Publishing firms in the education industry have been suffering from the transition to digital textbooks in high schools and universities, causing the domestic market to grow at a slower rate than decades ago. However, some global publishers, like Pearson PLC (NYSE:PSO), continue to present strong financial results. In fact, this company has been growing at a faster pace than the industry for over 10 years, and its shareholder return program is most attractive to investors and gurus like Steven Cohen (Trades, Portfolio), seeking to gain long-term benefits. Let’s dive into this publisher’s business strategy and see if it will survive the changing market structure.
Staying on Top of a Changing Market Landscape
Pearson is the world’s largest player in the domestic and international education markets. Apart from publishing textbooks and related course materials for U.S. educational institutions, which accounts for 60% of sales, the company also owns The Financial Times (15% of sales) newspaper and magazine. The Penguin book publishing business (18% of sales) is also an important segment for revenue income among younger scholars. However, due to a recent increase in market competition, the firm decided to enter a joint venture for its Penguin books with Bertelsmann’s Random House brand, where Pearson holds a 47% stake. The business deal is expected to offset possible secular headwinds, as well as trigger the company’s brand recognition in the European market.
The company’s number one position amongst competitors like McGraw Hill, Cengage or Houghton Mifflin Harcourt Co. (NASDAQ:HMHC) should come as no surprise, given the publisher’s long-term commitment to investing in digital products. Offers like the complimentary digital learning and online assessment program MyLabs, for example, put the firm at a competitive advantage towards its industry peers, but also ease the transition into the digital publishing era. Now, lower college enrollment figures and subsequent declines in bookstore sales in the domestic market have caused Pearson to steer investments not only towards technology, but towards the international markets. Thus, the divestiture of Mergermarket (a financial news provider) and investment in India’s Avanti Learning Centres will help drive growth looking forward.
Slow Growth, but High Returns
When it comes to government funding, Pearson enjoys a leading position in the K-12 market, from which it reaps approximately 30% of the annual market for new adoptions. However, state and local governmental departments have recently experienced budget cuts, which could adversely affect the company. Furthermore, the firm’s balance sheet has a history of solid results, but these have been sluggish over the past two years. While revenue currently marks negative growth of 3.7%, this is expected to change until 2017, due to an annual 4% growth rate. EBITDA margins will average 18% over the next five years, mainly due to fast growth of the emerging market segment.
Also, the current 10.2% operating margin will continue to expand, as the company pursues stronger sales in the digital business, allowing for less inventory and printing costs. But Pearson’s shareholder returns remain its most attractive feature for investors, who will gain significant profits from the booming 108.0% returns on capital, and solid 3.7% dividend yield. The company’s current stock price of $18.3 also seems fair considering its narrow economic moat and favorable market position. Therefore, I consider this publisher will have a bright future, as long as investments in technology remain a priority.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.