Our most recent investment Pearson PLC represents an opportunity to invest in a great company with potential to transform itself to a prominent fast-growing EdTech company
Pearson is one of the most renowned academic publishers in the world, and the largest within higher education, with a 40% market share in the US. However, when we looked at it closer, we realized that it today actually stands on three legs, of which publishing is not the largest. The largest segment is Assessment (~55% of operating contribution), followed by Publishing (~35% of contribution) and Online Program Management (OPM, ~10% of contribution).
We chose to invest in Pearson as we believe it is composed of a solid high FCF, predictable and growing business at the core (Assessment), with Publishing reaching an interesting inflection point, and a possibility to move Pearson closer to the end-user and further into the EdTech space during the next decade. As a step in this direction, the company recently hired Andy Bird, former chairman of Disney International, and one of the leading persons who moved Disney closer to the end user through digital B2C offerings (think Disney+). While it is not common to see companies successfully move closer to the end user (in Pearson’s case from a B2B2C to a B2C model), our analysis shows that we do not need to be successful in this respect to make great returns, but it could add significant additional upside.
We identified Pearson as a potential investment candidate when Cevian (an Activist fund) took a position in the company earlier this year. Our first entry price is ~7x EV/2019 EBITDA. We are up ~12% since our first investment.
Below follows a deep dive on each of the three segments if you want to learn more.
Higher Educational Publishing: a new and different decade ahead
Pearson’s higher educational publishing arm is the largest in the US with ~40% market share. During the last decade, the Company has been focused on navigating the digitalization of publishing. In many respects, the development looks a lot like the music industry a couple of decades ago, as new forms of distribution have affected customers willingness to pay for products. A trend that has accelerated during the last five years. Today over 65% of Pearson’s and the market’s higher educational publishing sales is coming from digital. But what is more important, a staggering ~2/3 of content is being consumed illegally or without paying, through pirate copies (21%) or through the usage of second-hand books (42%). The trend has seen sales of higher educational publishing decline, as the market has shrunk.
While this of course has been a great challenge for Pearson during the last ten years, we believe we are close to an inflection point. Partly by the share fact that there is not much revenue to lose and as ~2/3 of Pearson’s publishing business is already digital. But just like the music and streaming industry, we believe content will continue to be key going forward. As will the relationships that Pearson has with professors, authors, and universities.
With a solid and unaffected ~40% market share, Pearson, is so to speak, the Disney of Higher Educational Publishing. While the company has already made all its content available digitally and launched new business models (including rental of digital content), it has not yet made the step into Business to Consumer (B2C), i.e., making this content available to the end user through a proprietary digital channel, nor has it tried out a subscription model. Today, you must download the digital books produced by Pearson through your local online bookstore, Amazon, or the like, who take share of the profits. With a 40% share of higher education, Pearson is well positioned to create this proprietary digital channel.
Although the coming one or two years will continue to be challenging within publishing, we believe the next decade will be a different decade than the last. We believe Pearson will be able to accelerate publishing revenue growth in the next five years through B2C, subscription and by capturing the unaddressed market of pirate copies and second-hand books through novel product and pricing offerings. In addition, if the B2C initiative works out, margins could very well be significantly higher, in line with those of other direct to consumer software content businesses, capturing a significant additional margin potential. In addition, there is also opportunity to cut costs to match those of McGraw Hill (a smaller rival with higher margins owned by Private Equity).
Online Program Management: Potential to lean forward through a more scalable B2C offering
Online Program Management (called Global Online Learning) is today the smallest segment within Pearson (~10% of contribution). These are educational online programs (or a series of courses, or individual courses), that are produced and then distributed online. This includes everything from content (reading, sound, video), courses, assignments, tests, assessment, interaction with students and staff etc. Today this is a fragmented, fast-growing market, but Pearson was the innovator in this field and is one of the largest three players. Lately, competitors such as Coursera, 2U, EdEx have focused on making programs scalable to distribute these all over the world, direct to consumers.
This market is not competing directly against Publishing (or Assessment) but is targeting the overall Educational Market, a market which is about USD 3,7 trillion globally, or 400 times the size of Pearson PLC (yes that is right, 400 times larger). The buzzword EdTech comes from the realization that education is the market which could be next in line to truly be changed at its core through technology.
These online program management companies exist side by side with other start-ups such as ByJu’s (targeting K12), and other companies trying to “gamify” the educational experience, all trying to take share of the overall USD 3,7 trillion educational global market. We believe that only moderate success here could create a lot of shareholder value for Pearson’s stockholders.
Pearson Assessment: the core of Pearson consists of a double-digit growth segment with high free cash flow and strong competitive position
Pearson’s Assessment segment make up ~55% of operating contribution. It is a high margin business (30%+ before central costs) with strong competitive position (~33% market share in the US). Scale, national reach, and brand are key in choosing assessment vendor. 60% of the assessment segment is operating in double digit growth markets such as Certifications (e.g., assessment for IT certifications for Microsoft, Cisco, VMWare etc.) and Clinical Assessments. 40% is in Student Assessment, a market that is expected to be stable. Although Pearson is growing nicely in this segment and provides a solid bedrock from an investment point of view, we believe Pearson is not capturing its full potential here as the company is not growing as fast as the market. Key trends here are gamification, and thus the inclusion of assessment into programs, in a dynamic iterative process. Also, Pearson has converted the business into digital, with 2/3s of sales being driven by digitally enabled assessments and AI powered authentication and scoring of tests.
New CEO from Disney hired to move Pearson closer to the end user
Pearson has historically been a B2B2C company but will increasingly need to stay closer to the end user to keep up with the changes happening in the educational market and capture the upside potential this might entail. The upside potential here is much larger than any downside risk, as the target market is orthogonal to and 400 times larger than Pearson’s existing business. We believe the hiring of the former chairman of Disney International Andy Bird, who was responsible for Disney International and its digital international strategy, will be key in connecting to end users, and utilizing that contact, in the right way.
Note: Historic returns are no guarantee for future returns. The value of any investment may fall as well as rise.
