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Scapegoat Sharma: Resignation Leading to a Downward Spiral

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First, Standard and Poor's downgrades the U.S. debt. Next, Deven Sharma (S&P's president) announces that he has resigned. Now McGraw-Hill (NYSE: MHP), which owns Standard & Poor's, has roused proposals of splitting up the company.

Is this restructuring a result of poor decisions by McGraw-Hill or the markets disapproval of the credit downgrading?

Downgrading Spiral

McGraw-Hill stock has been sliding downhill this month after S&P announced the downgrade of U.S. debt rating from AAA to AA+. The controversial judgment has brought S&P's credibility into question and has also resulted in the resignation of President Sharma. The ripple effect of the downgrade also sunk U.S. Treasuries to a record low of 1.97 percent.

Moody's Investor Service (NYSE: MCO) and Fitch Ratings, the other two major ratings agencies, still rank U.S. debt at AAA.

One day after the resignation, shareholders Jana Partners and the Ontario Teacher's Pension Plan have proposed splitting McGraw-Hill into four different parts: Standard & Poor's, S&P index business, information & media, and education. Education was the least profitable in 2010 with 39 percent of total revenue but only 23 percent of the profit.

The split could potentially be more profitable for S&P but slightly dangerous for the losing education department. One could point the finger at the consumer market for the loss in education profits. Hardcover textbooks have been replaced by digital textbooks as college students move to products such as the Amazon (NASDAQ: AMZN) Kindle. In addition, MHP recorded its highest stock price of the year at 44.65 a share on August 1, five days before the downgrade announcement. Ten days later, the stock hit its lowest of the year at 35.35 per share and closed Tuesday at 38.59 per share.

Recovery

After the resignation, McGraw-Hill appointed Citibank North America's Chief Operating Officer Douglas Peterson to S&P President beginning in 2012. Peterson's number one priority must be to restore the credibility of the ratings agency.

“We have strengthened our governance and control framework by reviewing the quality and performance of our ratings and identifying areas for improvement; developing and enhancing the criteria we use to rate issues and issuers; interpreting and applying new regulations so we meet compliance requirements; and identifying and reporting on key areas of risk,” Edward Sweeney, a spokesman for S&P, told Bloomberg.

Even with this new model of research, don't expect Peterson to push the credit rating back to AAA immediately after a month of due-diligence. This could potentially put S&P's credibility in a deeper hole as well as risk labeling Sharma as being more than a scapegoat. Peterson has a long road ahead of him with now the Department of Justice looking into the rating's system.

Posted-In: Amazon Kindle Bloomberg budget deficit Citibank credit ratingNews Asset Sales Management

 

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