Thirteen years after Apollo Global Management, Inc. (APO) took McGraw Hill, Inc. (MH: $17/share) private, the global education solutions provider, raised $415 million in its initial public offering (IPO) at a valuation of $3.25 billion. Sold in 2021 by Apollo to Platinum Equity, LLC for $4.5 billion, the company sought a $4.2 billion valuation, and to raise $537 million. These details alone are enough to rouse the suspicion that this is a business in decline, at a time when private equity-backed IPOs are on the rise, even at the price of markdowns, in order to improve their liquidity in a climate of inflationary pressures, somewhat elevated interest rates, and geopolitical uncertainty. As this thesis will show, McGraw Hill is a business whose products are facing commodisation, which has experienced value-less growth, and faces pressure from niche players, and is priced for a surge in profitability. These factors lead me to assign a “Very Unattractive” rating to the forthcoming stock.
The Commoditization of Education Resources
With competitors such as AMBOSS, Amplify, Cengage, Curriculum Associates, Elsevier, Houghton Mifflin Harcourt, Macmillan Learning, Pearson plc (PSORF), RELX PLC (RELX), Savvas, and Wolters Kluwer N.V. (WOLTF), the industry structure is oligopolistic, with McGraw Hill touting in its S-1 filing, an industry defined by a “relatively small number of large competitors”, in which none of its peers competes with it “across the full learning lifecycle”, “from K-12 to higher education and through professional learning”. However, this is an industry under siege in the wake of the Internet Revolution. As McGraw Hill itself observes, it also faces competition from “open educational resources, which may offer similar digital products at lower costs”.
McGraw Hill’s core value proposition is being eroded by a fundamental shift in the education value chain. In decades past, the legacy providers benefitted from high transaction costs related to physical production, relationships with institutions, distribution networks, and bundled content, which made centralised publishers indispensable. These publishers could control distribution, and integrate that backwards with control of authors, in order to earn and conserve attractive profits. Indeed, the company says of itself that,
The quality of our content and the effectiveness of our digital solutions are fundamental aspects of our business, and third parties such as authors, subject matter experts and software engineers help to enable us to maintain and to continuously improve in these areas.
In a world of high transaction costs, control of supply relationships was enough to conserve attractive profits. The Internet Revolution reduced the cost of distribution to zero for those publishers with digital goods, reducing to little the importance of supply integration. Moreover, with the cost of transactions reduced to zero, distributors could integrate forward with their users at scale. With educators and learners integrated, direct access to modular, digital content, and platforms was enabled. With control shifting downstream toward users, supply has become commoditized, with user experience rather than control of supplier relationships the key differentiator. Consequently, as Mcgraw Hill acknowledges, it faces competition from digital products that can be delivered at no cost, and offered free of charge. Open education resources such as MIT OpenCourseWare, and Khan Academy, show that education resources have been commoditized. The company acknowledges this commoditization, saying,
Free or relatively inexpensive educational products are becoming increasingly available, particularly in digital formats and through the internet. For example, some governmental and regulatory agencies have recently increased the amount of information they make publicly available at nominal cost or for free. In recent years, there have also been initiatives by not-for-profit organizations to develop educational content that can be “open sourced” and made available to educational institutions for free or nominal cost. In addition, there have been initiatives by the U.S. federal government and certain state governments to enact legislation or regulations that mandate or favor the use by educational institutions of open sourced content and provide funding for the same. The increased availability of free or relatively inexpensive educational products may reduce demand for our products or require us to reduce pricing, thereby impacting our sales revenue.
Large language models ((LLMs)) pose another threat, delivering commoditized education resources in highly personalized ways, even as the company warns that it can deliver inaccurate information. Again, McGraw Hill acknowledges this. Much as Mark Zuckerberg aims at the commoditization of advertising and a world in which Meta Platforms (META) can create ads with AI, generative AI could lead to a world in which educational resources are created by cannibalizing existing content created by McGraw Hill and its peers.
Finally, with platforms such as Patreon and Substack making it possible for authors and subject matter experts to directly engage with educators, and students, the scale of competition is actually rather great. In its Risk Factors section, McGraw Hill acknowledge that,
The market shift toward digital education solutions has induced both established technology companies and new start-up companies to enter certain segments of our market. The risks of competition are intensified due to the rapid changes in the products our competitors are offering, the products our customers are seeking and our sales and distribution channels, which create increased opportunities for significant shifts in market share. Competition may require us to reduce the price of some of our products or make additional capital investments and may result in reductions in our market share and sales.
In attracting these authors and subject matter experts, McGraw Hill not only has to consider what competitors could offer them, but what they can earn if they embrace the disintermediation offered by the internet.
Where McGraw Hill paints a portrait of an attractive industry structure, the realities of the Internet Revolution are that McGraw Hill is structurally disadvantaged and prevents it from exercising the kind of pricing power needed to create value, or to protect the bottom line in challenging times. The import of this is that, while McGraw Hill can boast that “ in the United States, on average, 89% of K-12, higher education and medical school students, faculty and administrators would consider McGraw Hill for their classes”, there is downward pressure on the prices it can charge, because there are free alternatives.
Full Learning Lifecycle Integration is Not a Strength
McGraw Hill, as aforementioned, provides educational resources throughout the learning cycle, from K-12 to professional, competing in the United States and abroad. This is not the advantage that it appears to be. If transaction costs have hurtled toward zero as a result of the Internet Revolution, swelling the number of competitors, then, not only is it easier for niche producers to emerge such as AMBOSS, who educational resources for medical doctors and students, it is also easier for schools and students to access their content, and, I think, more sensible. The specialised knowledge that AMBOSS possesses is likely to be greater than that available to McGraw Hill, and, with focus comes an ability to better reflect the needs of niche markets.
Growth Without Value
Since fiscal 2023, McGraw Hill has grown revenue by 3.85% a year. This is a rather low level of growth and reflects the maturity of the business. Growth has come with rising profitability, with the firm’s net operating profit after tax (NOPAT) going from -$6.44 million to $159.04 million. Driving the rise in profitability has been an improvement in the firm’s NOPAT margin from -0.33% to 7.57%. McGraw Hill’s invested capital turns have declined, however, from 0.85 in fiscal 2024 to 0.48 in fiscal 2025, leading to a fall in return on invested capital (ROIC) from 3.78% in fiscal 2024 to 3.61% in fiscal 2025. McGraw Hill’s anemic profitability has profound consequences on its ability to create and grow value, that is, to earn ROIC in excess of the cost of capital, with the firm generating economic losses in both fiscal 2024 and 2025.
Debt Weighs Heavily on the Company
Absent the impact of the firm’s adjusted total debt, McGraw Hill has an economic book value (EBV) of $1.9 billion based on the IPO price, and a price-EBV ratio of 1.71, implying a 71% growth in NOPAT from current levels. However, with debt, some $3.27 billion, the EBV of the company sinks to -$877.56 million, with a PEBV of -3.7. Loaded with debt that its economics cannot support, McGraw Hill’s value has been obliterated.
Priced for a Surge in Profitability
Using my reverse discounted cash flow (DCF) model, I analysed the price-implied expectations for future cash flow, and found clear evidence that the company is a very unattractive investment proposition.
In order to justify its IPO price my model shows that McGraw Hill will have to:
- immediately improve its NOPAT margin to 9.9% in fiscal 2026, 12.37% in fiscal 2027, 17.32% in fiscal 2028, 19.8% in fiscal 2029, and 22.27% in fiscal 2030
- revenue grows by 3.85%, its 2-year CAGR.
In this scenario, McGraw Hill generates $2.5 billion in revenue, and $565.39 million in NOPAT in fiscal 2032, with NOPAT compounding by an average of 13.62% a year within its market-implied competitive advantage period (MICAP) of four years.
In my second DCF scenario, I unlocked the downsides of this valuation if this surge in profitability does not materialise.
If one assumes that McGraw Hill’s
- NOPAT margin rises to 9.9%, and,
- revenue grows by 7.18% a year, its 1-year CAGR, then,
McGraw Hill is worth $1.37 per share, a 91.94% downside to the target valuation. In this scenario, McGraw Hill generates $2.97 billion in revenue and $294.24 million in NOPAT in fiscal 2030.
Finally, if,
- NOPAT margin jumps to 14.85%, and,
- revenue grows by 7.18% a year, then,
McGraw Hill is worth $10.07 per share, a downside of 40.76% from the target valuation. In this scenario, the firm earns $441.36 million in NOPAT.
In each of these scenarios, I assumed that Mcgraw Hill will not have to grow its net working capital or adjusted fixed assets. Should McGraw Hill need to grow its invested capital, the stock’s riskiness is even greater. The lesson is simple: given how deep a hole the firm’s debt has left, even incredible performance will not be enough to make the present valuation palatable.