Fool on the Street: McGraw-Hill Poised for Profits

At the recent Global Media Conference hosted by UBS (NYSE: UBS  ) , McGraw-Hill (NYSE: MHP  ) presented its outlook and strategic vision. The company was justifiably optimistic, given strong headwinds in many of its key markets.

McGraw-Hill's three main markets are education, financial services, and media. In education, McGraw noted that 24 states boosted K-12 educational funding budgets for 2007, and 20 states increased higher education funding, which means more dollars for McGraw textbooks and testing materials. The company also noted that the "No Child Left Behind" initiative looks like it will be re-approved in 2007, given that the two committee chairs with authorization oversight are strong supporters.

McGraw also has some exciting pockets of growth in digital products, with 40 new online courses released in 2006. The company expected the career school, elementary through high school, and college markets to grow 4% to 6%, and expects to outperform these growth rates and take market share.

In financial services, McGraw-Hill continues to occupy a sweet spot in the industry. Through its credit rating subsidiary, Standard & Poor's, the company continues to benefit from globalization of financial markets, securitization, leveraged buyout growth, and increasingly sophisticated methods of packaging and repackaging credit (such as increasing usage of collateralized debt obligations, structured finance, credit default swaps, and other credit-linked derivatives). For example, because of globalization, foreign investors look to overseas markets for fixed-income securities, which creates a new base of customers for credit ratings. All of these trends increase demand for Standard & Poor's services, as well as those of fellow credit rating firm Moody's (NYSE: MCO  ) .

McGraw-Hill also provides informational services and indexing products through recently acquired Capital IQ and Compustat. By coupling Compustat with Capital IQ, McGraw provides a more powerful informational database that many customers find indispensable. Since its 2004 acquisition, Capital IQ's subscriber count has doubled. Also, in 2006, 35 exchange-traded funds (ETFs) based on S&P indices were launched, with 43 more already on tap for future launch.

Management provided an update on the Credit Rating Agency Reform Act -- an initiative to overhaul credit rating regulation. The company was pleased with some key improvements in the bill, which include stipulations that for a firm to attain status as a nationally recognized statistical rating organization (NRSRO), the firm must provide its customers with the value of its credit rating services. The law was also drafted to supersede state regulation -- which prevents 50 different states from drafting their own sets of complex regulations. Currently, only five firms enjoy NRSRO status. The easier it becomes to attain a NRSRO designation, the more potential competition current NRSROs such as S&P face, so it's positive if barriers to entry become steeper. All in all, McGraw expects to see continued double-digit growth in financial services.

In the media segment, Business Week continued to show lackluster results, with flat ad pages and circulation -- which actually isn't that bad, considering that competitors have seen declining circulation bases. Also, marketing information provider J.D. Power and Associates, which was acquired in 2005, continues to diversify its revenue base away from its traditional auto-related niche.

Although McGraw-Hill's stock is up 26% over the past year, which makes it less attractive to potential value investors, the S&P engine should continue to chug along for years. As I stated in an earlier article, S&P and Moody's have superb competitive advantages, spit out free cash flow and should benefit from years of strong organic growth. I also like companies that have powerful brands, such as Business Week and J.D. Power, so I'd put McGraw-Hill on the "watch" list.

Moody's is a Motley Fool Stock Advisor selection. You can take a free 30-day trial of our flagship investing service.

Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. The Motley Fool has a disclosure policy. Emil appreciates comments, concerns, and complaints.

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