Rating Action: Moody’s downgrades Houghton Mifflin’s CFR to Caa1; outlook stable
Global Credit Research – 27 Aug 2020
Approximately US$690 million in rated securities affected
New York, August 27, 2020 — Moody’s Investors Service, (“Moody’s”) downgraded Houghton Mifflin Harcourt Publishers Inc.’s (“HMH”) credit ratings, including its Corporate Family Rating to Caa1 from B3 and Speculative Grade Liquidity Rating to SGL-3 from SGL-2. The outlook is stable.
“The downgrades reflects Moody’s expectation of a sharp decline in revenue in 2020 caused by budgetary constraints and likely deferrals of purchasing decisions by school districts amid the coronavirus pandemic, which will lead to HMH’s earnings decline and a spike in leverage in the next 12-18 months,” according to Dilara Sukhov, Moody’s lead analyst on Houghton Mifflin. “Meaningful rebound in the company’s performance in 2021 is unlikely given the potential educational funding pressures at state and local level, making it difficult for HMH to achieve earnings growth that is necessary to reduce its very high leverage and generate positive free cash flow”.
The company’s improved balance sheet going into the pandemic, no maturities until November 2024 and adequate liquidity provide some flexibility over the next 12-18 months to manage the effects of pressure on state and local government budgets.
The speculative-grade liquidity rating downgrade to SGL-3 from SGL-2 reflects Moody’s expectations for negative free cash flow generation in 2020, an erosion of the cash balances because of earnings decline in 2020 and the likelihood that recovery will be slow in 2021. HMH’s adequate liquidity is nevertheless supported by its $139 million of cash and $109 million availability on the revolver as of June 30, 2020. In July the revolver was fully repaid and remains undrawn. Also supporting the company’s liquidity are lack of near term maturities, lack of term loan financial maintenance covenants, and a springing minimum fixed charge coverage ratio on the revolver that Moody’s does not expect to be triggered.
..Issuer: Houghton Mifflin Harcourt Publishers Inc.
…. Corporate Family Rating, Downgraded to Caa1 from B3
…. Probability of Default Rating, Downgraded to Caa1-PD from B3-PD
…. Speculative Grade Liquidity Rating, Downgraded to SGL-3 from SGL-2
….Gtd Senior Secured Term Loan B, Downgraded to Caa1 (LGD4) from B3 (LGD4)
….Senior Secured Regular Bond/Debenture, Downgraded to Caa1 (LGD4) from B3 (LGD4)
..Issuer: Houghton Mifflin Harcourt Publishers Inc.
….Outlook, Remains Stable
HMH’s Caa1 CFR reflects the company’s exposure to a highly cyclical K-12 core educational market, which leads to volatility in year-over-year operating performance, cash flow, and leverage. The company’s earnings are dependent on shifts in school budgets, highly seasonal school spending, dependence on yearly fluctuations in state adoptions and intense competition from a push to utilize technology to cost-effectively improve student learning outcomes. The Caa1 corporate family rating also takes into account Moody’s expectation of the company’s negative projected free cash flow generation over the next 12-18 months and a sharp increase in Debt/EBITDA (Moody’s adjusted) to around 9x (Moody’s adjusted) by the end of 2020 from 2.9x as of FYE2019, with no meaningful rebound expected in 2021. All metrics incorporate Moody’s standard adjustments and factor in cash prepublication as a reduction to EBITDA.
Moody’s believes that HMH will need meaningful earnings growth to generate positive free cash flow in 2021 to bring down its very high debt-to-EBITDA. There are substantial risks to achieving this performance, including factors that are not in the company’s control such as the actions of competitors as well as state and local budget appropriations at a time when tax revenues are pressured by the pandemic. The company’s primary customers in the Education segment (89% of FY2019 total revenue) are public school districts, and their primary sources of funding are state and local tax collections, which are under pressure due to the coronavirus outbreak. Sufficient liquidity and lack of near-term debt maturities diminish near-term default risk and provide HMH sufficient flexibility to recover its operating performance from COVID-related revenue decline and execute its growth initiatives.
HMH’s rating continues to garner support from its good market position within K-12 educational publishing, a broad portfolio of educational publishing products, established relationships with customers, large sales force and high industry entry barriers and a well-known brand. In addition, the company’s learning Intervention products perform well, and HMH intends to expand and grow its presence in the Extensions products over the next several years. HMH is also looking to transform its business towards a service-like offering, adopting a more incremental approach toward product development. The strategic shift towards greater focus on Extensions and continuous incremental product investment will likely provide for reduced cash flow volatility over the long term and reduce reliance on highly cyclical core educational materials adoptions, but there is some operational and investment risks associated with this move as well. Moody’s anticipates that competition will remain strong, particularly in the more discretionary Extensions market. Moody’s also expects digital adoption of courseware in the K-12 market to accelerate due to the on-line and hybrid learning formats that many schools adopted across the country, presenting a growth opportunity to HMH.
The stable rating outlook reflects Moody’s expectation that HMH will maintain adequate liquidity and will manage its cost base appropriately should actual sales and billings continue to decline.
An on-going digitalization of education content and delivery is driving a shift in the education market. Moody’s views growing acceptance of educational solutions in digital formats as an important social trend that has been reshaping and will continue to transform the way HMH and its peers go to market. HMH responds to these social trends by investing in adaptive learning, real-time interaction and personalized educational content in a platform- and device-agnostic manner. Further accelerated by the coronavirus pandemic, schools are using more digital content in their classrooms and implementing online or blended learning tools, which is shifting the historical mix of print and digital educational materials, continuing to transform the company’s growth strategy.
The spread of the coronavirus outbreak and deteriorating global economic outlook are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The media/publishing has been one of the sectors most significantly affected by the shock given its sensitivity to consumer demand and sentiment. More specifically, the weaknesses in HMH’s credit profile have left it vulnerable to shifts in market sentiment in these unprecedented operating conditions and the company remains vulnerable to the outbreak continuing to spread. The timing and format of all schools’ reopening around the country remains uncertain, as different jurisdictions evaluate potential public health implications of reopening. The closure of physical facilities has led to an accelerated transition to various forms of remote learning and to a broader adoption of digital courseware. Moody’s regards the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety.
The coronavirus outbreak has placed an increased level of uncertainty regarding school districts’ ability and willingness to make purchasing decisions in the midst of the coronavirus pandemic and during the recovery, when school districts may face funding constraints as states consider passing revenue declines downstream to balance their budgets.
The governance risks Moody’s considers in HMH’s credit profile include an aggressive financial strategy. While the current management team has noted their priority of debt repayment as a financial strategy and has successfully managed a challenging liquidity position during a trough period, the company has taken advantage of strong adoption year performance to provide for shareholder returns in 2015-2016, resulting in subsequent liquidity challenges.
LIQUIDITY AND STRUCTURAL CONSIDERATIONS
The company’s SGL-3 speculative-grade liquidity rating reflects adequate liquidity. It is based on Moody’s expectations that HMH’s existing cash and availability on its $250 million ABL revolver (undrawn in July) are projected to be sufficient to absorb negative free cash flows over the next 12-18 months and fund seasonal working capital needs and the term loan amortization. The ABL revolver matures in November 2024. It is subject to a springing minimum 1.0x fixed charge coverage ratio (FCCR) that Moody’s does not expect to be tested over the next 12-18 months. HMH does not face funded debt maturities until November 2024 when the term loan comes due.
HMH’s $306 million senior secured note due February 2025 and the $380 million first lien term loan due November 2024 are each rated Caa1, reflecting the company’s Caa1-PD Probability of Default Rating and an average expected family recovery rate of 50% at default as these obligations account for the vast majority of the capital structure. The first-lien debt is effectively subordinated to the $250 million ABL revolver with respect to the securitized assets.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Ratings could be downgraded due to a material miss in the key 2020 Q3 metrics, if investment spending or operating weakness leads to continued negative free cash flow, leading to liquidity deterioration (including heavy reliance on the ABL revolver). Market share erosion and extended delays in local or state spending on education materials will also result in a downgrade.
HMH will need to stabilize and grow revenue and earnings, generate positive free cash flow and meaningfully reduce leverage to be considered for an upgrade.
The principal methodology used in these ratings was Media Industry published in June 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1077538. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
Headquartered in Boston, MA, Houghton Mifflin Harcourt Company is one of the three largest US education publishers focusing on the K-12 market with roughly $1.25 billion of reported revenue for the 12 months ended June 30, 2020. The company is publicly traded with Anchorage Capital Group, L.L.C. as the largest shareholder with an approximate 15.9% ownership of the company; Wellington Management Company owns 10.7% and the Vanguard Group Inc. owns 7.4%, with the remainder being widely held.
For further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
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Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
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Dilara Sukhov, CFA Asst Vice President - Analyst Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Lenny J. Ajzenman Associate Managing Director Corporate Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653
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