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28 January 2013 | Education | Pearson plc

Pearson Cautions Market but Expects to Meet Market Expectations on Earnings in 2012

Pearson cautioned the market in its regular January trading update last week. It continues to face tough market conditions and structural industry change, although it believes it continues to gain share in key markets and to benefit from its investments in digital services and developing economies.

​Despite its warning about general market conditions, the Company still expects good revenue growth at constant exchange rates, operating profit of approximately £935m and adjusted earnings of approximately 84p per share and cash conversion close to 90%. Brokers forecast earnings in 2013 increasing to around 88p, putting the shares on a forward earnings multiple of 13.4x.

Pearson highlighted market weakness in higher education, higher education, consumer publishing and corporate advertising.

The Company’s North American education business witnessed modest revenue growth at constant exchange rates, which it argues indicates significant market share gains in the year. The Company says its strength in digital learning has helped to protect it from a particularly tough year in the US educational materials market which saw an 11% decline in the first 11 months of the year according to the AAP.

Pearson says its international education business will report double digit sales growth at constant exchange rates as it continues to perform well in developing markets, assessment and English Language Teaching, although margins will remain flat as it continues to invest and build scale in developing markets.

Pearson’s professional education business will report operating profits significantly lower than in 2011. Although its professional testing business has continued to grow the UK adult training business, Pearson in Practice, suffered a dramatic fall in demand due to changes in the apprenticeships programme. The Company is now planning for the exit or closure of this business. As previously announced, the cost of closure and impairment is expected to be approximately £120m and will be reported as a loss on disposal in Pearson's 2012 statutory accounts.

The Company expects the Financial Times Group will report good revenue growth for the full year, in spite of a slow fourth quarter caused by weaker advertising sales. Digital and subscription-based revenues continue to grow well at both the FT and Mergermarket, although profits will be constrained by further actions to accelerate the shift from print to digital. The Penguin business benefited from a good fourth-quarter publishing performance and traded in line with our expectations in its key selling season.

Comment:

If Pearson chooses to dispose of the Financial Times Group in 2013 as has been widely rumoured and the Penguin JV with Bertelsmann clears the necessary regulatory hurdles, the remaining wholly owned business will represent an All-In bet on the education and training sectors.

The question investors will inevitably be asking is whether now is the right time to be placing such a bet on a sector which ultimately depends, to a greater or lesser extent, on state funding at a time when governments around the world are severely budget constrained and will remain so for many years to come.  The collapse of the Pearson in Practice business is also a useful reminder that Pearson’s management is not infallible and demonstrates how a sudden and relatively small change in government policy can result in the collapse of a once strong business unit.

Disruptive technological change has the power to destroy capital formation and to do so in a blink of the eye. The education sector is arguably more affected by these trends than many other sectors. Although Pearson is a pioneer in the digitisation of information its pre-eminence is no guarantee of continued success. 

We have been impressed by Pearson’s ability to build up subscription revenues for its online content at both the FT and Mergermarket. Not only has this helped strengthen the Company’s cashflows, as subscriptions tend to be paid up front, it has also shown how online consumers are willing to pay a premium for quality content delivered by a strong brand.

We think the FT is a quality brand with an intrinsic value far higher than that which is inferred from Pearson’s forward earnings multiple. This may tempt management to cash in but it only makes sense if it is able to re-invest the proceeds to achieve superior returns on capital in the education sector over the long term.  We do not believe returns on capital in the education sector will be superior to those currently achieved in the FT businesses and any economic recovery is likely to boost spending on subscriptions and advertising long before governments feel able to start spending on education at historic levels adjusted for inflation.

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