United States Vs. McGraw Hill: The Case For Efficient Markets
FIMALAC, a French firm, owns Fitch's, the third rating agency, as a 50% joint venture with privately held Hearst Corp. French markets are currently closed, but interestingly, FIMALAC only shed $1.7 M in market cap yesterday. It would appear that market participants are discounting the threat of legal action against Fitch.
According to the Wall Street Journal, there is not any publicly available information which indicates why the DOJ is focusing on S&P or to what extent the investigation will spread. In fact, in a statement made by S&P, this fact appears to be central to their defense. They claim that they were using the same data available to the rest of the market, and reached the same conclusions as their competitors.
Nevertheless, there is a greater degree of uncertainty surrounding Fitch which is not reflected in the price of FIMALAC (FIM) shares. I understand that since they only own 50% of Fitch, they face only half of any liability incurred by their subsidiary, but if investors gave Fitch the same chance as Moody's of also facing litigation, they should be liable for approximate $38.64 Million*(calculation explanation at the bottom). Significantly more than the $1.7 Million they declined by yesterday.
In addition to these short term movements, one must consider whether litigation is a binary event. Do these companies either win or lose? I would argue that it is not. It is possible to settle out of court for a fraction of the costs, it is possible to win in court yet still incur costs, it is possible to lose in court for the full $5B, or the firms could lose in court but incur a lesser liability. $5 Billion would be a crippling settlement against McGraw Hill, which had Net Income of around $867 Million in the last 12 months. Speculating on the awards of the court or the legal outcome of this case is beyond my area of expertise; however, watching the market react in real time to the publication of further information is fascinating, and sometimes profitable.
*5B represents 31.3% of MHP's market cap. FIMALAC is significantly smaller. 31.3% of 1.03 B (FIM market cap) is $322 Million. 12% (market odds of Moody's being found liable) of 322 M is $38.64 Million.
By Kapitall Contributor David Emami