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The Depth Report – Houghton Mifflin Harcourt (HMHC) – Big Price for the Publishing Division

In early February, we wrote about Houghton Mifflin Harcourt (HMHC) recommending purchasing the stock due to an improving business model. In that piece, we noted that the company was considering the sale of its Books & Media business, and that proceeds would likely be used to pay down debt. Yesterday, Houghton Mifflin announced the sale of this division to HarperCollins Publishers, a division of News Corp for $349MM.

It’s a Big Price:
During the past 3 years, adjusted EBITDA for the Books & Media division was $26.6MM, $14.9MM, and $21.9MM[1]. In conjunction with the deal, Houghton Mifflin reduced billings guidance for 2021 by around $200MM and kept unlevered free cash flow margin in the 9% – 11% range. So, the division has been earning around $20MM a year, and the company just adjusted guidance by around $20MM for this year. That means News Corp is paying 17.5x EBITDA for the division. We suspect that HarperCollins will be able to cut costs, and that the pro-forma multiple they’re paying will be lower. Either way, the price is a win for HMHC.

Use of Proceeds:
Houghton Mifflin has already said they’ll use the proceeds of the deal to pay down debt. As of 12/31/20, HMHC had $644MM of gross debt and $363MM of net debt. That means that following the sale, the company will be completely deleveraged. Assuming the company can use sale proceeds to reduce the debt load, it can cut 2020’s $66MM of interest expense by more than 50%. Netting the $20MM of sold EBITDA against the interest savings means that HMHC could end up with an additional $15MM of EBITDA annually post-sale. Given that we estimate mid-cycle free cash flow to be around $115MM, the transaction should lead to a 13% lift in average annual free cash flow.

Houghton Mifflin got a huge price for a non-core division, increased post-deal free cash flow, and completely deleveraged the company in one transaction. We note that we alerted Deep Knowledge Investing subscribers to the opportunity in HMHC in late January with the stock at $5. As of this writing, it is up 50% in the two months since then. Last week, when the stock dropped below $6, we alerted subscribers that we were buying more. As of this writing, it is up 25% in the 3 days since then.

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[1] HMHC 2020 10-K report, page 10.

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