Ontario Pressures McGraw-Hill as Teachers’ Pension Needs Rise
McGraw-Hill Cos. may be forced to sell its education business, and some of the pressure is coming from Canadian teachers seeking to bolster their pension.
The Ontario Teachers’ Pension Plan disclosed on Aug. 1 that it’s working with hedge fund Jana Partners to press New York- based McGraw-Hill for changes that would boost the share price. The company’s units, which include Standard & Poor’s and J.D. Power & Associates, are worth about a third more when separated than they are under the roof of 123-year-old McGraw Hill, said William Bird, an analyst at Lazard Capital Markets.
The move into public shareholder activism is an unusual step for Ontario Teachers’, and highlights the need for pension plans to invest more aggressively to meet rising liabilities. Teachers’, which in the past has shunned high-profile activist investments in favor of deals with investors suchs as Brazilian billionaire Eike Batista to buy stakes in companies and build them up, has to pay two retirees for every three teachers still working, compared with 20 workers for every two retirees in 1970.
“It’s unusual that they’re out there in this way trying to influence what management does,” said Steven Kaplan, a professor at the University of Chicago Booth School of Business. “They’re taking the strategy from private equity to the hedge funds.”
Deborah Allan, a spokeswoman for Teachers’, declined to comment on McGraw-Hill beyond the government filing.
McGraw-Hill, founded in 1888 by Chief Executive Officer Terry McGraw’s great-grandfather, James H. McGraw, has struggled to regain its 2007 stock-price peak of $71.96. Investors would benefit if the company were to separate its education business, whose growth has stalled, from more profitable financial- information units, said Ed Atorino, an analyst at Benchmark Co. in New York.
“The education business is clearly holding it back,” Atorino said in a telephone interview. “That would be a logical division of McGraw-Hill that Wall Street has been talking to Terry McGraw about for years.”
Teachers’ and Jana’s combined stake, at 5.2 percent, may not be enough to dictate the publisher’s strategy, Atorino also said.
Aside from its education and bond-rating businesses, McGraw-Hill’s financial division sells the S&P indexes, equity research and products for valuation and risk strategies and quantitative analysis. J.D. Power & Associates is a marketing information services company. In 2009, the company agreed to sell BusinessWeek magazine to Bloomberg LP, the owner of Bloomberg News.
Other units include Platts, which provides energy and commodities information, Aviation Week, with publications on airlines, aerospace and defense, and McGraw-Hill Construction, a specialty publisher for builders and architects. McGraw-Hill Broadcasting owns local television channels in California, Colorado and Indiana.
The units are worth about $50 a share, 21 percent above the closing price of $41.41 on Aug. 1, Atorino said. Bird at Lazard Capital Markets put the breakup value at about $55 a share, 33 percent more, in a note Aug. 1. The value could climb to $70 if McGraw-Hill buys back stock and sells businesses at a premium, he said.
McGraw-Hill rose 22 cents, or 0.5 percent, to $44.65 at 4 p.m. yesterday in New York Stock Exchange composite trading. The stock gained 7.3 percent on Aug. 2 after Jana and Teachers’ made their filing. It has gained 23 percent this year.
Teachers’, which managed C$107.5 billion ($112 billion) as of the end of 2010, owns a stake in McGraw-Hill equaling about 2.9 percent of the shares outstanding, according to the filing. The pension owns some shares directly and some through a separate account managed by Jana, the filing said.
The relationship investing unit, part of Teachers’ public equities business, is managed by William Royan, a former executive at Lehman Brothers Holdings Inc. and JPMorgan Chase & Co. who joined Teachers’ in 2008.
Royan and Jana’s Barry Rosenstein are scheduled to meet with McGraw-Hill Chairman Terry McGraw next week to discuss their ideas for the publisher, two people familiar with the matter said.
Teachers’ has pursued a strategy of direct investing for almost two decades, pressing to maximize returns in areas such as private equity and real estate. Doing its own investing helps Teachers’ avoid fees that private-equity managers charge, typically 2 percent annually and 20 percent of profits, a structure known as “2 and 20.”
The pension does make investments in, and pay the requisite fees to, a small number of private-equity and hedge funds that have expertise it can’t easily replicate in-house, including media specialist Providence Equity Partners Inc. and technology investor Silver Lake Partners, as well as Jana, which works on activist deals like McGraw-Hill.
The need for higher returns is more than academic for Teachers’, where liabilities are growing faster than assets. That’s because the ratio of working members to retirees dropped to 1.5 to 1 in 2010, from 10 to 1 in 1970. Benefit payments exceeded contributions by $1.8 billion last year, according to the pension’s annual report, which is posted on its website.
Teachers’ on July 6 said the government and the teachers’ federation approved a plan to address a C$17.2 billion shortfall, which includes a contribution rate increase and smaller cost-of-living increases for some pensioners.
Ontario Teachers’ relationship investing division was an early backer of low-cost carrier WestJet Airlines Ltd. (WJA), and energy and resources companies including Sherritt International Corp., OGX Petroleo & Gas Participacoes SA and Nexen Inc. The team has established a history of working cooperatively with management, according to Teachers’ website.
The fund invested in Brazilian mining company MMX Mineracao e Metalicos SA in 2006, and worked with management and provided capital to help build a logistics company, LLX Logistica SA, which has traded publicly since mid-2008.
In 2008 Teachers’ joined investors led by Corsair Capital LLC in the $7 billion recapitalization of Cleveland-based bank National City Corp. Later that year, Ohio’s largest bank was sold to PNC Financial Services Group Inc.
Last year, what began as a cordial relationship turned sour with Toronto-based Maple Leaf Foods Inc. (MFI) Royan and Wayne Kozun, who oversees all of the pension’s public equities investments, resigned from Maple Leaf Foods’ board of directors and sold its stake in the firm, after Teachers’ publicly opposed a so-called poison pill provision that the company sought to put in place.
Teachers’, through Royan’s relationship investing group, is currently part of a group of banks and pensions that’s offering to buy Toronto Stock Exchange owner TMX Group Inc.
Teachers’ said in April it had a 14 percent return on its investments in 2010, the best performance in the fund’s history according to Leech. The pension manages the benefits of 178,000 teachers at secondary and elementary schools in the province, the country’s most populous, as well as 117,000 pensioners.
While it dates to 1917, it was made an independent entity in 1990. Since then, the pension has moved toward making most of its investments directly and about 60 percent of its private- equity deals are managed in-house instead of through third-party funds. Building that expertise has given Teachers’ confidence to expand its horizons, especially as returns become more important, University of Chicago’s Kaplan said.
“They pick funds that are very good, and they have their own people to analyze deals,” he said. “It’s very consistent with private equity. The economic motivation is the same.”
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