AI And Digital Subscriptions Will Shape Earnings Amid Competitive And Demographic Headwinds

Catalysts

About McGraw Hill

McGraw Hill provides technology enabled education solutions across K 12, Higher Education, professional and international markets.

What are the underlying business or industry changes driving this perspective?

• Although digital and AI powered tools like ALEKS, AI Reader and McGraw Hill Plus are scaling rapidly, ongoing compute costs, data infrastructure needs and content modernization may cap incremental operating leverage, tempering margin expansion and earnings growth.
• Despite strong adoption of Inclusive Access and Evergreen, the maturation of Higher Education digitization and potential enrollment pressure from demographic shifts could slow courseware volume growth over time, moderating revenue and EBITDA momentum.
• While upcoming California Math, Florida ELA and Texas Math adoptions expand the K 12 addressable market, heavy competition, cyclical budget variability and execution risk on bundled Core plus Supplemental solutions could constrain capture rates and limit upside to revenue and net margins.
• Although long standing content, proprietary learning data and domain expertise currently differentiate McGraw Hill from AI first entrants, rapid innovation in open platforms and institutional experimentation with alternative tools may compress pricing power and mix benefits, weighing on future net margins.
• While the shift toward higher margin subscriptions and growing remaining performance obligations enhances visibility, slower than expected international recovery and exposure to weaker regions such as Canada and Spain could offset domestic growth, dampening consolidated revenue and earnings expansion.

Assumptions

This narrative explores a more pessimistic perspective on McGraw Hill compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming McGraw Hill's revenue will grow by 2.4% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -5.0% today to 9.9% in 3 years time.
• The bearish analysts expect earnings to reach $222.6 million (and earnings per share of $1.16) by about December 2028, up from $-104.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $324.1 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 21.6x on those 2028 earnings, up from -31.2x today. This future PE is greater than the current PE for the US Consumer Services industry at 16.9x.
• The bearish analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.72%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• McGraw Hill's accelerating Higher Education momentum, including 14% segment revenue growth, 18.4% digital growth and market share rising to 30%, could sustain above market expansion over several years. This could lift consolidated revenue and earnings faster than implied by a flat share price outlook and support a higher valuation multiple on those earnings.
• The structural shift toward recurring, digital and subscription based models, with reoccurring revenue now 63% of total, digital revenue 53% of total and remaining performance obligations above $1.9 billion, may continue to improve visibility, pricing power and margin mix over the long term. This could drive compounding growth in revenue quality and net margins.
• Secular AI adoption in education, combined with McGraw Hill's deep proprietary content, learning data and domain expertise, is already reducing product development costs and time to market while enhancing efficacy. Management explicitly frames AI as a long term margin tailwind, which could expand EBITDA margins beyond current levels and materially increase earnings.
• Upcoming K 12 adoption cycles and a roughly $300 million larger K 12 total addressable market in fiscal 2027, together with early wins in California Math and strong positioning in Florida ELA and Texas Math, create a multi year cyclical and structural growth opportunity. This could reaccelerate K 12 revenue and support higher consolidated revenue and earnings growth than a flat share price would imply.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for McGraw Hill is $16.0, which represents up to two standard deviations below the consensus price target of $20.83. This valuation is based on what can be assumed as the expectations of McGraw Hill's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $27.0, and the most bearish reporting a price target of just $16.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $2.2 billion, earnings will come to $222.6 million, and it would be trading on a PE ratio of 21.6x, assuming you use a discount rate of 8.7%.
  
• Given the current share price of $16.99, the analyst price target of $16.0 is 6.2% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.