UK Edition
Questor: Keep Pearson book closed for now as it struggles to adapt to digital age
Dame Marjorie Scardino was cock-a-hoop when US president George W Bush unveiled his “No Child Left Behind” initiative within days of taking office in 2001.
Introducing mandatory annual maths and reading tests, plus a massive increase in the federal education budget, went a long way to validating the former Pearson chief’s decision to focus the jumbled conglomerate on education.
Times have moved on, as have Dame Marje and Dubya. Would that John Fallon, today’s boss of Pearson, could bank on a similar boost from the newest White House inhabitant.
Fallon does not need to monitor Donald Trump’s late-night Twitter feed to discern his opinion on the state of American learning. On the campaign trail, the Donald pushed for more school choice and questioned why the US was spending more per student than almost any other major country, only to deliver middling returns.
Don’t expect education to get the same spending boost as infrastructure.
Economic boom is bad news
Pearson derives 63pc of sales from the US. The strong dollar gave it a lift last autumn, but flattered to deceive as underlying sales in the region slid 9pc in the first nine months of 2016.
A booming economy almost always bad news for education providers.
Near full employment means fewer would-be students are inclined to enrol in courses, choosing instead to learn on the job. But the company, which has already suffered a couple of profit warnings, is struggling because of structural more than cyclical issues that have put pressure on Fallon to cut costs and sharpen his strategy.
Vision looks old-fashioned
For all talk of digital enlightenment, Pearson is still in the dead trees business, with print accounting for about a third of its activities.
Analysts are concerned that Generation Rent has come to college textbooks. Students that don’t care if they never own a home or a car have discovered they can also rent instead of buying $200 (£164) books. Even if divisional sales look better in the imminent trading update, it is a trend that worries the bearish Ian Whittaker at Liberum, who points out that US higher education accounts for an estimated 45pc of profits.
Pearson has virtually finished reducing its 40,000-strong headcount by 4,000 and Fallon has reaffirmed operating profit guidance for 2016 of £580m to £620m. He has staked everything on hitting £800m in 2018.
Morgan Stanley calculates to do that Pearson must push through another £100m of savings but also find £230m of extra revenues, equivalent to a 2.5pc annual growth rate the likes of which Pearson has not registered since 2010. For a company that would be a technology player, with a vision of lifelong, screen-based learning, its top line looks distinctly old-economy.
Online threat to revenues
The central irony to Pearson’s investment case is that it sold its media businesses, the Financial Times and half-share in the Economist, to focus on education, but is now finding it tough to convince customers they need to keep paying when so many study aids can be found for free online.
Meanwhile, the FT, operating in a news industry fraught with uncertainty, is driving up subscriptions and ancillary income for its new owner Nikkei.
There will be more asset sales as Fallon tightens the portfolio. One bright spot could come in the shape of Penguin Random House. Pearson owns 47pc of The Girl on the Train and Me Before You book publisher formed in a £2.4bn merger four years ago. It has had the option to sell its stake since late 2015. Fallon has previously indicated that 2017 could be the year.
That windfall should ensure the management can keep its promise of preserving the dividend. It is a pledge that might not be upheld by the next chief executive, if the newish chairman Sidney Taurel decides to give someone else a try. Fallon is far from safe.
The stock has ticked up marginally from 786p where it stood when Questor last took a look in early December and yields 6pc. But for investors that dropped Pearson as it has struggled over the past two years, it is too early to re-enrol on the share register. Avoid for now.
Pearson
817p
Questor says: Avoid