Digital Shift And AI Adoption Will Reshape Education Revenue Mix Over The Long Term

Catalysts

About McGraw Hill

McGraw Hill is an education company that provides content and technology solutions across K-12, Higher Education, professional and international markets.

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

• Growing digital usage in education is aligning with McGraw Hill's 53% digital revenue mix in Q2 and 63% contribution from reoccurring revenue, which can support more predictable top line and steadier earnings over time.
• The shift by colleges toward Inclusive Access models and institution-wide deals, where McGraw Hill already serves about 2,000 campuses and sees 15 to 20x activation ramps over a couple of years, can support continued revenue growth and operating leverage as more courses move into these agreements.
• Increased adoption of AI tools in teaching and assessment, including ALEKS, AI Reader, Sharpen Advantage, Writing Assistant and Teacher Assistant, is creating new ways to embed the company deeper into workflows, which can support retention, cross sell and therefore revenue and net margin resilience.
• Multiyear K-12 curriculum adoption cycles, with RPO of US$1.4b and a larger K-12 TAM expected in fiscal year 2027 from opportunities such as California Math and Florida ELA, can provide visibility for future K-12 revenue and support EBITDA stability as those contracts are fulfilled.
• Ongoing mix shift toward higher margin digital contracts, AI enabled efficiencies such as a 27% reduction in K-12 order processing times and content tools that recouped investment in about a year are creating cost savings that can support gross margin and adjusted EBITDA margin over time.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming McGraw Hill's revenue will grow by 3.7% annually over the next 3 years.
• Analysts assume that profit margins will increase from -5.0% today to 9.6% in 3 years time.
• Analysts expect earnings to reach $225.0 million (and earnings per share of $1.17) by about January 2029, up from $-104.0 million today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 27.9x on those 2029 earnings, up from -29.1x today. This future PE is greater than the current PE for the US Consumer Services industry at 17.1x.
• 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 8.8%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The K-12 segment is facing a smaller market in fiscal 2026, with Q2 K-12 revenue down 11.2% and first half K-12 revenue down 7.3%. If future state adoption cycles or the expected US$300 million K-12 TAM uplift in fiscal 2027 are weaker than anticipated, Core and Supplemental curriculum sales could fall short of expectations, which would pressure revenue growth and adjusted EBITDA.
• International revenue in Q2 decreased 8.8% year over year, with ongoing softness in markets such as Canada and timing issues in Spain. If these headwinds persist or broaden, the smaller International segment could limit diversification benefits and weigh on consolidated revenue and earnings.
• The company is investing heavily to embed AI in products like ALEKS, AI Reader, Sharpen Advantage, Writing Assistant and Teacher Assistant. While management expects margin expansion, higher compute and data costs or lower than expected customer adoption could dilute the margin benefit and restrain net margin and adjusted EBITDA improvement.
• Higher Education growth is currently driven by market share gains, Inclusive Access expansion and value based pricing, with Q2 Higher Education revenue growth well above preliminary enrollment trends. If competitive responses, pricing pressure or slower IA ramps reduce that share momentum, revenue growth and earnings from this key segment could slow.

Valuation

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

• The analysts have a consensus price target of $20.83 for McGraw Hill based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• 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 analysts, you'd need to believe that by 2029, revenues will be $2.3 billion, earnings will come to $225.0 million, and it would be trading on a PE ratio of 27.9x, assuming you use a discount rate of 8.8%.
  
• Given the current share price of $15.83, the analyst price target of $20.83 is 24.0% higher.
  
• 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.