Tue. Jul 5th, 2022

Pearson, a perennial disappointment to investors, has found another way to disappoint.

The educational publishing group has been a fantasy takeover target for decades. With private equity house Apollo’s bid this month, those dreams almost became reality. But after a third rebuff from Pearson’s board, Apollo has walked away.

Pearson would have made a neat addition to the narrative of private equity investors snapping up undervalued UK assets on the cheap.

These may become fewer and farther between after a flurry in recent years, as interest rate increases make debt-fueled deals potentially more difficult to do.

Some of the easiest targets have been picked off, and buyers now have the UK’s new National Security and Investment Act to bargain with, too. Ultra Electronics’ private equity-backed takeover is still in the wilderness awaiting government approval more than two months after the regulator’s recommendation was put to ministers.

Pearson, however, is a prime candidate. That is partly because the experience of investors during the John Fallon era still hangs over the company 18 months after he left.

Seven profit warnings in seven years leaves a skepticism about Pearson’s ability to perform that is hard to erase, even if new chief executive Andy Bird managed an earnings upgrade earlier this year. And while the Pearson that former Disney executive Bird inherited in October 2020 is a different beast from the one Fallon took on, when the company still owned stakes in the Economist, Financial Times and Penguin Random House, it is still in need of an overhaul.

The US textbook market has been in decline for years. A shift to a digital-first model, advocated by Bird, is logical. So is a push into the life-long learning market. But that was the way Pearson was heading even under Fallon. The question is whether Bird can pull it off.

Bird and incoming chair Omid Kordestani have significant experience in digital and content businesses: Bird at Disney and Kordestani at Twitter, Klarna and Google. What they do not have – and Apollo does – is form at turning round an ailing educational publisher.

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Bird’s plans for Pearson rest on a “direct to consumer” pitch that shifts its focus away from the universities and higher education institutions that have been its core customers. Cue countless comparisons to Netflix and Spotify thanks to a product called Pearson Plus, which allows students access to all its online textbooks for the bargain price of $ 14.99 a month.

A subscription model for textbooks makes sense, since the price of hard copy books has rocketed and Pearson and others have lost out on a thriving second-hand market. But it is hard to justify extending the likeness to the streaming giants further.

Students will only use it if Pearson textbooks are their core course books. If they only use one of those a semester, the pricing is neutral, Berenberg analysts calculated last year. And it is not yet clear how willing they are to pay for it. Hopes that it might foster an enduring life-long learning relationship with Pearson post-study seem far-fetched.

Growth in key areas such as workforce skills may require some chunky acquisitions. Pearson has done a couple of deals, buying workforce analytics company Faethm and digital credentials group Credly. These seem too small to move the dial, however, and investors’ appetite for larger acquisitions is unlikely to be generous given previous management’s unimpressive M&A record.

Apollo’s offers, topping out at 870p plus dividend, are undoubtedly opportunistic, coming at a similar level to where Pearson traded last July. But the company has since ceded a pandemic-induced bump from its virtual learning business.

Analysts at UBS, meanwhile, estimated that Apollo might make a 14 percent internal rate of return on its earlier 854p offer, not exactly stellar. Apollo would have doubtless used its experience with McGraw Hill, bought in 2012 for $ 2.5bn and sold last year for $ 4.5bn, to help improve returns. But Pearson is not a straightforward fixer-upper that Apollo was attempting to buy on the cheap.

Still, investors backed Bird when he came on board, in spite of an expensive pay package. He has enjoyed the apparent support of activist Cevian Capital, which built a 5.4 per cent stake towards the end of Fallon’s tenure and had almost doubled it by February to more than 10 per cent.

It is fair to give him more time to deliver public market investors, rather than private equity, improved returns. If he fails, there will be scope for another round of fantasy M&A.


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