March 27, 2013 / 6:35 PM / 5 years ago

McGraw-Hill stock finding fans after S&P fraud lawsuit

NEW YORK (Reuters) - The immediate impact to the stock valuations of credit ratings agencies from the U.S. government’s $5 billion civil fraud suit against Standard & Poor’s appears to be wearing off.

Shares of McGraw-Hill Companies MHP.N, the parent company of rating agency S&P, have recovered more than half of a 27-percent plunge last month following the Justice Department’s filing of the 119-page complaint against the firm. As of Tuesday the stock had rebounded 18 percent.

The confidence of investors is returning as fears of a worst-case scenario for the company fade, with talk of a settlement helping the stock from its stumble last month and company insiders, such as the CEO, buying shares.

Some investors and industry analysts said the stock could gain even more in the coming weeks as Wall Street begins to weigh the weaknesses of the federal government’s case in holding S&P accountable for billions of dollars in losses on mortgage-backed securities during the financial crisis.

S&P bulls also discount the possibility the government’s case will result in major changes in the rating agency’s business model and note McGraw-Hill’s long track record in fending off financial crisis era litigation.

“I thank the government for filing the suit because it brought the stock back into valuation as far as I’m concerned,” said Chuck Carnevale, the founder and chief investment officer of F.A.S.T. Graphs, a stock analysis company. He owns what he described as a “small” position in the company.

McGraw Hill’s MHP.N slide wiped well over $4 billion off the company’s market cap in the week from February 1 to February 8 - as if investors foresaw the company paying out almost all the damages the Department of Justice is seeking.

The company’s price to earnings ratio of 15.3 is slightly higher than its 10-year median of 14.6. Still, the ratio dropped since the lawsuit was announced, and the company is now in the middle of the pack against other stocks.

It’s not clear who has been buying shares of McGraw-Hill in recent weeks. A number of large mutual funds with positions in the company, such as Dodge Cox Balance Fund, Mawer US Equity Srs F and American Funds Income Fund of America, declined to comment. Money managers do not have to report stock purchases or sales during the first quarter before May 14.

But filings since the government suit show that insiders have scooped up stock, including chairman and chief executive Harold McGraw, who bought 210,000 shares. Chief Financial Officer Jack Callahan and three executive vice presidents, Charles Teschner, John Berisford and Kenneth Vittor also increased their stakes.

One private investor who saw the lawsuit as a buying opportunity is Jonathan Wolfe, who said he began accumulating some shares when the stock, currently trading around $50, tumbled to $44.

“I’m looking to hold it until probably around $52 a share and then I’ll be out,” said Wolfe, an engineer by trade who manages his own money.

Ben Strubel, president of Strubel Investment Management, whose firm has about $5 million in assets under management and started buying shares of McGraw-Hill in 2010, said federal prosecutors don’t have a strong record in these kinds of financial crisis cases.

“You look at everything else the government has done as far as prosecuting financial fraud and it’s just an abysmal record,” Strubel said.

One large hedge fund that scooped up shares of McGraw-Hill a few months before the lawsuit was filed is Tiger Global Management, which reported buying just over 2 million shares in the final quarter of 2012. Tiger Global declined to comment through a spokeswoman.

Also benefiting McGraw-Hill’s stock is the company’s sale of its textbook business to private equity firm Apollo Global Management LLC (APO.N) in an all-cash, $2.4 billion deal. The company now plans to focus on serving global capital and commodity markets, McGraw-Hill said in a statement last week.

“McGraw Hill is going to be loaded with cash,” said Ed Atorino, an analyst with the Benchmark Company. He said he’s not worried about the federal lawsuit, which is at least three years away from coming to trial, if it ever gets to a courtroom.

Still, plenty of investors remain worried about the rating agency’s future. Last month David Einhorn, hedge fund manager and chairman of reinsurer Greenlight Capital Re Ltd, said rating agencies are vulnerable because of the suit.

The government’s action reinforces his short positions in McGraw-Hill and Moody’s Corporation (MCO.N)., Einhorn said last month.

Greenlight declined to comment for this article.

Nor is Einhorn alone: Through the end of last month, shorts on McGraw-Hill have more than doubled compared to January. But that could eventually help the stock if those short-sellers cover their positions.

Some industry analysts said for many investors Moody’s Corp (MCO.N), a McGraw Hill competitor, remains the more attractive buying candidate because the federal government didn’t sue it. Shares of Moody’s, which has declined to comment on the litigation, initially plunged 22 percent but have recovered to within 7 percent of their pre-suit price.

Craig Huber, chief executive officer at Huber Research Partners, an independent investment research and advisory firm, said some of the investors he talks “to have been more willing to dip into Moody’s.” He said a recently authorized $1 billion share buyback by Moody’s also has helped entice investors.

Reporting by Luciana Lopez; additional reporting Katya Wachtel; editing by Matthew Goldstein and Alden Bentley

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