Tax reform has helped businesses large and small, and for Graham Holdings (NYSE: GHC), the impact of reduced corporate tax rates was extremely large. The company behind the Kaplan education brand has had to deal with headwinds to its business, and so the windfall that tax reform gave Graham was welcome even if it didn't directly address some of the fundamental problems that the mini-conglomerate's various divisions have faced lately.
Coming into Friday's fourth-quarter financial report, Graham Holdings' investors wanted to see better operational results from the company's businesses. Challenges both for education and in Graham's broadcast operations took their toll on the tax-adjusted figures. Let's look more closely at Graham Holdings and what its results mean for the future.
Image source: Kaplan, a division of Graham Holdings.
A gift from the tax man
Graham's fourth-quarter numbers certainly look impressive on their face. Revenue rose 7% to $675.8 million, which accelerated slightly from what the company managed to produce in the third quarter. GAAP net income jumped nearly sixfold to $214.2 million. However, when you exclude the impact of various restructuring charges and other one-time items, adjusted earnings of $7.77 per share were down substantially from the corresponding $9.68 per share figure for the fourth quarter of 2016.
The big reason for the different looks for Graham's performance was tax reform. The education and media conglomerate said that it earned a positive adjustment of $177.5 million, or almost $32 per share, from the revaluation of net deferred tax benefits related to the Tax Cuts and Jobs Act.
Graham's Kaplan business kept weighing on overall performance, with segment revenue falling 3% for the quarter and operating income declining by more than a third. As we've seen in the past, the weakest performance came from Kaplan's higher education concentration, with a double-digit percentage drop in sales that hit the unit's bottom line by nearly 70%. By contrast, the test preparation business saw only a 3% revenue decline, and the division reversed a year-earlier operating loss to actually post modest income. The highly profitable international education segment saw revenue gains of 3%, but operating income was down by 15% from year-ago levels.
Performance at Graham's broadcast division was mixed. Revenue was higher by 2%, but those gains stemmed from the acquisition of two new stations, without which adjusted sales would have fallen by 4%. Reduced political advertising was the primary culprit, and operating income plunged 30% due to higher network fees for the media properties.
Once again, what Graham refers to as "other businesses" arguably had the best results. Sales soared 42%, and despite a big rise in expenses, operating income reversed a year-earlier loss to make $3.75 million. Businesses like social media marketing specialist SocialCode saw nice gains in operating income from its digital ad services, while a host of other unrelated businesses were mixed.
Can Graham Holdings do better in 2018?
Going forward, tax reform should have a markedly positive impact for Graham. The company's effective tax rate in 2016 was more than 32%, and without the one-time adjustments for tax reform, 2017 saw an increase to nearly 35%. A 21% corporate tax rate won't necessarily pull Graham's overall effective taxes down the full 14 percentage points, but it will still be a positive influence that should help lift earnings when the company starts reporting 2018 results.
More broadly, there are some reasons why 2018 might be better for Graham. On the broadcast side of the business, events like the Winter Olympics could help with first-quarter viewership, and the expectation for a contentious midterm election at the end of the year could drive political advertising to unprecedented levels after recent weakness. Meanwhile, Kaplan seems to be moving forward as best it can with restructuring efforts, but the environment for the for-profit education industry seems to remain mixed at best.
Graham Holdings investors seemed satisfied with the results, and the stock climbed 2% on Friday following the earnings announcement. Lower taxes will help Graham, but it eventually needs to find more ways to boost the growth of its core businesses in order to find long-term success.
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