Executive Summary / Key Takeaways

• Digital Transformation Inflection: McGraw Hill has invested over $2 billion in digital learning solutions over the last decade, driving digital revenue to 53% of total sales and re-occurring revenue to 63%, creating a subscription-based model with 80.6% gross margins that fundamentally changes the company's earnings power and resilience.

• Higher Education Dominance: The Higher Education segment delivered 14% year-over-year growth in Q2 FY26, with digital revenue up 18.4% and market share rising 160 basis points to 30%, taking share from all competitors while realizing value-based pricing and expanding Inclusive Access to nearly 2,000 campuses.

• K-12 Cyclical Trough, Not Structural Decline: While K-12 revenue declined 11.2% in Q2 due to a smaller market opportunity and tough comparisons, the segment's re-occurring revenue grew 2.8% to $216 million, positioning McGraw Hill to capture an additional $300 million TAM in FY27 driven by California Math, Florida ELA, and Texas Math adoptions.

• Aggressive Deleveraging Creates Financial Flexibility: The company used $385.7 million in IPO proceeds to repay debt, prepaid another $150 million in October, and has reduced net leverage to 3.3x with a target of 2-2.5x, generating over $40 million in annualized interest savings while maintaining $913 million in total liquidity.

• Valuation Disconnect Amid AI Leadership: Despite being ranked by teachers as the most effective AI education company and launching five major AI tools in 2025, shares trade at $16.68—creating a compelling risk/reward at 9.8x EV/EBITDA and 7.9x operating cash flow.

Setting the Scene: The Education Publisher Reinvented

McGraw Hill, Inc., founded in 1888 and headquartered in New York, has spent 137 years building one of education's most trusted content libraries. For most of its history, the company operated as a traditional print publisher, but the last decade has witnessed a deliberate and expensive transformation. Taken private by Apollo Global Management (APO) in 2012 for $2.5 billion and later acquired by Platinum Equity in 2021 for $4.5 billion, McGraw Hill used its private ownership period to invest over $2 billion in digital learning solutions without the quarterly scrutiny of public markets.

This investment created a fundamentally different business model. The company now operates across four segments: K-12 (52% of six-month revenue), Higher Education (33%), Global Professional (6%), and International (8%).

The strategic pivot from print to digital is most visible in the revenue mix—digital revenue reached $352 million in Q2 FY26, representing 53% of total sales and growing 7.6% year-over-year despite overall revenue declining 2.8% due to K-12 headwinds. More importantly, re-occurring revenue hit $422 million (63% of total), growing 6.5% and providing forward visibility through multi-year contracts and upfront payments.

The education publishing industry sits at an inflection point where digital adoption, AI personalization, and budget pressures are reshaping competitive dynamics. McGraw Hill's position in this value chain is unique: it sells directly to school districts, colleges, and students through proprietary e-commerce platforms, bypassing traditional distribution channels that competitors like Pearson (PSO) rely on. This direct relationship creates a data flywheel—billions of student interactions feed machine learning models that improve personalization, which drives better outcomes and higher retention.

Industry trends favor McGraw Hill's approach. The K-12 digital curriculum market is growing at 19% CAGR, while higher education faces a "demographic cliff" that management argues is overstated for their business since their average student customer is in their mid-to-late 20s, with many community college students in their 30s and 40s. The proliferation of AI and demand for personalized content delivered via intuitive digital solutions creates a tailwind, but also invites competition from AI-first entrants and free resources like Khan Academy.

Technology, Products, and Strategic Differentiation: The Multilayered Moat

McGraw Hill's competitive advantage rests on three pillars: 137 years of intellectual property and trusted content, proprietary data from billions of student interactions, and decades of domain expertise integrating digital tools into curriculum. This "multilayered moat" is not just marketing language—it manifests in tangible product performance and market share gains.

The company's AI philosophy centers on saving educators' time, strengthening student-teacher relationships, and personalizing learning. ALEKS, an AI-powered supplemental math solution, uses machine learning to pinpoint knowledge gaps and has demonstrated 20% improvement in pass rates according to a Clemson University case study. The Evergreen content delivery model, launched across over 700 titles, provides continuous content updates and contributed to a record-high Net Promoter Score during the fall 2025 semester.

In 2025, McGraw Hill accelerated its AI deployment dramatically. The AI Reader tool, launched in spring 2025, expanded to over 600 Connect titles and the First Aid Forward solution for medical students by back-to-school season. By Q2, 1 million students had engaged with the tool, generating 11 million learning interactions in the quarter alone and accelerating to 20 million through October. This isn't passive content consumption—students are actively engaging with generative AI embedded directly in their learning materials.

Four new AI-powered solutions launched in October 2025 demonstrate the breadth of the platform:

• Sharpen Advantage: An enterprise solution providing real-time faculty dashboards to track progress and address learning gaps, offering a responsible alternative to generic chatbots.
• Clinical Reasoning: Virtual patient interactions for medical students leveraging evidence-based content.
• Writing Assistant: Real-time personalized feedback for grades 6-12, generating over 130,000 interactions across 877 school districts in October alone.
• Teacher Assistant: A GenAI-powered chatbot reducing K-12 teacher prep time, currently available for California Math with nationwide rollout planned.

These tools create network effects. As more students use AI Reader, the system learns which explanations work best for specific learning styles. As more districts adopt Teacher Assistant, the platform accumulates lesson plan templates and best practices that make it more valuable for new customers. This data advantage is difficult for competitors to replicate—Pearson's assessment-heavy tools lack the same instructional integration, while Wiley's (WLY) research-focused platforms are slower to adopt AI at scale.

The technology also drives internal efficiency. AI implementation reduced K-12 order processing times by 27% and automated 25% of service checks. AI-powered content creation tools delivered strong ROI, recouping initial investment in a year. These operational improvements support the 43% Adjusted EBITDA margin while the company reinvests in growth.

Financial Performance & Segment Dynamics: Higher Education Leads, K-12 Lags Temporarily

McGraw Hill's Q2 FY26 results tell a tale of two segments. Higher Education is firing on all cylinders while K-12 navigates a cyclical downturn. Understanding this divergence is critical to evaluating the investment case.

Higher Education: The Growth Engine
Revenue expanded 14% year-over-year to $213 million, with digital revenue growing 18.4% to $186 million. This performance was driven by four factors: continued market share gains, Inclusive Access growth, enrollment favorability, and value-based pricing. The trailing 12-month market share rose 160 basis points to 30% according to MPI data, taking share from all competitors. A decade ago, McGraw Hill's market share was barely 21-21.5%—this represents a remarkable turnaround.

Inclusive Access, a course material affordability program, grew 37% year-over-year and now represents over 50% of Higher Education sales, adopted by nearly 2,000 campuses. The model works because it provides students with materials on day one at reduced cost while guaranteeing publishers revenue. New relationships typically take two years to fully scale, with activations for accounts landed in FY26 expected to increase 15-20x by FY28. This creates a predictable revenue ramp that competitors like Wiley, with slower AI adoption, struggle to match.

The segment's Adjusted EBITDA grew 12.9% to $89 million, demonstrating operating leverage as digital mix expands. The average age of student customers in their mid-to-late 20s mitigates demographic cliff concerns, and management expects to continue growing regardless of enrollment trends due to TAM expansion and share opportunities.

K-12: Cyclical Headwinds Masking Structural Strength
Revenue declined 11.2% to $359 million, consistent with an anticipated smaller market opportunity and lapping exceptional capture rates in the prior year. However, the underlying health is stronger than the headline suggests. Re-occurring revenue grew 2.8% to $216 million, supported by multiyear procurement cycles and upfront payments that provide strong forward visibility. The segment's Remaining Performance Obligation stands at $1.43 billion, creating a foundation for FY27 growth.

Management is positioning for a significant rebound. The FY27 K-12 TAM is expected to grow by an additional $300 million, roughly 10% more than FY26, driven by California Math, Florida ELA, and Texas Math adoptions. Two large California Math deals have already been booked in FY26. The nationwide Emerge! pilot for K-5 Core English Language Arts is progressing ahead of the large California ELA opportunity in FY28.

McGraw Hill Plus, available in 10 states with two more coming next fiscal year, saw a 67% increase in districts accessing it this school year and a 4x increase in unique users year-over-year. Twenty-five percent of teachers using Core Math products now have access, nearly a 50% increase. This positions the company to capture the Supplemental and Intervention market, where it holds only 5% share today despite it being a multibillion-dollar opportunity.

The segment's Adjusted EBITDA declined 7.4% to $172 million, but margins remained robust at 48%. The company continues to outperform the market and retain its leadership position in Florida science, while expanding share by 200 basis points in districts outside Florida and Texas.

Global Professional and International: Stable but Smaller
Global Professional revenue was flat at $40 million, with re-occurring revenue growing 5.4% to $25 million as strength in medical and engineering offset the exit of nonstrategic print. International revenue decreased 8.8% to $50 million, an improvement from Q1's double-digit decline, with softness in Canada due to enrollment reductions and timing issues in Spain. However, the company grew market share in Canada by over 3.5% to 27-27.5%, up from barely 15% in 2019, and sees upside in Latin America and the GCC market.

Consolidated Financial Strength
Gross profit margin increased nearly 150 basis points to 79.2%, driven by efficient operations and favorable digital mix. Adjusted EBITDA reached $286 million with a 43% margin, up 60 basis points year-over-year, reflecting strong operating leverage despite reinvestments. Interest expense decreased 30.2% to $24.2 million due to debt refinancing and repayments, with total interest savings expected to be approximately $5 million in the second half.

Cash flow from operations was $265 million in Q2 and $168 million for the six-month period, with the decline primarily due to working capital timing related to K-12 market dynamics. The company ended the quarter with $463 million in cash and $913 million in total liquidity, providing ample flexibility for continued debt reduction and strategic investments.

Outlook, Management Guidance, and Execution Risk

McGraw Hill raised its FY26 guidance across the board, a decision rooted in strong Q2 results and increased visibility after the seasonally important back-to-school period. The company now anticipates total revenue of $2.031-2.061 billion, up from $1.986-2.046 billion previously. Re-occurring revenue is projected at $1.504-1.524 billion, while Adjusted EBITDA is expected to be $702-722 million, up from $663-703 million.

Management's confidence stems from several factors. First, the Higher Education momentum appears sustainable, with market share gains continuing and Inclusive Access expanding. Second, the K-12 RPO of $1.43 billion provides revenue visibility, and the FY27 TAM expansion creates a clear growth catalyst. Third, AI tools are showing strong early adoption, with AI Reader's 20 million interactions demonstrating student engagement that should translate to retention and expansion.

The tax picture improved significantly with the July 2025 enactment of H.R.1, the One Big Beautiful Bill Act, which is expected to reduce domestic income tax payable. The company purchased federal tax credits for $50.3 million in May 2025, and the FY26 tax liability is expected to be lower than the previous $30-50 million range. The GAAP effective tax rate is projected at 15-20%, with a marginal non-GAAP cash income tax rate around 18%.

Execution risks center on three areas. First, the K-12 recovery must materialize as expected, with California Math and Florida ELA adoptions driving FY27 growth. Second, AI tools must convert early engagement into measurable learning outcomes that justify premium pricing. Third, the company must balance debt reduction with strategic investments, as management noted a "full funnel of smaller tuck-in M&A opportunities" but no transformational deals currently.

Risks and Asymmetries: What Could Break the Thesis

The most material risk is that K-12 market recovery takes longer than expected. While management is confident in FY27 TAM expansion, state and local budget pressures could delay purchasing decisions. However, the company notes that 90% of district revenue is funded by state and local budgets, with less than 1% of K-12 budgets tied to course materials, making this a low-priority target for cuts. The company is not seeing widespread delays or changes in purchasing patterns due to federal funding concerns.

AI disruption concerns, which contributed to the weak IPO pricing, appear overblown. McGraw Hill is not being disrupted by AI—it is leading AI implementation in education. A recent Morning Consult survey ranked it as the education company using AI most effectively among K-12 teachers and administrators. The company's multilayered moat of content, data, and domain expertise is precisely what generic AI tools lack. As CEO Simon Allen noted, "Helping teachers harness the power of AI to address specific student needs differentiates McGraw Hill from emerging AI-first entrants."

Debt remains a concern but is being actively managed. Net leverage at 3.3x is above the 2-2.5x target, but the company has prepaid $542 million year-to-date and generated $265 million in quarterly operating cash flow. A 100 basis-point increase in Term SOFR would increase annual interest expense by only $7.7 million, manageable given the company's cash generation.

Legal risks include a Florida False Claims Act complaint alleging K-12 overcharges, an author class action on royalty calculations, and a patent infringement case. While management believes these should not have a material adverse effect, legal overhangs can pressure valuations.

The upside asymmetry comes from the Supplemental and Intervention market, where McGraw Hill's 5% share in a multibillion-dollar market represents a significant expansion opportunity. If AI tools like Teacher Assistant and Writing Assistant gain rapid adoption, the company could accelerate share gains beyond current guidance.

Valuation Context: Cash Flow at a Discount

At $16.68 per share, McGraw Hill trades at a significant discount to its IPO price of $17.00 and well below the initially targeted $19-22 range. This valuation disconnect appears disconnected from fundamentals, as the company demonstrates strong cash generation and improving margins.

Key valuation metrics tell a compelling story:

• EV/EBITDA: 9.83x based on TTM figures, below Pearson's 11.44x and Scholastic's (SCHL) 13.16x, despite superior growth and margins.
• Price/Operating Cash Flow: 7.92x, indicating investors pay less than 8x for each dollar of operating cash generated.
• Price/Free Cash Flow: 14.35x, reasonable for a company with 6.5% re-occurring revenue growth and 43% EBITDA margins.
• EV/Revenue: 2.68x, slightly above Wiley's 1.54x but justified by higher digital mix and growth.

The negative profit margin (-4.97%) is misleading, reflecting one-time items and amortization rather than operational weakness. Operating cash flow of $646 million TTM and free cash flow of $485 million demonstrate the business's true earnings power. With no dividend and a focus on debt reduction, cash flow is being deployed to strengthen the balance sheet.

Balance sheet metrics show improvement in progress: Debt/Equity of 3.64x is elevated but declining, Current Ratio of 1.01x provides adequate liquidity, and the Quick Ratio of 0.80x is manageable for a subscription-based business with predictable cash flows.

Comparing to peers highlights McGraw Hill's strengths. Pearson's gross margin of 51.45% lags McGraw Hill's 80.61% due to slower digital transition. Wiley's 74.26% gross margin is closer but Wiley grows slower and faces print headwinds. Scholastic's negative operating margin (-37.28%) and Stride's (LRN) lower gross margin (39.20%) show McGraw Hill's operational superiority.

Conclusion: A Digital Education Leader Trading at Cyclical Valuations

McGraw Hill has successfully transformed from a print publisher into a digital education platform with AI leadership, market share gains, and strong cash generation. The Higher Education segment's 14% growth and 30% market share demonstrate competitive strength, while the K-12 segment's temporary decline masks underlying re-occurring revenue growth and a clear FY27 catalyst with $300 million in additional TAM.

The company's aggressive deleveraging—$542 million in debt prepayments generating $40 million in annual interest savings—improves financial flexibility while maintaining over $900 million in liquidity. AI investments are paying off with 20 million student interactions and teacher-ranked leadership in effective AI implementation.

Despite these strengths, shares trade at 9.8x EV/EBITDA and 7.9x operating cash flow, reflecting investor skepticism about AI disruption and K-12 cyclicality that appears misplaced. The central thesis hinges on two variables: execution of the FY27 K-12 market recovery and conversion of AI engagement into measurable learning outcomes that sustain pricing power.

If management delivers on its raised FY26 guidance and positions for FY27 growth, the valuation gap should close. The risk/reward is compelling for investors willing to look through temporary K-12 headwinds to see a digital education leader with durable competitive advantages and accelerating AI adoption.