The literacy boom has two winners — and the difference is how schools pay

Every state legislature in the country has been talking about literacy. States are passing science-of-reading laws, requiring evidence-based curricula, mandating teacher training. If you're an investor, the intuitive move seems obvious: buy the education company.

But two public companies sit in the middle of this literacy boom, and one is growing while the other is shrinking. The reason has nothing to do with which company's reading programs are better. It has to do with how schools pay.

McGraw Hill (NYSE: MH) and Scholastic (NASDAQ: SCHL) both sell to K-12 schools. Both claim to serve the science-of-reading movement. McGraw Hill's revenue grew to $2.1 billion last fiscal year with expanding margins. Scholastic's fell 3% to $1.6 billion , with its education segment plunging 14%.

The difference is revenue model. McGraw Hill now gets 77% of its revenue from subscriptions that renew automatically. Scholastic still sells products — decodable books, book fair boxes, curriculum kits — that schools choose to buy each year. When school budgets tighten, schools stop choosing.

This matters because school spending is cyclical and volatile. Districts face uncertain federal funding, local tax pressure, and multi-year procurement cycles. A subscription locks in a school's commitment for the contract term. A one-time purchase disappears the moment cash gets tight.

McGraw Hill makes this distinction concrete. Its "re-occurring revenue" — the portion tied to annual subscriptions and multi-year contracts — grew 5.8% last fiscal year to $1.54 billion even as total revenue was essentially flat. Its remaining performance obligation, which is revenue already contracted but not yet delivered, was $1.67 billion as of March. That's three-quarters of next year's sales, already won. The company reported an 81% gross margin and $744 million in adjusted EBITDA.

Scholastic's education solutions segment tells the other side of the same story. Revenue fell from roughly $311 million to $268 million in a single year — a 14% drop. Management cited "funding volatility and pressure on supplemental curriculum spending". Schools didn't spend the money. Not because they stopped caring about literacy, but because the mandate to improve reading doesn't create new budget lines. Schools have to fund the change from the same constrained pot.

The broader company is worse off. Children's book publishing — which includes the iconic school book fairs — was roughly flat at $964 million. Book clubs fell 11%. Trade publishing dropped 6%. Across the company, the declines were broad. Across all segments, operating income came to $15 million on $1.6 billion in revenue. That's a 1% operating margin. Scholastic is returning capital to shareholders — $285 million in buybacks and dividends last year, plus a 25% dividend increase — partly because the business can't grow the revenue and partly because there's nothing else to do with the cash.

What makes this counterintuitive is that Scholastic has more brand recognition in schools than any education company in America. Every child has a Scholastic book fair. The name is synonymous with kids reading. But brand recognition doesn't create renewing revenue. It creates one-time purchases that schools delay when budgets are uncertain.

McGraw Hill's transition to recurring revenue was not easy. The company was taken private by Veritas Capital, loaded with debt, and has spent years converting one-time textbook and curriculum sales into annual digital subscriptions. The balance sheet still reflects that history: $4.6 billion in total debt against $788 million in equity, for a debt-to-equity ratio of 3.3. Free cash flow dropped nearly 47% year over year. The stock is down 25% year-to-date. The company is leveraged, and the market is pricing in debt risk.

But the revenue mechanics are working. McGraw Hill's K-12 recurring revenue grew 2.9% last fiscal year even while total K-12 revenue fell 8.9%. The subscriptions held. The one-time deals didn't. The company's own language about the "nationwide Science of Reading refresh" signals they see the literacy mandate as a growth opportunity — and their subscription model means they can actually capture it when budgets open up.

The valuation gap reflects the different business realities. Scholastic trades at roughly 6x enterprise value to EBITDA and under 0.4x sales. It yields nearly 3% in dividends. The market has priced it as a declining brand with no growth path. McGraw Hill trades at about 10x EV/EBITDA and 1.1x sales. The premium is real, but it's buying a business where three-quarters of revenue renews automatically.

The risk for each is different. Scholastic's risk is structural: unless it can convert schools to subscriptions, it will keep losing education revenue in every funding downturn. The buybacks and dividend increases are real shareholder returns, but they can't offset a revenue model that depends on schools saying yes in a given year. McGraw Hill's risk is financial: the debt load is large, and if recurring revenue growth stalls, the leverage becomes a problem. The forward PE looks infinite because analysts expect earnings to compress as the company invests.

The way to think about the literacy mandate isn't "education companies win." It's "companies with subscriptions to schools win, and companies selling products to schools don't." The mandate creates urgency, but urgency without a subscription model just creates more pressure on an already-stressed budget.

What to test: Watch Scholastic's education segment quarter by quarter. If it starts growing consistently, the company has found a way to convert the literacy demand into revenue. If it keeps declining or staying flat, the brand is real but the business model isn't. For McGraw Hill, the test is simpler: does the recurring revenue keep growing double digits, or does the subscription transition peak? The $1.67 billion in contracted future revenue makes the next year visible. After that, the debt question becomes the main one.