On 23 July, those of us who love the Financial Times were shocked to learn that its owner, Pearson PLC (LON:PSON), had sold the pink pages to the Japanese media group Nikkei for £844 million. Pearson had owned the 127-year old newspaper since 1957.
A Greek economist friend emailed me immediately: Another bastion of the British establishment falls into foreign hands, ha-ha! Fair enough: I had spent the previous weeks torturing him with ribald reflections on the inanities of Greek politics.
This was probably not good news for our beloved FT. The Japanese media have a much more deferential attitude to authority, and they tend to believe that they should be apologists for the Japanese national interest, whatever that may be. But I can quite understand why this was a logical strategic move for Pearson. You see, what Pearson has become is not a media company; it is an education company with important publishing interests.
(Interestingly, Pearson’s website still features a bespectacled buffer reading the FT; clearly parting is such sweet sorrow).
What is Pearson without the FT? It is a company that has become adept at bridging the gap between conventional learning technologies (books) and their digital successors. The codex, the bound book which was itself a huge technical advance on its predecessor, the scroll, in the early 21st century, has been challenged by the Kindle™ and its imitators.
But the codex is not doomed. You will see people on your commuter train clutching old-fashioned, printed books, and evidently enjoying them; but these days it’s not either-or. Publishers are becoming digital services companies at the same time. The core activity (information gathering) facilitates both physical and digital formats.
In fact, the most profitable part of the global media industry in the second decade of the 21st century is book publishing and its digital spin-offs. The marginal cost of printing and distributing the millionth copy of a Harry Potter is negligible, yet the last hardback when it was released would have cost you £17.99. And the marginal cost of the millionth Harry Potter download is of course zero.
In contrast, TV companies are facing challenges due to their awkward revenue models (advertising and/or subscription); the movie business is still a lottery; and newspapers face declining sales. Only the streamers (like Amazon and Netflix) seem to be thriving in this space.
But there is still mileage in good old paper. Anybody can download menus from the internet for free at any time, and yet millions of us choose to fork out for celebrity cook books at £20 a go.
In 2012, the TV chef and professional Essex Boy, Jamie Oliver, clocked up book sales of over £126 million and became the second biggest selling author (in money terms) of all time[i] after one JK Rowling. Delia and Nigella were also in the top 20 – well ahead of frigging Gordon, who languished at number 45 with a mere £28.5 million of annual sales. (Nigella’s sales have sadly slumped since then for reasons best discussed elsewhere.)
True, there are books available on Amazon, Kindle-only. But these tend to be minority interest tomes, often self-published by amateurs who consider themselves lucky if they get a few dozen downloads.
For me, a download is not a substitute for a beautiful book with colour plates – a tactile object with its own distinctive smell. But if people find the digital book more convenient, that’s fine by me. And the publishers don’t mind either.
Digital book sales are growing faster than paper book sales[ii] and in the developed world this trend will continue. But in the developing world, where an expanding middle class increasingly collect books, paper book sales will surge in years to come. Moreover, in the education sector, physical books and their digital counterparts will not be in competition: rather, the one will reinforce the other.
Book publishing is a fascinating business which, despite globalisation and the primacy of English, is still fragmented by language. Hachette Livre is the dominant player in the Francophone world (owned by the Lagardère group). The Dutch have Wolters Kluwer. Random House, part of Bertelsmann, is the largest name in Germany, followed by Springer. Grupo Planeta is massive in the Spanish-speaking world as is De Agostini in Italy, and so on. Just as the Japanese and the Chinese have their own giant book publishers, which are active entirely within their domestic markets.
In the English-speaking world, the Americans boast some world-class names: Thomson-Reuters, McGraw-Hill, Harper Collins (part of News Corporation), Simon & Schuster and many smaller players. On this side of the pond, the three biggest players are: Pearson, RELX PLC (formerly Reed Elsevier) and Oxford University Press.
Pearson is, by some measures, the biggest publisher in the world though its current business model is focused on education.
Its origins go back to the 1840s, when it started as an engineering company in Yorkshire. It is one of the few companies to have been a constituent of the FTSE-100 since the index was launched in 1984. However, the company behind the name has transformed itself over that time by becoming the world’s leading learning company with over 40,000 employees across more than 80 countries.
Pearson has gone from a straightforward book publisher to a digital services company expanding rapidly in fast-growing developing economies, especially China, India, South Africa and Brazil. Headquartered in the UK, 60% of Pearson’s sales are in North America. Other operating regions are “Core” (UK, Italy and Australia) and “Growth” (emerging markets, including Africa).
Pearson owns a slew of cutting-edge companies which produce teaching, training and assessment materials and qualifications packages (e.g. BTEC) for schools and colleges across the world. It supports academic institutions in the provision of online learning services. It is a global leader in English language training, not least in China and Brazil, and in the publication of academic textbooks. Students completing multiple-choice examinations at the University of Arizona have their exam papers evaluated by Pearson’s marking systems.
Until the summer of 2013, Pearson was also one of the great literary publishers of the world, thanks to its ownership of Penguin Books. Largely as a response to the increasing dominance of Amazon, Penguin Random House (PRH) was formed on 01 July 2013, following an agreement between Bertelsmann and Pearson to merge their book publishing subsidiaries, with the parent companies owning 53% and 47%, respectively.
PRH has continued to contribute to Pearson’s bottom line but, in accounting terms, it is an affiliate, thus giving Pearson a leaner balance sheet. It employs over 10,000 people in five continents, controlling nearly 250 independent publishing houses that publish over 15,000 new titles annually. Its publishing list includes hundreds of the world’s best-selling authors.
In the bigger financial picture, Pearson is an example of a quality company in the strict technical sense. Firstly, quality firms generate high cash flow. Second, they enjoy and maintain a conservative capital structure. Thirdly, they have prudent management. We can confirm this by looking at three key indicators.
Firstly, Pearson’s return on equity (ROE) has been historically strong. Secondly, the company has long been cash rich – always a good sign. Cash is always better than intangibles but, for a business like this one which has grown over many decades by acquisition, significant goodwill may be expected to arise. That is the case with Pearson. Thirdly, it had a decent debt-equity ratio.
As evidence of this quality status, Nick Train, who runs the Finsbury Growth Income Trust, and other managers, have been favouring Pearson for some time.
In 2014 Pearson generated profit before tax of £305 million on sales of £4.874 billion. Earnings per share were 58.1 pence. Half-year results to the end of June, released on 24 July, show sales up one percent reflecting growth in North America, Brazil and China, and strength in digital and services, including Connections Education and Pearson On Line Services. This was partly offset by a decline in the textbook market in US schools and lower college enrolments in South Africa.
Growth in the contribution from Penguin Random House was offset by costs related to the Penguin de-merger, and contract termination charges arising from the disposal of Pearson’s three Saudi Arabian further education colleges.
The de-merger of Penguin, an iconic brand for book-lovers, was controversial. However, with a global trend towards harmonisation of educational methodologies in the English-speaking world, the focus on the educational offer seems like a winning strategy.
If the latest results are encouraging, the share price has been sliding from a high of 1,503 pence on 23 March to below 1,200 pence on 06 August. The market has been quite sniffy about the disposal of the Financial Times. But the streamlined beast that remains is nonetheless impressive.
On 06 August Pearson’s outperform rating was reaffirmed by BNP Paribas in a research report issued to clients. They currently have a 1,650 pence price target on the stock, indicating a potential upside of over 37% from the current level.
The firm also recently announced an interim dividend to be paid on Friday, 11 September. Stockholders on record on Thursday, 13 August will receive a dividend of 18 pence per share. This represents a current dividend yield of 1.48%.
Pearson has been engaged in an intensive investment and restructuring programme, the full benefits of which may be about to crystallise. The potential rebound story is compelling. Pearson, as a quality company, should rate a BUY.
[i] http://www.dailymail.co.uk/news/article-2200368/Pukka-Jamie-sells-126-400-000-cookery-books-goes-second-JK-Rowling-fifty-time-valuable-authors-list.html
[ii] See, for example, article in Publishers’ Weekly, 30/08/2013, available at: http://www.publishersweekly.com/pw/by-topic/industry-news/financial-reporting/article/58960-a-profitable-six-months.html