RELX
In 2020 the company continued to show modest growth in its less-cyclical businesses, with 2% underlying revenue growth (i.e., excluding the impact of acquisitions and divestitures closed in the previous 12 months and changes in foreign exchange rate) for the combination of scientific, technology, and medical (STM) business—usually referred to as Elsevier—which grew 1%. The Risk and Business Analytics segment grew 3%, and Legal grew 1%. The Exhibitions business was deeply affected by the pandemic and lost 71% of its revenues, leading to a combined –9% revenue decline for RELX overall. The company’s three more stable businesses grew their combined adjusted operating profit by 4%, while Exhibitions swung to a £164 million (approximately US$211 million) loss from a £331 million (approx. US$425 million) profit in 2019, leading to an overall –18% decline in the total adjusted operating profit for the company. The STM business grew headline revenues by 2%, but only by 1% when the impact of exchange rate and acquisi-tions/divestitures is stripped out. (This impact is almost entirely attributable to foreign exchange variations.) Headline adjusted operating profit was up 4%, but—once again—when stripped of the impact of foreign exchange variations and acquisitions/divestitures, profits grew by only 1%.
Headline adjusted profit uses a company’s income from operations, trading, and investments, excluding exceptional items like write-offs or acquisitions. It is therefore a way to assess how well a company is doing during “business as usual.”
In the presentation of annual results, RELX’s management indicated that STM revenues from digital products grew by 3% in 2020, while print declined at a pace double that of recent years. The company also took credit for opening its content in response to the COVID-19 pandemic. According to its presentation of 2020 results, RELX “mobilized content and data analytics expertise in support of its global response to Covid-19 pandemic” [by providing] “50,000+ articles and 200 million downloads.”1 Predictably, it failed to discuss its initial reluctance to open up content—reluctance which was shared by other publishers. For 2021, management issued guidance to another year of modest underlying revenue growth. There was no discussion of the resilience of the subscription model during downturns, in contrast to the messages management had communicated in previous updates during 2020. The business remains very profitable, with an adjusted operating margin of 37.2%.
While the overall financial position of RELX deteriorated visibly, it remains strong. Free cash flow declined by –28%, or £481 million (approx. US$617 million). Over 85% of the decline was driven by the £415 million (approx. US$533 million) decline in adjusted operating profit. Broadly speaking, all other sources and uses of cash were unchanged relative to 2019. However, in 2019 the company used £600 million (approx. US$766 million) to buy back shares. The suspension of the share buyback after the first quarter led to a much smaller cash outflow (£150 million, equal to about US$193 million). The company, however, did increase spending on acquisitions (£878 million/US$1,127 million, vs. £416 million/US$531 million in 2019). This increased outflow, coupled with the lower cash flow from operations and the fact that currency translations did not contribute to cash inflows in line with 2019, means that year-end net debt rose by 11.4% from £6,191 million (US$8172.1 million) to £6,898 million (US$9415.8 million). Net debt/EBITDA rose from 2.5 at the end of 2019 to 3.3 at the end of 2020. While not excessive, this level of debt is higher than the 2.5 to 3.0 target net debt/EBITDA ratio the company has historically pursued. Management seemed to regard this unusually high level of debt as a temporary event driven by the decline of the Exhibitions business; this statement seems to rule out an issuance of new shares to repay some debt and return the company to its target Education and professional services revenues declined by –3%, but with diverging performances for Education Publishing, which grew by 2%, and Professional Learning, which declined by –8%. This segment also remains quite profitable (albeit less so than the research segment) with an EBITDA margin of 25%.
EBITDA refers to earnings before interest, taxes, depreciation, and amortization.
Net debt/EBITDA ratio indicates a company’s ability to pay off its debt. The lower the ratio, the higher the ability of a firm to pay off its debt. Many analysts consider ratios lower than 3 acceptable and higher than 4 a possible indicator of future distress.
EBITDA margin measures a company’s operating profit as a percentage of its revenue without considering interest, taxes, debt, and amortization. It is a widely used way to compare companies based on what they earn, since it strips out the impact of a company’s capital structure and tax policies and focuses on operating performance. EBITDA margins are best used to compare companies in the same industry.
The financial position of Wiley remains strong, with a net debt/EBITDA ratio of 1.7x (including the impact of the Hindawi acquisition).
Wiley provides detailed guidance, unlike some of its peers. The company offered a numeric range for revenues, EBITDA, EPS (Earnings Per Share), and cash flow. Taking the actual 2021 results and comparing them to the midpoint of the guidance, management guides these growth rates: 7.4% revenue growth, 1.4% EBITDA growth, flat earnings per share and a –18.3% decline in cash flow. The expected muted growth of earnings is attributable to the return to spending for in-person business and for some investments, and higher capital expenditures also explains the large decline in expected cash flow generation.
Pearson
The 2020 results were poor, but unsurprising. The company reported a 10% revenue decline and an adjusted operating profit of £313 million ($US402 million).
Pearson’s higher education courseware business declined by –12% in the US and by –13% in North America overall. It is worth underlining that this performance was visibly worse than that of Cengage (+1% in the March–December 2020 period) and McGraw Hill (+2.5% in the March–December 2020 period). Even if the periods are not directly comparable, Pearson appears to have lost significant share. In part, this share loss is driven by the lower percentage of revenues deriving from digital products (70%, vs. 81% at McGraw Hill and 83% at Cengage) versus print textbooks. Because print textbooks sales are generally higher priced, the loss of print sales affects revenues disproportionately. Looking ahead, Pearson expects US higher education revenues to rise in 2021 and 2022 on the back of increases in enrollment, the erosion of the “secondary” book market determined by the declining availability of used textbooks and the hope to stabilize or regain some of the lost market share. Whether these forecasts will prove correct remains to be seen, of course.
The company continues to have a strong financial position. Net debt/EBITDA declined from 1.3x at the end of 2019 to 0.8x at the end of 2020 in spite of the much lower EBITDA (–45% compared to 2019) and operating cash flow (–25%). In large part, the debt reduction is due to the disposal of the remaining 25% stake in Penguin Random House (PRH), which contributed £530 million (US$681 million). In addition, management decided in March 2020 to stop returning money to shareholders (over and above the ordinary dividend, which was left stable) through a share buyback. At the time of the decision to halt the buyback, the company had £183 million left to spend. Adding up the proceeds from the PRH disposal and the share buyback halting, the total accounts for 129% of the net debt reduction. In other words, the PRH disposal and the halting of the share buyback went into debt reduction and into covering the lower cash generation from operations. Going forward, the company plans to focus on further reducing operating costs, including through a symbolic downsizing of its central London headquarters.
Pearson offered generic guidance for 2021, something that was not a given in light of current uncertainties. The company expects to achieve revenue growth in 2021 (with a smaller decline in the US higher education courseware business relative to 2020). There was no guidance on profitability for 2021.
Pearson’s CEO Andy Bird made a reference to sustainability in his presentation, focusing on the company’s carbon footprint and the goal to become carbon neutral by 2030. This is not a particularly ambitious goal, since the company expects to phase out print products altogether in the next five years, and no reference was made to social equity issues beyond the generic statement that “education should be affordable for everyone” at the beginning of the presentation.
The new Pearson strategy comes as no surprise. From the very beginning, Andy Bird was clearly bound to turn the company into a much more consumer-oriented company. Bird, who has an extensive background in consumer media, announced earlier in 2021 several senior appointments of people coming from the same mold. This is not an entirely new idea. Four years ago, previous CEO John Fallon had hired a chief strategy officer who came from the market research industry in the hope of focusing the company on consumers. This is a welcome change from the old Pearson culture of viewing boards of education and faculty as their customers, although it remains to be seen what this will mean in substance.
Bird has also reorganized the company along new reporting lines, both for the purpose of managing the businesses and to provide financial information to the investment community. The company has reorganized several times since 2006. Surprisingly, John Fallon announced the last reorganization just at the beginning of 2020, when he had already announced he would be leaving. Investors have seen geographic divisions, products divisions, matrix organizations, and even a mix of geographic and product divisions. Bird is returning Pearson to a pure product divisions structure, with the goal of moving as many costs as possible into the divisions rather than centrally (except where it is financially unjustified).
Bird also announced in March 2021 that the higher education courseware business will be merged into one global division called Higher Education, but that all the higher education businesses outside the US (including Canada) are effectively for sale (although a formal decision to do so has not been made, and these activities will still be reported for the time being as part of the higher education business). Since the US accounts for almost 90% of all higher education courseware revenues, the divestiture of the non-US businesses would allow management to focus further into the only market where Pearson has real scale.
Over the years, investors have been treated to many widely diverging messages about the sources of Pearson’s competitive advantage: it was, at different times, a company rooted in sound educational science and research, or at the forefront of the digital classroom revolution, or a global digital platform on which local content could be easily overlaid, or the operator of virtual classrooms (both in K–12 and college). Now it is the turn of the consumer-oriented company that looks at Spotify and Netflix as the examples of what consumers want. Investors are right to be confused.
It is definitely true that failing to understand that students were decision makers along-side faculty, and that they could rebel against paying high prices for textbooks, was a fatal weakness. However, failing to understand—at least until recently—that the quality of content still matters to faculty, and that students could pressure their faculty to adopt less expensive materials like open education resources (OER) could leave Pearson in a position where it does not know how to compete. Pearson recently chose to launch Pearson+ and compete directly with Cengage Unlimited in offering deeper discounts, in spite of having no obvious incentive to do so as the market leader. This decision may well be driven by the continued share losses, but it raises questions as to whether Pearson can return to sustainable revenue growth in US higher education courseware, as deeper discounts may negate over time any progress obtained by eliminating the secondary textbook market.
McGraw Hill
Total company revenues declined by –4% for the fiscal year which ended on March 31, 2021, in large part because of the sharp decline in print revenues (–21%), which were almost totally offset by a 10% increase in digital revenues. It should be noted that, differ-ently from Cengage, which earns 12% of its revenues from high schools, K–12 accounts for 35% of MGH’s 2021 revenues (and 38% in 2020). The adoption calendar for states, as well as the mix between print and digital adoptions, drive a significant volatility both in terms of the total weight of K–12 revenues and the mix between print and digital. Excluding K–12, digital revenues for MGH grew by 17% in FY 2021. In spite of the overall revenue decline, the aggressive cost savings program executed to manage the impact of the COVID-19 pandemic allowed MGH to post a significant rise in EBITDA, which grew by 18%. Aggressive cash conservation actions increased the cash flow of the company by 50%.
The US higher education business performed well in the past year. Total billings grew by 5% as a result of a further sharp decline in print revenues (25%), which was more than offset by a 15% increase in digital sales; the EBITDA of the higher education business grew by 28%. As in the case of Cengage, MGH reported market share gains (120 basis points per share vs. 100 bps for Cengage). Though numbers are not available for all publishers, Pearson reported a 12% revenue decline for its US higher education business. The numbers are not perfectly comparable, because Cengage and MGH both close their fiscal year in March, and the first quarter of the calendar year is syphoning away revenues from Q4 of the previous calendar year (this shift is the consequence of print sales being recorded at the time when books are shipped, while digital sales are recorded when licenses are activated). Nonetheless, the decline of Pearson’s revenues in calendar year 2020 is likely to represent a major source of market share gains for both MGH and Cengage. Very much as in previous years, MGH attributes a major role to Inclusive Access in the growth of its digital business and in its market share gains.
The 2020 Update: SPARC Landscape Analysis & Roadmap for Action (INSERT LINK) spotlighted the high levels of debt incurred by MGH, particularly in the aftermath of the failed merger with Cengage. The company has worked very hard to reduce debt, and its net debt/EBITDA ratio stands at 4.0x, a marked improvement compared to 5.4x at the end of 2019 and 7.0x at the end of 2018. While 4.0x is still a relatively high number, it is now starting to approach a comfortable level even in case financial markets were to tighten (there have been periodic scares in the spring of 2021 about possible, unanticipated interest rates increases because of the resurgence of inflation). It is unclear how much the sharp improvement in cash generation achieved in 2020 can be sustained, because cost cutting and lower capital expenditures can easily be reversed, but even maintaining the current revenue/spending ratio should allow MGH to reduce its net debt/EBITDA ratio to close to 3.0x in a year. In June 2021, Apollo Global Management sold McGraw Hill to Platinum Equities, and the deal closed on August 2, 2021. It will then be the new owners who will refinance the debt of the company. At that point, they will decide whether to continue to pay down debt or increase leverage again to pay for some of the $4.5 billion they agreed to pay for the equity of the company.
Cengage
Company cash revenues declined by –6% for the full fiscal year (which runs from April 1 through March 31). This performance covers the entire course of the COVID-19 pandemic until now, as the impact in Q1 of calendar year 2020 was minimal. The –6% decline is a much better result that management may have feared one year ago: at the time, management indicated it had developed a number of scenarios for revenue decline, and the most pessimistic scenario was based on a –25% revenue decline. The decline was primarily driven by international higher education, which declined by –19%, by the secondary school business (–16%) and by English language teaching (–31%). Earnings before preprint expenditures were flat at $315 million, a particularly strong performance in a business that is largely based on fixed cost businesses (like most media companies, and particularly so with digital media businesses). The flat earnings were largely achieved through aggressive cost cutting, and it remains to be seen how sustainable these cuts will prove over time.
The US higher education business cash revenues grew by 2%, and net sales grew by 4% for the full year. This growth, coupled with cost cutting and the steady migration from print to digital courseware, led to a 14% increase in EBITDA. Cengage reports this commonly used metric by subtracting prepublication costs, since management views prepublication as akin to investment rather than as an ongoing expense. In its call with investors, management underlined the continued focus on Cengage Unlimited (CU) and on inclusive access: Cengage does not break down the individual components of what it defines as “institutional sales” (a category that includes both CU and inclusive access), but it communicated that the entire category grew by 40% over the preceding 12 months. Finally, management estimates it grew its US higher education market share to 26.1%, a 100 basis points increase in the preceding 12 months. Since McGraw Hill has also guided to continued market share gains in the same time frame, it is reasonable to assume that share has been taken away from Pearson, which had a poor start in the first part of 2020, and possibly from smaller publishers.
In the case of Cengage, high debt has been a cause of concern, particularly early in 2020 when yields on Cengage’s debt spiked under the twin effects of uncertainty triggered by the pandemic and by the failed merger with McGraw Hill. At the end of March 2021, Cengage had reduced its net debt/EBITDA ratio to 5.6x from 6.1x one year ago. This ratio is still quite high, and further reduction will likely have to come from significant revenue growth. The company has done a great deal to reduce costs, and further cuts will be more difficult to achieve. In addition, cash flow growth in 2021 was significant: unlevered free cash flow (i.e., cash generated irrespective of whether it is used to pay interest) grew by almost 24%, but the bulk of this growth was obtained by reducing working capital. In turn, some of this is driven by the transition to digital (as physical inventory shrinks and individual digital sales can be monetized sooner). Cengage already stands at 83% digi-tal sales in higher education, and opportunities for further gains will likely decline going forward. Management does believe that further revenue growth is coming, particularly in US higher education, thanks to a combination of enrollment rebound, stimulus spending raising participation rates, the phaseout of the used books market through digital contracts and, possibly, further market share gains.
