McGraw-Hill Ryerson Ltd. [TSX: MHR], a publisher and distributor of educational products (both print and digital media) in Canada, is currently trading at $42 per share. In my opinion, the company is worth at least $80 per share, a 90% premium. The investment thesis is pretty straight-forward:
- MHR trades at a significant discount to its peers and parent company
- MHR distributes most of its free cash flow to shareholders through dividends
- the shift from print to digital media will continue to improve gross profit margins and
- MHR could/should be acquired by its parent company later this year.
MHR operates in three divisions: School (K-12), Higher Education (Post-Secondary), and Professional. The company had a market capitalization of $84.2 million as of Wednesday, April 25th. According to the 2011 4th-quarter earnings release (pdf), MHR had $42.6 million of cash & marketable securities and no debt. Over the last year, the company has generated $14.6 million of free cash flow (defined as Operating Income + Depreciation + Amortization - CAPEX - Pre-Publication Costs). Therefore, the company is currently trading at approximately 2.8x Enterprise Value to LTM Free Cash Flow. The McGraw-Hill Companies, Inc., (MHP), which owns 70% of MHR, trades at 8.1x EV/EBITDA and Pearson PLC (NYSE: PSO) is currently valued at 9.7x EV/EBITDA. MHR's current stock price is way too cheap.
MHR currently pays a quarterly dividend of 28.5 cents per share ($1.14 annually). This equates to a 2.7% annual dividend yield. Over the past three years, however, the company has been paying a special annual dividend. MHR paid out approximately $10 million or $5.00 per share in special dividends to shareholders in 2011 (for a total dividend yield of over $6.00 per share or roughly 14.5%). In 2010, the company paid out $5 million in special dividends to shareholders (for a total dividend yield of over $3.50 per share or roughly 8.4%). In 2009, MHR paid out $14 million in special dividends to shareholders (for a total dividend yield of approximately $8.00 per share or roughly 19.2%).
MHR is planning a tax-free spin-off of its education division (McGraw-Hill Education) by the end of 2012 (recently received IRS approval). It makes a lot of sense for McGraw-Hill Education to acquire the remaining 30% of MHR that it does not own. Not only will there be cost savings as a single company, but the acquisition of MHR will create synergies as McGraw-Hill Education tries to capture global share of the education marketplace. It appears that this thought process may already be starting to play out. In the recent 2011 annual report, MHR reported that David Swail (CEO of McGraw-Hill Ryerson) is taking on broader responsibilities within The McGraw-Hill Companies. The McGraw-Hill Education publishing operations in Australia, and New Zealand, now report to Mr. Swail.
I believe MHR is worth at minimum 8.0x Enterprise Value to LTM Free Cash Flow. With 1,996,638 shares outstanding, $42.6 million of net cash, and $14.6 million of LTM Free Cash Flow, MHR's shares would be worth $80 per share. In the spirit of efficiency and maximizing value for the McGraw-Hill Education brand, it makes every bit of sense for McGraw-Hill Education to acquire the rest of MHR. According to MHP's recent earnings press release:
McGraw-Hill Education will seek to maintain the core business for profitability while simultaneously pursuing growth. The Corporation is also working to expand its educational services, exploit high-growth digital-enabled learning, build presence in emerging markets and pursue compelling acquisitions and partnerships.