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McGraw-Hill Downgrades S&P CEO Deven Sharma

By Jim Fink on August 25, 2011

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The much-feared downgrade was supposed to push up the US government’s borrowing costs. Instead, it’s created a windfall opportunity to cut interest costs by refinancing debt at historically low rates. And that reaches into the private sector as well.

– Roger Conrad, Big Yield Hunting

This past Monday (Aug. 22nd) – just a little more than two weeks after Standard and Poor’s shocked the world by downgrading the U.S. sovereign credit rating to AA+ — S&P’s corporate parent McGraw-Hill (NYSE: MHP) decided to get into the downgrading profession itself. Specifically, McGraw-Hill announced that S&P CEO Deven Sharma would be downgraded to the rank of unemployed by the end of the year (Sharma gets a four-month stipend for helping with the transition).

The official line is that Sharma is leaving voluntarily because he was not happy with his reduced supervisory responsibilities since November 2010 after the S&P indices, market data, and risk strategies business was split off in into a separate division called McGraw-Hill Financial. But nobody really believes this charade. After all, back in November 2010 Sharma sounded excited about leading the slimmed-down credit ratings business division, stating:

As the capital markets develop and grow, we will continue to build out our ratings capabilities and insights to help investors navigate risks around the world.

Furthermore, a few days after the U.S. downgrade, Sharma sounded upbeat about his job, stating that “staying focused and continuing to drive the organization are my goals.”  When asked what the U.S. downgrade meant for S&P’s reputation, he replied proudly:

It should reinforce to investors and the marketplace broadly that we make the calls on the credit risk as we see it, to the benefit of investors.

None of these statements sound like a man looking to leave. Let’s just admit what really happened: he was fired for having the guts and integrity to downgrade the U.S. credit rating. As one analyst put it:

It looks like he’s being helped out the door. If it was a planned retirement, it should have been handled in a different way.

Kiss Honest Credit Ratings Goodbye

Firing Mr. Sharma angers me because it guarantees that credit ratings will be more politicized and less truthful than ever. Investors that rely on these ratings going forward should have their heads examined. Do you seriously think that new S&P CEO Douglas Peterson will maintain the U.S. at AA+ for very long or downgrade an important issuer client like the city of Los Angeles (which just fired S&P) after seeing what these downgrades meant for his predecessor’s employment security?

Of course not; Peterson will “go along to get along.”

The U.S. Government Should Be Ashamed for Shooting the Messenger

I’m not just mad at McGraw-Hill. I’m also disgusted with the U.S. government, not only for the complete dysfunction and brinkmanship it displayed in handling the debt ceiling crisis, but also for compounding its sin by “shooting the messenger” rather than take responsibilities for its own failings.

Soon after the U.S. downgrade, the Senate Banking Committee announced that it was investigating S&P for its “irresponsible move” in downgrading U.S. debt. A few days later, the Securities & Exchange Commission (SEC) announced that it was also investigating S&P to see whether any S&P employees engaged in insider trading to financially benefit from the U.S. downgrade. And a few days after that, the U.S. Justice Department announced that it, too, was investigating S&P for failing to downgrade mortgage-backed securities in a timely manner prior to the 2008 financial crisis.

The message of all of these U.S. government investigations is clear: mess with the U.S. credit rating and we’ll mess with you even worse. Perhaps McGraw-Hill feels that sacking Sharma and using him as a sacrificial lamb will appease the Obama Administration and Congress and convince them to call off their attack dogs. I doubt it, at least until S&P “gets with the program” and raises the U.S. credit rating back to triple-A.

Activist Shareholders Want McGraw-Hill to Split into Four Pieces

In the meantime, McGraw-Hill is also facing criticism from activist shareholders who want the company to restructure. On August 1st, hedge fund Jana Partners and the Ontario Teachers’ Pension Plan both filed Schedule 13Ds with the SEC announcing that they had collectively amassed a 5.2% stake in the company (2.9% for Jana and 2.3% for Teachers) and wanted to “bring about changes to increase shareholder value.” The specific changes they want are described in an August 22nd presentation filed with the SEC:

  • Separate McGraw-Hill Education
  • Separate Information & Media
  • Separate the S&P Index business
  • Collapse its corporate overhead and right size its segment cost structures to achieve peer margins.
  • Accelerate its share buyback ahead of pursuing these value creating steps to maximize resulting shareholder value.
  • Bolster S&P Ratings with a well-known independent oversight figure to help manage an increasingly complex global regulatory landscape and improve dialogue with investors, regulators and the public.

The company responded to the 13D filings by saying that it has already undertaken several restructuring initiative to unlock shareholder value, including the creation of McGraw-Hill Financial in November 2010, the planned divestiture of its television broadcasting business, and a new 50-million share repurchase program.

Back then on August 1st, McGraw-Hill didn’t mention firing Deven Sharma as part of its restructuring plan, but the U.S. government’s heavy-handed acts of retribution after the credit downgrade sealed Mr. Sharma’s fate.

Big Yield Hunting Has an “Income Plus” Investment Philosophy

With Sharma’s firing, S&P will likely return the U.S. credit rating to triple-A status sooner rather than later, which will cause interest rates to fall further and make it even more difficult for fixed-income investors to earn decent returns. Fortunately, high-yielding investments still exist in the corporate bond and stock markets.

For the best double-digit yields, check out Big Yield Hunting, the high-yield investment service from Roger Conrad and David Dittman. Roger and David are humble value investors who thoroughly vet a stock before recommending it to subscribers. They take an “income plus” approach to their recommendations. High yield alone is not enough; they demand high yield “plus” a healthy and growing business:

High yields without strong businesses behind them will be at perpetual risk of devastating dividend cuts. And they have no chance of growing either, so they’re guaranteed losers if inflation emerges.

In contrast, only growing and healthy companies will continue to pay their distributions. If we see more inflation, growth is our best chance of keeping pace. Adopting an “income-plus” strategy won’t save your portfolio from all volatility if credit or inflation conditions worsen. But it remains the best approach.

An “income plus” investment standard disqualifies many high-yield companies from Roger and David’s consideration. Big Yield Hunting has recommended Canadian income trusts, telecommunications companies, master limited partnerships (MLP), and a fascinating stock/bond hybrid security. All of these top-notch stocks sport very high yields that are stable and sustainable.

Give Big Yield Hunting a try today!

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