OREANDA-NEWS. November 24, 2015. Fitch Ratings has affirmed the 'B+' Issuer Default Ratings (IDRs) of Houghton Mifflin Harcourt Publishers Inc. (HMH) and its subsidiaries. Fitch has also affirmed HMH's senior secured term loan at 'BB+/RR1'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

Fitch's rating has consistently incorporated the belief that HMH's capital structure was not permanent and that leverage would increase to fund acquisitions and/or shareholder returns. Recent actions by the company confirm Fitch's expectations. In May 2015, HMH upsized their existing term loan to \\$800 million to fund the acquisition of Scholastic's Educational Technology and Services business (EdTech) and a \\$300 million incremental share repurchase program. Concurrent with reporting its results for the third quarter ended Sept. 30, 2015, HMH announced that its board approved an additional \\$500 million in share repurchases, increasing the program total to \\$1 billion through the end of 2018 (as of Sept. 30, 2015, approximately \\$760 million would have been available). The company simultaneously announced that it would issue \\$250 million of debt, although they did not provide details regarding timing.

Pro forma for the EdTech acquisition and related debt issuance only, total Fitch-calculated leverage at Sept. 30, 2015 was 4.5x using total debt to EBITDA and 3.3x using Funds From Operations (FFO) Adjusted Leverage. Fitch focuses on FFO Adjusted Leverage to measure Total Leverage given the increase in revenue recognition timing differences arising from digital revenue growth. As a result of GAAP treatment of digital revenues, a growing portion of total annual revenues are deferred over an adoption's term. Although digital cash receipts in a given year may eventually match revenues recognized in that year, Fitch does not expect that to occur within the rating horizon.

HMH continues to be a leader in the K-12 educational material and services sector, capturing 40% of its Association of American Publishers' addressable market. Fitch believes investments made in digital products and services will position HMH to take a meaningful share of the rebound in the K-12 educational market. Fitch expects HMH will be able to, at a minimum, maintain its market share.

HMH has significant financial flexibility to invest in digital content and new business initiatives. These investments into international markets and adjacent K-12 educational material markets may provide diversity away from highly cyclical state and local budgets.

The Recovery Rating reflects a restructuring scenario, assuming going-concern EBITDA of \\$250 million resulting in an adjusted, distressed enterprise valuation of \\$1.5 billion using a 6x multiple. Given the strong recovery prospects, the \\$250 million asset-backed credit facility and \\$800 million senior secured term loan were notched up to 'BB+/RR1'. The \\$250 million going-concern EBITDA is adjusted to include changes in deferred revenues to account for the growing importance of digital revenues.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for HMH include:

--2015 estimate is pro forma for the Ed Tech acquisition;
--Mid-single digit revenue growth for 2016, 2017 and 2018;
--Margin improvement driven by continued growth in higher margin digital revenues;
--\\$250 million of debt issuance in 2016;
--\\$250 million of annual share buybacks.

RATING SENSITIVITIES

Positive rating actions may be considered if a clear financial policy commensurate with a higher rating is communicated, which could include a leverage target and/or strategy around shareholder policy in terms of dividends and share buybacks. Also, long-term, meaningful diversification into international markets and into new business initiatives could lead to positive rating actions. In addition, HMH demonstrating that it can consistently generate positive Fitch-calculated free cash flow (FCF) in excess of Fitch's expectations may drive positive rating momentum.

A negative rating action would occur if the company exceeds 4.5x FFO adjusted leverage, which would be outside a level expected for a B+ rating. The company's recent comments regarding increased shareholder returns and new debt issuance could exacerbate this scenario. Although HMH could present a credible plan for returning total leverage to a level more acceptable for the rating, this scenario is not expected given that the company has not provided a total leverage target at this time. An additional negative rating action driver would occur if HMH begins experiencing significant erosion in market share.

LIQUIDITY

As of Sept. 30, 2015, the company had solid liquidity consisting of \\$377 million in cash and \\$146 million in short-term investments and \\$203 million of availability under its \\$250 million asset-backed revolver, due 2017. HMH's liquidity position and overall financial flexibility is supported by FCF, which amounted to approximately \\$182 million for the LTM period ended Sept. 30, 2015. Fitch expects pro forma FCF to range from \\$175 million to \\$250 million during the ratings horizon. Maturities are manageable with \\$8 million of annual amortization under an \\$800 million secured term loan that matures in 2021.

Fitch expects HMH to continue to deploy cash towards organic growth, share repurchases, and acquisitions in digital and adjacent K-12 educational material markets. Fitch believes HMH has sufficient liquidity to fund these actions over the next three years within the context of the current rating.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Houghton Mifflin Harcourt Publishers Inc.
--Long-term IDR at 'B+';
--Senior secured asset-backed revolver at 'BB+/RR1';
--Senior secured term loan at 'BB+/RR1'.

Houghton Mifflin Harcourt Publishing Company
--Long-term IDR at 'B+'.

HMH Publishers LLC
--Long-term IDR at 'B+'.

The Rating Outlook is Stable.