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.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.
These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
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.
The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.
Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.
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
© 2020 Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved.
CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. AND/OR ITS CREDIT RATINGS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND MATERIALS, PRODUCTS, SERVICES AND INFORMATION PUBLISHED BY MOODY'S (COLLECTIVELY, "PUBLICATIONS") MAY INCLUDE SUCH CURRENT OPINIONS. MOODY'S INVESTORS SERVICE DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT OR IMPAIRMENT. SEE MOODY'S RATING SYMBOLS AND DEFINITIONS PUBLICATION FOR INFORMATION ON THE TYPES OF CONTRACTUAL FINANCIAL OBLIGATIONS ADDRESSED BY MOODY'S INVESTORS SERVICE CREDIT RATINGS. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS, NON-CREDIT ASSESSMENTS ("ASSESSMENTS"), AND OTHER OPINIONS INCLUDED IN MOODY'S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY'S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR COMMENTARY PUBLISHED BY MOODY'S ANALYTICS, INC. AND/OR ITS AFFILIATES. MOODY'S CREDIT RATINGS, ASSESSMENTS, OTHER OPINIONS AND PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND MOODY'S CREDIT RATINGS, ASSESSMENTS, OTHER OPINIONS AND PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. MOODY'S CREDIT RATINGS, ASSESSMENTS, OTHER OPINIONS AND PUBLICATIONS DO NOT COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY'S ISSUES ITS CREDIT RATINGS, ASSESSMENTS AND OTHER OPINIONS AND PUBLISHES ITS PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL, WITH DUE CARE, MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE.
MOODY'S CREDIT RATINGS,ASSESSMENTS, OTHER OPINIONS, AND PUBLICATIONS ARE NOT INTENDED FOR USE BY RETAIL INVESTORS AND IT WOULD BE RECKLESS AND INAPPROPRIATE FOR RETAIL INVESTORS TO USE MOODY'S CREDIT RATINGS, ASSESSMENTS, OTHER OPINIONS OR PUBLICATIONS WHEN MAKING AN INVESTMENT DECISION. IF IN DOUBT YOU SHOULD CONTACT YOUR FINANCIAL OR OTHER PROFESSIONAL ADVISER.
ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY'S PRIOR WRITTEN CONSENT.
MOODY'S CREDIT RATINGS,ASSESSMENTS, OTHER OPINIONS AND PUBLICATIONS ARE NOT INTENDED FOR USE BY ANY PERSON AS A BENCHMARK AS THAT TERM IS DEFINED FOR REGULATORY PURPOSES AND MUST NOT BE USED IN ANY WAY THAT COULD RESULT IN THEM BEING CONSIDERED A BENCHMARK.
All information contained herein is obtained by MOODY'S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided "AS IS" without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY'S is not an auditor and cannot in every instance independently verify or validate information received in the rating process or in preparing its Publications.
To the extent permitted by law, MOODY'S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability to any person or entity for any indirect, special, consequential, or incidental losses or damages whatsoever arising from or in connection with the information contained herein or the use of or inability to use any such information, even if MOODY'S or any of its directors, officers, employees, agents, representatives, licensors or suppliers is advised in advance of the possibility of such losses or damages, including but not limited to: (a) any loss of present or prospective profits or (b) any loss or damage arising where the relevant financial instrument is not the subject of a particular credit rating assigned by MOODY'S.
To the extent permitted by law, MOODY'S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability for any direct or compensatory losses or damages caused to any person or entity, including but not limited to by any negligence (but excluding fraud, willful misconduct or any other type of liability that, for the avoidance of doubt, by law cannot be excluded) on the part of, or any contingency within or beyond the control of, MOODY'S or any of its directors, officers, employees, agents, representatives, licensors or suppliers, arising from or in connection with the information contained herein or the use of or inability to use any such information.
NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY CREDIT RATING, ASSESSMENT, OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY'S IN ANY FORM OR MANNER WHATSOEVER.
Moody's Investors Service, Inc., a wholly-owned credit rating agency subsidiary of Moody's Corporation ("MCO"), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by Moody's Investors Service, Inc. have, prior to assignment of any credit rating, agreed to pay to Moody's Investors Service, Inc. for credit ratings opinions and services rendered by it fees ranging from $1,000 to approximately $2,700,000. MCO and Moody's investors Service also maintain policies and procedures to address the independence of Moody's Investors Service credit ratings and credit rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold credit ratings from Moody's Investors Service and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading "Investor Relations — Corporate Governance — Director and Shareholder Affiliation Policy."
Additional terms for Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY'S affiliate, Moody's Investors Service Pty Limited ABN 61 003 399 657AFSL 336969 and/or Moody's Analytics Australia Pty Ltd ABN 94 105 136 972 AFSL 383569 (as applicable). This document is intended to be provided only to "wholesale clients" within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODY'S that you are, or are accessing the document as a representative of, a "wholesale client" and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to "retail clients" within the meaning of section 761G of the Corporations Act 2001. MOODY'S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail investors.
Additional terms for Japan only: Moody's Japan K.K. ("MJKK") is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody's Overseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody's SF Japan K.K. ("MSFJ") is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization ("NRSRO"). Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively.
MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any credit rating, agreed to pay to MJKK or MSFJ (as applicable) for credit ratings opinions and services rendered by it fees ranging from JPY125,000 to approximately JPY250,000,000.
MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.