Company summary

Pearson is the global leader in education, providing print and digital learning materials and services used by millions of students every year, principally in North America but also Europe, Asia and Latin America. The Company's education related revenues top $6.5bn. The Company also owns The Financial Times Group, which has an international network of business and financial newspapers and online services and Penguin Group, which is one of the pre-eminent names in consumer publishing.

01 March 2013 | Education

Company research

Pearson Shares Drop on Plans to Accelerate the Expansion of Digital and Key Developing Markets

Pearson’s shares fell on the release of its 2012 results. Despite a 7% increase in the dividend, the Company now expects its earnings in 2013 to remain broadly level with 2012. Additionally, the Company announced a £200m restructuring programme for 2013 and 2014.

​Pearson plans to continue the move towards digital content away from print, further develop education services and  focus more heavily on emerging markets with the aim of achieving faster growth, larger market opportunity and greater impact on learning outcomes.

Market conditions and industry change

• The Company draws a contrasting picture between digital and print and between new world and old world economies. It says market conditions are generally weak in the developed world but generally strong in the emerging economies. Print businesses are in decline across all geographies but digital and services businesses are continuing to grow. 

• The Company points to the challenges of the structural changes in education funding, retail channels, consumer behaviour and content business models.

• It continues to see considerable growth opportunities in education driven by the rapidly-growing global middle class, adoption of learning technologies, the connection between education and career prospects and increasing consumer spend, especially in emerging economies.

The Company highlights areas of strong performance

• North American Education revenues up 2% in a year when US School and Higher Education publishing revenues declined by 10% for the industry as a whole.

• International Education revenues up 13% with emerging market revenues up 25%.

• FT Group revenues up 4% with the Financial Times’ total paid print and online circulation up to 602,000; digital subscriptions exceed print circulation for the first time.

• Penguin revenues up 1%, with strong publishing performance and eBooks now 17% of sales.

Accelerated shift to digital & services and to fast-growing economies

Pearson intends to incur gross restructuring costs of approximately £150m in 2013 (£100m net of cost savings achieved in the year), which it says will be focused on significantly accelerating the shift of Pearson’s education businesses towards fast-growing economies and digital and services businesses and separating Penguin activities from Pearson central services and operations in preparation for the merger of Penguin and Random House.

Restructuring is expected to generate annual cost savings of approximately £50m in 2013 and £100m in 2014 which it plans to reinvest in fast-growing education markets, expanding its digital capabilities and further restructuring, including the Penguin Random House integration The Company believes the restructuring programme will produce faster growth, improved margins, stronger cash generation and higher returns on capital from 2015 onwards.

Outlook

• Pearson expects the external environment to remain challenging for its developed world and publishing businesses in 2013 owing to a combination of cyclical and structural factors: pressures on education budgets and college enrolments; retail consolidation; the shift in its business model from print sales to digital subscriptions; changing consumer behaviour and a dynamic competitive landscape. In general, it expects market conditions to remain favourable for its businesses in developing economies and education software and services.

• Excluding restructuring costs and including Penguin for the full year, Pearson expects to achieve 2013 operating profit and adjusted EPS broadly level with 2012.

John Fallon, chief executive, said: “Pearson has a sound, successful strategy: now we are significantly accelerating its implementation. Trading conditions are tough and structural changes mean many of our traditional publishing activities are under pressure. But the underlying demand for effective education remains immensely powerful and our developing world and digital services businesses have real scale and momentum. The restructuring of the company that we are announcing today is designed to strengthen dramatically Pearson’s position in digital education services and in our most important markets for the future – and to enable us to capture the once-in-a-generation opportunity that comes with being the world’s leading learning company.”

Graph sourced: stockopedia.co.uk
Graph sourced: stockopedia.co.uk

John Fallon, chief executive, said: “Pearson has a sound, successful strategy: now we are significantly accelerating its implementation. Trading conditions are tough and structural changes mean many of our traditional publishing activities are under pressure. But the underlying demand for effective education remains immensely powerful and our developing world and digital services businesses have real scale and momentum. The restructuring of the company that we are announcing today is designed to strengthen dramatically Pearson’s position in digital education services and in our most important markets for the future – and to enable us to capture the once-in-a-generation opportunity that comes with being the world’s leading learning company.”

Strategy Review

The Company is re-focusing resources and capital in the business towards fast growing activities and away from print and less important geographical markets

• It plans to concentrate on four global businesses: school, higher education, English and business. It will adopt an increasingly global view of educational needs, consumer trends and product development for these businesses;

• It intends to apply a rigorous framework to prioritise geographic markets and to determine where it can offer global products and services; where it must customise for local needs; and where a fully local approach is required. It is targeting its investment at a small group of markets where it sees the biggest growth opportunities and reducing local infrastructure and investment in a ‘long tail’ of smaller markets.

John Fallon said in an interview after the results announcement that key developing markets were, “….. China, Brazil, India, (and) we put South Africa in that bracket as well where there is a huge opportunity to grow because of a rapidly growing middle class”.

“Then there is another group of countries, the watch markets countries, like Mexico, Indonesia, Turkey where we’re starting to invest more. We think they could be very rapid growth there in the next few years and we’re just waiting for the trigger to push ahead. Then there is a group of countries that I call maintain markets. Places like Australia, Italy where we’ve good solid profitable businesses, but where the growth opportunity frankly is rather less exciting. So, we’ll sustain the current businesses we’ve got, but rely increasingly on global products and services to drive the growth.”

“Then there is the long tail of countries where we’re actually going to quite rapidly dismantle our local infrastructure which is primarily textbook publishing led and by doing that, freeing up resources to do much more high quality global products and services, globally aligned curriculum, very high-powered learning systems and technology that you couldn’t afford to do on a country-by-country basis, we can actually serve the needs of those countries more effectively and we can work more effectively through local distributors and partners. By dismantling that local infrastructure, we free up the resources to go after the global opportunities in those growth markets in a much more aggressive way.”

• Third, it plans to channel its investment into four business models: direct to consumer; ‘Pearson Inside’ (its comprehensive institutional services); assessment and certification; and learning services.

Running throughout this strategy is a process to ensure that its products and services deliver demonstrable learning outcomes to the student or the institution. The Company has therefore developed the Pearson efficacy framework which it claims is a unique, rigorous and scalable quality assurance system that checks that the necessary conditions are in place for an education programme to deliver intended learning outcomes. All of its acquisitions and all product investments over $3m will go through the Pearson efficacy framework and set out a plan to implement its recommendations before approval.

John Fallon said in the interview, “I think you can see where we are from the results in the sense that our services revenues, digital and services revenues are now 50% from around a third just five years ago. Emerging markets is 15% of our total sales now. It was only 5% five years ago. Where I want to be by 2015, and I think what we’re doing today will enable us to get to is to get to more like 70% or more of our revenues from digital and services and 25% or more of our revenues from emerging markets.”

He added “If we do that, then we will have a faster growing business in terms of top line sales. We will have a more cash generative business with lots more financial characteristics in terms of improved margins and the like. But as importantly, we’ll also have a business that for the first time is really able to measure its impact on education in terms of outcomes; in terms of how many people around the world we really are able to help make progress in their lives in a very meaningful way and that to me, that sense of purpose, that idea of Pearson as the efficacy company is as important as building a faster growing, more cash generative, more profitable one”

Financial Overview

Key Trading Highlights 

NORTH AMERICAN EDUCATION

• In Higher Education, the publishing market declined by 6% net in 2012, according to the Association of American Publishers. Total US College enrolments were 2% lower in 2012 than in 2011, affected by rising employment rates, state budget pressures and regulatory change affecting the for-profit sector. In a difficult trading environment Pearson gained share for the 14th consecutive year, again benefitting from its lead in technology and ability to customise

• Student registrations at eCollege grew 3% to 8.7 million, despite pressure in the for-profit college market. Pearson won new online enterprise learning contracts with California State University and Rutgers University. Its strong managed enrolment services and student marketing product offering, coupled with continued strong growth at Arizona State University, helped its online enterprise learning business to grow 150% to almost 44,000 enrolments. In October 2012, the Company announced the acquisition of EmbanetCompass for $650m which provides a full range of services targeted towards online graduate programmes.

• Pearson’s pioneering ‘MyLab’ digital learning, homework and assessment programmes grew well with student registrations in North America up 11% to almost 10 million with strong usage growth with graded submissions up 12% to almost 320m across the globe. 

• Revenues from the Company’s Assessment and Information business were flat in 2012. State funding pressures and the transition to Common Core assessments continued to make market conditions tough for its state assessment and teacher testing businesses.

• Pearson continued to produce strong growth in secure online testing, an important market for the future. It increased online testing volumes by more than 10%, delivering 6.5 million state accountability tests, 4.5 million constructed response items and 21 million spoken tests. 

• Pearson won new state contracts in Colorado and Missouri and a new contract with the College Board to deliver ReadiStep, a middle school assessment which measures and tracks college readiness skills. Pearson also won five Race To The Top (RTTT) state deals (Kentucky, Florida, Colorado, North Carolina and New York) led by Schoolnet. PowerSchool won three state/province-level contracts (North Carolina, New Brunswick and Northwest Territories). 

• In School, the textbook publishing market declined 15% in 2012, according to the Association of American Publishers. There were several pressures on the industry including weakness in state budgets, a lower new adoption opportunity (total opportunity of $380m in 2012 against $650m in 2011) and delays in purchasing decisions during the transition to the new Common Core standards.

• Connections Education, which operates online K-12 schools in 22 states and a nationwide charter school programme, served more than 43,000 students in 2012, up 31% from 2011 and broadened its product offering to include virtual classrooms for public school campuses. Connections Academy Schools have consistently high performance ratings, particularly in states focused on measuring growth in student learning.

INTERNATIONAL EDUCATION

• In English Language Learning, Wall Street English (WSE), Pearson’s worldwide chain of English language centres for professionals, opened a net of 11 new centres around the world, bringing the total number to 460. Student numbers fell by 2% to more than 191,000, primarily due to the closure of a large franchise centre in Chile with approximately 7,000 students. MyEnglishLabs enrolments grew 60% to 263,000 supported by the launch of its next generation platform which supports 13 languages and 43 new courses. The Company acquired GlobalEnglish, a leading provider of cloud-based, on-demand Business English learning, assessment and performance support software, for $90m in cash in July 2012.

• More than 1.1 million students registered for the Company’s  MyLab digital learning, homework and assessment programmes, an increase of 18%, with good growth in school, ELT and institutional selling in higher education.

• In the United Kingdom, the Company marked more than 6.3 million GCSE, A/AS Level and other examinations with 90% using onscreen technology and more than 3.8 million test scripts for over half a million pupils taking National Curriculum Tests at Key Stage Two in 2012. The Company launched its Next Generation BTECs which are now the leading vocational qualification on the new funding and accountability frameworks in schools. Its Vocational qualifications business grew well with the continued popularity of BTEC amongst employers and universities and a strong performance in work-based learning (with registrations now up to 170,000) further boosted by a good performance from EDI.

• In China, student enrolments at Wall Street English increased 15% to almost 61,000, boosted by good underlying demand and the launch of ten new centres taking the total to 66. The Company’s students rapidly acquire high-level English skills with average grade levels achieved rising by 8% during 2012. Enrolments at Global Education, its test preparation services for English language qualifications, increased 16% to more than 1 million, through 73 owned and 372 franchised learning centres.

• In South Africa the Company held share in school publishing in market conditions which were tougher than expected despite a year of major curriculum reform. Student enrolments grew strongly at CTI, up 19% to more than 10,000. It partnered with UNISA, South Africa's largest university and the largest distance learning provider in Africa, to provide 30,000 students with access to its MyLabs software, digital resources and customised e-books.

• In Brazil, Pearson ended 2012 with 533,000 students in its public and private sistemas (or learning systems) and added 24,000 students in its two largest private sistemas, COC and Dom Bosco, up 8% on 2011. Its public sistema, NAME, includes the top performing lower secondary school in Brazil and test scores for its public school students are, on average, 20% above the 2011 national IDEB standard for 4th and 8th grade students.

PROFESSIONAL

• Professional testing continued to see good revenue and profit growth with test volumes at Pearson VUE up 7% on 2011 to almost 8 million with Certiport adding an additional 2.3 million tests, up 13% on 2011. There were key renewals of the National Council of State Boards of Nursing contract running until 2019 and the Computing Technology Industry Association contract was secured with Pearson VUE as the single vendor running through to 2017.

• Professional training was very weak with the Company’s UK adult training business, Pearson in Practice, facing a dramatic fall in demand as a result of changes to the apprenticeships programme. The Company believed this business no longer has a sustainable model and announced in January that it intends to exit Pearson in Practice. The cost of exit and impairment is £113m and is reported as a loss on closure in Pearson's 2012 statutory accounts.

• Professional publishing grew modestly with good profit growth. In the US, growth of eBook sales and other digital products and services continued to outpace ongoing challenges in the traditional retail channel.

FINANCIAL TIMES GROUP

Digital and services revenues accounted for 50% of FT Group revenues (31% in 2008). Content revenues comprised 61% of revenues (48% in 2008), while advertising accounted for 39% of FT Group revenues (52% in 2008). 

• The Financial Times digital readership continues to grow strongly with digital subscriptions increasing 18% to almost 316,000 and with 3.5 million FT Web App users. The FT’s total paid circulation was more than 602,000 across print and online, modestly up on 2011, with digital subscriptions exceeding print circulation for the first time. Mobile devices now account for 30% of FT.com traffic and 15% of new subscriptions. The FT now has almost 2,800 direct corporate licenses, up 40% on 2011.

• FT Live, the Company’s events business, continued to grow strongly and launch new events, including the Global Commodities Summit, delivering more than 200 events that attracted over 17,000 delegates. The Company launched a digital portal that offers on-demand webinars, live-streamed events and social media tools.

• Mergermarket grew well, despite challenging markets, due to a good performance from Debtwire, mergermarket, Xtract and Remark underpinned by a strong offering following investment in its product breadth, strong editorial analysis and global presence. The Company launched several new products and services, including a new mergermarket Android app, a Debtwire Analytics platform in Europe and Policy and Regulatory Report (PaRR), a global intelligence, analysis and proprietary data product focused on competition law, IP and trade law, and sector-specific regulatory change. Pearson also expanded its coverage in faster growth markets such as Latin America, China and the Middle East, generating new business and extending its international reach.

COMMENTARY

Following a series of significant acquisitions over the last few years which have turned Pearson into the world’s largest education company a period of consolidation is required. Pearson, is to use a poker term “pot committed” to the education market and has no choice but to tackle some of the business issues arising from its exposure to debt-laden mature markets and to address the power of disruptive technology to destroy capital formation in its print businesses. The long rumoured sale of the FT Group would only add additional importance to the planned restructuring.

The following graph illustrates the problem. Whilst operating margins in the education business are excellent, despite the slight drop in 2012, returns on assets and capital are less impressive, especially when compared to the historic returns generated by the FT Group which employs far less capital even when adjusting for size. 

The following chart shows the three businesses, education, Penguin and the FT Group and their respective profitability and returns on two different measures of capital in 2011. Sadly, the trading statement for 2012 does not provide information on the amount of capital invested in each part of the business to allow us to provide a more up to date analysis.  

We have been particularly impressed by Pearson’s ability to build up subscription revenues for its online content at both the FT and Mergermarket. Digital revenues in the FT Group have doubled since 2007 and now represent more than 50% of sales. The FT boosted its circulation to over 602,000 in 2012, an all-time high, demonstrating consumers are willing to pay a premium for quality content delivered by a strong brand over the web. 

John Fallon, the Company’s new CEO and his colleagues no doubt recognise the quality of the FT Group franchise, its high returns on capital and strong and improving cashflow as subscription revenues grow. He may feel the business is too small contributing only around 6% of continuing adjusted operating profit and is a distraction given the job which needs doing to re-position the education business.

Management may be tempted to cash in by selling the FT Group to Bloomberg, News International or one of the other potential buyers mooted by the press, although Mr Fallon points out in the trading statement how the FT brand plays an important role in providing credibility to some of the Company’s education and training initiatives. 

Based on today’s share price of £11.71 (25/2/2013), the Company is trading on a forward price to earnings multiple of 13.9x 2013 projected earnings before restructuring costs. We do not believe this is excessive for a company with a dominant market position, good returns on capital and mid-teen operating margins. With the dividend up 7% in 2012 which currently yields 3.8% and with management committed to a progressive payout many investors will be happy to give Mr Fallon the benefit of the doubt for the time being.

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