Fitch: Houghton Mifflin’s Bank Facility Would Be Rated BB+/RR1
Fitch Ratings has a D Issuer Default Rating (IDR) on Houghton Mifflin Harcourt Publishers Inc. (HMH) and its subsidiaries. There is no assigned Rating Outlook.
Fitch believes upon exiting bankruptcy (expected by the end of June 2012), the IDR of HMH and its issuing subsidiaries would be B+. Given the strong recovery prospects, the $250 million senior secured term loan and the $250 million asset backed credit facility would be notched up at a BB+/RR1 rating. This Recovery Rating analysis reflect a restructuring scenario (going-concern) and an adjusted, distressed enterprise valuation of $1.4 billion using a 6 times (x) multiple.
Term loan facility provisions/covenants includes 1% annual required amortization and a provision that requires 50% of excess cash flow to be dedicated to reducing debt balances (starting in 2014, the excess cash flow repayment is not required if covenant leverage is under 0.75x); covenant leverage of 2.25x (declining to 2x on Dec. 31, 2013); interest coverage of 7x (increasing ultimately to 9x by March 31, 2014); and change of control provision. Fitch notes that the restricted payments are primarily limited by the financial covenants and a required minimum liquidity of $250 million.
Fitch does not believe that the post bankruptcy capital structure will be permanent. The current private equity ownership and the risk to HMH’s balance sheet from shareholder friendly actions and an investment exit weigh on the ratings. Fitch believes the sponsors could look to extract shareholder returns (leveraged dividend) prior to exiting their investment. Fitch does not believe that such a transaction would occur in the near term.
Upon bankruptcy exit, Fitch calculates post plate unadjusted gross leverage of 2.1x as of March 31, 2012. Fitch expects leverage to decline by years end, remaining above 1x. Fitch expects total funded debt post bankruptcy to be $250 million.
Liquidity upon exit of bankruptcy is expected to include $141 million in cash and HMH’s undrawn $250 million ABL facility. Fitch expects 2012 ending cash balance to be $350 million to $450 million.
Fitch expects free cash flow (FCF) to continue to be negative in 2012 (impacted in part by cost associated with the new debt issuance, bankruptcy filings and interest payments associated with its previous $3.1 billion debt balance). Fitch expects FCF to turn positive by 2014. Fitch believes the company has sufficient liquidity to endure negative FCF over the next one to two years.
HMH continues to be a provider in the K-12 educational material and services sector, capturing 41% of its Association of American Publishers addressable market. Fitch believes investments made into digital products and services will position HMH to take a meaningful share of the rebound in the K-12 educational market. Fitch’s expects HMH will be able to, at a minimum, defend its market share.
Fitch expects Basal revenues to continue to decline in the mid to high- single digits in 2012. Under Fitch conservative base case, total revenues decline in the low single digits can be accommodated in the potential B+ rating. The education business is in a cyclical trough, and Fitch believes that HMH and its peers will benefit from the adoption of common core standards in 2014/2015.