Our first reaction to McGraw-Hill’s acquisition of J.D. Power was “here we go again.” The industry is littered with research firms that have floundered under the ownership of big media firms. Think Yankee and Tower Group under Reuters, and Simba under Primedia. The research industry's operating paradigms are entirely different from big media firms'; managing a research company is unlike almost anything McGraw-Hill does today.
There’s no obvious strategic fit between McGraw-Hill’s other properties in B2B markets and J.D. Power’s consumer satisfaction ratings; nor is there any evident operational leverage or synergy beyond corporate functions like finance, HR, and perhaps IT. There might be opportunities to drive consumer satisfaction data into the rich data McGraw-Hill provides to industries like construction, aviation, and healthcare.
At the end of the day, however, looking for a strategic fit here might be missing the point. Word on the street is that the usual potential strategic buyers have come and gone, without voting with their dollars. McGraw-Hill likely got a deal on J.D. Power – perhaps as low as 1.5x or 2x revenue, less than $300 million, and it can choose to pay cash and not add to debt. What it gets in return is what we estimate to be a 5 percent boost to its earnings per share in the first year, a relatively small deal in terms of McGraw-Hill's $5.25 billion revenue. Or, put another way, McGraw-Hill’s market capitalization of $18.15 billion on that revenue adds up to a 3.5x market cap valuation ratio, compared to the 1.5x to 2x it paid for J.D. Power - so the market cap is well leveraged.
In other words, if the deal pays financially, any strategic leverage it can squeeze out of it is all gravy. Which just goes to show you that looking for the strategic fit is not always the only way to view these deals. For Wall Street and large public companies, in some cases a financial play makes great sense. By maintaining J.D. Power’s independence and brand, and keeping tabs on costs, McGraw-Hill can reward shareholders through this deal, even if there are questions about J.D. Power's near-term revenue growth and transition to online methodology.
