The crisis engulfing Pearson deepened after the education company cut its profit forecast and predicted years of gloom in the U.S. market, forcing it to slash its dividend and put its stake in the iconic Penguin Random House book business up for sale to raise cash.
The unscheduled announcement sent the stock tumbling the most on record. Pearson projected operating profit this year as much as 19 percent below analysts’ average estimates, after missing half-year estimates in six of the last eight reports. Pearson’s partner in Penguin Random House, majority owner Bertelsmann SE, said it would consider raising its stake in the venture.
The capitulation contrasts with months of optimistic statements by Chief Executive Officer John Fallon about the challenges Pearson faces in the U.S., where college enrollments and its testing business are down, and textbook sales unexpectedly declined. Now the Penguin stake is up for sale, meaning Pearson may lose another storied name after recent divestments of the Financial Times and a 50 percent stake in the Economist.
The shares were halted on volatility after continuing their skid as analysts peppered executives with questions about their business and the industry on a conference call that extended past an hour. The company’s enrollment projections were too aggressive and it underestimated the impact of rising textbook rentals on its business, executives said on a conference call.
“It’s a difficult time for Pearson,” Fallon said on the call. The company is seeking to build a more sustainable and growing digital business, he said. “We’ll manage our balance sheet so we can sustain the company through this challenging transition.”
It’s been a steep decline for Pearson, which was once the darling of the FTSE 100 Index and thrived under the leadership of its former CEO, Marjorie Scardino. Now, mired in an education business under threat from new technologies, Pearson is the worst-performing stock in the FTSE 100 in the new year, and has fallen more than any other in the past five years.
Pearson sank 28 percent to 578 pence at 12:52 p.m. in London, cutting the company’s market value to 4.75 billion pounds ($5.83 billion).
Creditors also reacted. The company’s 500 million euros of bonds due in May 2025 fell 2 cents on the euro to 98 cents, the lowest since May, according to data compiled by Bloomberg. And the cost of insuring Pearson’s debt with credit-default swaps jumped 20.5 basis points to an 11-month high of 128 basis points, according to data compiled by Bloomberg. The contracts were the worst performing among 125 companies in the Markit iTraxx Europe Index on Jan. 18.
Analysts question whether executives at Pearson are capable of handling structural shifts in higher education: Fewer older students are enrolling, community college admissions are dropping, and more students are renting textbooks, while new entrants such as Amazon.com pose a major threat.
“Management’s credibility is likely to be severely impacted by today’s news,” Ian Whittaker, an analyst at Liberum Capital, wrote in a note. The Penguin stake may raise as much as 1.2 billion pounds, he estimated.
While Pearson’s Fallon accepted responsibility for not reading the market, the board has told management to move ahead with its plan, he said on a call with journalists. The company plans to boost the share of digital revenue in the U.S. higher education division – Pearson’s biggest and most profitable – to 75 percent by 2020 from 50 percent currently, including by working with more institutions to sign up large blocks of students and cutting electronic book-rental prices by 20 percent to 50 percent, he said.
Pearson will use proceeds of the Penguin Random House sale to strengthen its balance sheet and return excess capital to shareholders, the company said. The dividend, which amounted to 52 pence a share for 2016, will be cut beginning this year to reflect the lower earnings guidance. The current dividend equals 6.4 percent of Pearson’s share price, the highest yield among companies in the U.K.’s benchmark FTSE-100 Index.
Analysts have been questioning the health of Pearson’s education business since last year. Neil Campling, at Northern Trust Securities, called the announcement “the warning we’ve been expecting,” in a note on Wednesday.
“The higher-education business declined further and faster than the company expected in 2016 although in light of the plethora of negative data points we have highlighted throughout the year we are not surprised,” Campling wrote. “The North American higher-education courseware market essentially collapsed in the critical fourth-quarter back-to-school season.”
Operating profit in 2017 will be 570 million pounds to 630 million pounds, the London-based company said in a statement, below the average analyst estimate compiled by Bloomberg of 702.9 million pounds. The world’s largest education company withdrew its profit goal for 2018 after sales of materials for U.S. higher education dropped 30 percent in the fourth quarter.
Pearson combined Penguin with Bertelsmann’s Random House in 2013, leaving the British company owning just under half of the venture, which publishes books from writers including John Grisham, Ken Follett and George R. R. Martin. In 2015, it generated revenue of 3.7 billion euros ($3.95 billion) and operating earnings before interest, taxes, depreciation and amortization of 557 million euros.
Bertelsmann isn’t obligated to buy Pearson’s stake in Penguin Random House. The German company is open to increasing its holding “provided the terms are fair,” CEO Thomas Rabe said in a statement. “Strategically this would not only strengthen one of our most important content businesses, it would also once further strengthen our presence in the United States, our second largest market,” Rabe said.
Pearson gets almost all its profit from education after already selling the Financial Times and its half of the Economist Group. The company announced a reorganization last year as it seeks to address sluggish demand in its main business.
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