Houghton Mifflin Owner EMPG set for Refinancing

The Irish Independent is reporting advanced debt for equity discussions with loaning banks of troubled Houghton Mifflin Harcourt owner Education Media Publishing Group. The refinancing is likely to significantly reduce CEO/Chairman Barry O'Callaghan's 38pc ownership in EMPG. (Independent)

Other items of note:

• Operationally EMPG appears to be doing well with 'strong cash flow'
• Synergy and savings are pushing EBITDA close to $1bill up 20%
• The company has pulled out of the ratings service after downgrades
• Lending banks have agreed to relax some of their covenants
• Bertelsemann offered to invest $300mm in EMPG but was rejected
• The debt to equity swap will further dilute Reed Elseviers share
  

Houghton Mifflin Harcourt Lose Credit Rating

Speculation about the financial health of Houghton Mifflin Harcourt took another turn for the worst when Moody's debt rating agency removed its' rating on HHM's debt. According to the report in the Irish Times the action by Moody's will impact virtually all the company's debt and it likely to both further raise the cost of their borrowing (although they were already at Caa3 with a negative note) and increase the expectation the company will default. From the Irish Times report:

Moody’s said that it took into account “the business risk and competitive position of the company versus others within its industry; the capital structure and financial risk of the company; the projected financial and operating performance of the company over the near-to-intermediate term, and management’s track record and tolerance for risk”.

Last month, Moody’s downgraded some of HMH’s debts to Caa3 from Caa1, and put it on a negative outlook. The move meant that it classed the company’s debts as high risk.

Earlier this year, long time HMH executive and current CEO Tony Lucki retired and was replaced by Barry O'Callaghan.

Riverdeep Syndication Update

The Irish Independent is reporting that the banks supporting Riverdeep in its acquisition of Harcourt may be able to syndicate some of the debt they financed in the deal. The company had been saddled with over $7.0bill in debt but have reduced the debt by selling their college division for $600m. Credit Suisse the lead bank has sold down their senior debt and is now working on the secondary loan. The company also reaffirmed it will achieve operating efficiencies amounting to $320mm per year within three years from the combination of the operations of Houghton Mifflin and Harcourt.

From the article:

Credit Suisse is in the process of selling down EMPG's €1.7bn second-lien loan, which ranks behind a traditional senior credit facility in terms of security. "We expect this tranche to be fully syndicated by the end of the summer," said Barry O'Callaghan, executive chairman of EPMG in a letter to shareholders. "This demonstrates that, notwithstanding the current issues with credit markets globally, investors have sufficient confidence in our business model and prospects to purchase our debt."

The Riverdeep Deal

The Irish Independent takes a look at the Riverdeep deal and concludes that if all the pieces fall into place Barry O'Callaghan's stake in the business could soar to $2.2bn. Davy, which is the broker for Riverdeep, comments in their offering document that "equity investors could potentially double their investment over the next two years". They go on to explain how this may occur via various an exit strategy options:

While the broker said it is too early to discuss how investors will realise gains, potential exit strategies over the next two to five years include a stock market flotation in America or a trade sale "to a large international publishing company such as Newscorp or Viacom". It said a third option of refinancing the group is the least likely route, given the current state of the debt markets and EMPG's relatively high existing debt.

In the Independent article all so notes the potential for cost and efficiency gains that are assumed in the combination of HM and Riverdeep.

Cengage Swoop on HM College Division

Cengage announced they have reached a definitive agreement to acquire the College publishing assets of Houghton Mifflin for $750mm in cash. The companies also announced that on closing they would work together to expand the distribution of Cengage’s college textbooks and related materials into the U.S. high school market, with particular emphasis on Advanced Placement and Honors programs. From the press release:

“We’re very pleased to acquire the well-respected assets of HM College, which are highly complementary to our existing business,” said Ronald Dunn, President and CEO of Cengage Learning. “We look forward to combining the people, products and publishing programs of HM College and Cengage Learning to expand and enhance our range of services for students, instructors and institutions in the higher education market.”

The divestiture will enable Houghton Mifflin to focus on its K-12 education products but it will undoubtedly strengthen Cengage's position in College. How valuable the marketing agreement will be is unknown although selling College text into the high school market has been growing over the past five years.

Importantly, Cengage has demonstrated that despite the huge price paid for the business they are able to go back to the well (bankers) to make this acquisition. Their investors recognise that the base business is doing well and this acquisition represents an opportunity to strengthen their market position. Perhaps this is at the expense of Houghton Mifflin whos banks announced last week that they could not sell their loan syndication.

On a related note, Cengage presented a brief overview of their first quarter performance and they reported consolidated revenues of $650.1mm up 5.1% versus the same period last year. Operating Income of $247.1mm was up 10% (before allocations and amortization). Higher ed and International delivered strong performance with revenues up 7% and 13% respectively. The library division (Gale) under performed with revenues and operating income off 5.9%. During the conference call CEO Ron Dunn listed several areas where the company is focusing their attention. These include establishing their new leadership team, driving revenue growth, reorganization of international and merging higher ed and professional publishing.

Riverdeep Syndication Gone Awry

As mentioned a few weeks ago, Riverdeeps banks (Credit Suisse, Lehman Brothers and Citigroup) conducted a roadshow to sell the debt associated with the Riverdeep acquisition of Harcourt. According to the Irish Times, the banks have suspended this process and will hang on tooth and nail to the debt themselves until the markets improve.

This will have limited impact on the operations of Riverdeep/Houghton Mifflin and while this is not positive news it could only reflect a desire for the banks to maintain a decent margin on the syndication rather than judgements about the risk of the underlying loans. At least that's what I would be saying if I were Riverdeep.

Riverdeep Syndication

Riverdeep's banks are in the process of delivering their road show (Reuters) to sell the debt proposed as part of the Riverdeep acquisition. If there are any legitimate concerns regarding the financial structure of this deal they are likely to become apparent as this syndication gets underway. As reported earlier this month, an analyst from Dresdner suggested their were concerned about the ability of Riverdeep to service the debt load that their acquisition binge has imposed on the company; however, no one else has voiced a similar concern since that statement was made public. If you want to get in on it you need to be in London on the first of November or New York on the fifth. We wait to see.

Riverdeep Rumor and Reed Elsevier "Buy"

A curious note from Usman Ghazi of Dresdner Kleinwort who, in the process of recommeding Reed Elsevier as a buy - with a target price of 780p - takes note of rumors suggesting Riverdeep risk "either not securing the bank funding required to finalize the [Harcourt] transaction or going bankrupt in the intervening period, leaving the deal unfinished." He dismisses these rumours and I can't find any other suggestion of these issues so how much of a concern are they?