabilities; what it takes to succeed. What is the business? In the case of both J.D. Power and Construction, it is about data. It is about data modeling. It is based on delivering this data, in a new way, direct to customers through desktop technology.
We were, just last week, with J.D. Power out in California, and if you look at what some of the things they are trying to do; they have a big reengineering program underway around next-generation. A lot of what they are trying to accomplish and the way they interact with the customers is very similar to some things that Platts, and to some degree even Cap IQ is accomplishing.
So, but right now we see them, as I mentioned earlier, as far as it relates to our thinking around the Growth and Value Plan, which was to really get out of more publishing-related assets. That period is now done. Going forward, we see a lot of things that link the businesses together. But along the way, each business is going to have to own its – is going to have to earn its way into the overall portfolio. And if it businesses is – if the synergies are not there that we anticipate, or the business is not delivering, then obviously there's other alternatives for us to consider.
Manav Patnaik – Barclays Capital
Well, I guess I’ll just ask one last one. I'm surprised nobody is asking this. But – and there is obviously an opinion piece in the Wall Street Journal article today on the DOJ case, et cetera. But can you give us the latest on what the next dates, steps, catalysts, et cetera, that we should look forward for that?
Sure. So, basically, at the last session we had with Judge Carter, you know, the question to us was how long will it take us to defend? How much time do we need for discovery?
At that session, we said, “Well, gee, it's difficult for us to answer that question because some parts of the complaint refer to 33 CDOs, and others refer to two or three years' worth of CDOs.” The judge agreed with us, and asked the DOJ to go back and fine-tune their complaint to something that is more manageable for the court.
They have to come back mid-November with that update, at which time we’ll then have one month to look at what their claiming now, and decide how long it takes us to put together a discovery plan and be able to defend ourselves against those claims. But any way you look at it, those are the next steps. This is going to be a long, multiyear project.
Manav Patnaik – Barclays Capital
Yes. Anything else there? Well, I guess the breakout session, again, is at the Gibson Suite, if you guys want to ask some more questions there.
Manav Patnaik – Barclays Capital
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