It's a Textbook Case for These Companies

If you buy college textbooks you may feel the odds are stacked against you with textbook prices rising higher than any other category in the Consumer Price Index.  But this stranglehold on students' dollar has been loosened by digital alternatives and free content upstarts. How are book related stocks like CHEGG (NYSE: CHGG  ) , Pearson (NYSE: PSO  ) , and Barnes & Noble (NYSE: BKS  ) faring in a competitive landscape that has changed virtually overnight?

Print textbooks may go the way of the encyclopedia
In an article last year on the "textbook bubble," economist Dr. Mark Perry wrote of the "open educational resources" trend. He compared the future of the overpriced textbook to that of the encyclopedia, that is, extinct like the dodo bird. Open educational resources refers to companies like Boundless.com which offers free, widely used textbooks in an online format.

Interestingly, Pearson is one of a number of textbook publishers trying to lay Boundless low under a mountain of legal paper (see legal complaint here.). Boundless CEO Ariel Diaz told the Chronicle of Higher Education last year these publishers are, "using litigation to protect an antiquated business model."

The  big textbook publishers' business model had been to regularly offer slightly revised editions at ever higher prices. Even when transitioning to digital the publishers keep the huge price tags by utilizing time-sensitive add-on software.These slight revisions made wealthy the authors, like N. Gregory Mankiw who penned Principles of Economics, but more so, the publishers, at the same time impoverishing already strapped students.

Despite tweaking digital to cost the same or more than classic textbooks, the industry is quaking in its boots. Just in time for this year's Fall semester Boundless started offering an interactive textbook, tweaked just like the big boys, for $19.99. Another free content provider FlatWorldKnowledge.com offers over 100 free commonly used texts and  apps to professors to personalize content to their syllabus.

Electronic delivery, free content providers, and a cottage industry of used textbook sellers disrupt a very profitable business model which saw prices rise higher than medical services and new homes.

Who wins?
CHEGG, the used textbook rental company, just debuted on Nov. 13 and sagged 20% from its IPO price of $12.50. As someone who buys and rents used textbooks for a kid in college it comes as no surprise. CHEGG has debuted among a competitive space with a plethora of competitors including eBay's half.com and Amazon.com as well as numerous privately held used textbook vendors online. Although CHEGG does offer e-textbooks there are small privately held competitors in this space like eTextbooks.com, as well.

Investors weren't too keen to buy into a company with a net loss of $49 million from 2010-2012 and anemic topline growth.  Francis Gaskins, of IPODesktop.com told Reuters,"(The) income statement just does not support that high a price.They were losing too much money and topline revenue is not increasing that much."

Meanwhile HMH Holdings (NASDAQ: HMHC  ) , better known as Houghton Mifflin Harcourt, soared on its IPO one day later. It has since pulled back from a high of $17.50. This company owns such evergreen franchises as Lord of the Rings, Curious George and Cliffs Notes.

88% of its business comes from the K-12 public school textbook business, a business that doesn't have the used book business to challenge it. Despite having a virtual monopoly, sales have sequentially declined since 2010, according to the 2012 annual report, from $1,507 million in 2010 to $1,285.6 million in 2012.

Although HMH Holdings is not exposed to the college textbook market per se, it does offer test prep for the GED, SAT, ACT, and AP subject tests. The company may have seen the writing on the blackboard wall with used book upstarts like CHEGG and the open educational resource movement  several years ago as it sold its college textbook assets to Cengage Learning in 2008. Cengage Learning is another plaintiff in the lawsuit against Boundless.com.

McGraw Hill Financial must have also seen the writing on the wall as it too, sold its education assets to private equity firm Apollo Global Management in March this year for $2.4 billion cash.

This leaves very few publicly-traded players in the textbook business. Barnes & Noble has exposure with its chain of university bookstores. London-based Pearson has a number of educational publishing names under its umbrella: Scott Foresman, Addison- Wesley, Benjamin Cummings,Prentice Hall, Allyn and Bacon, and Longman. Pearson is self-described as the largest publisher globally of higher education materials.

Pearson has been transitioning rapidly to be more a digital content provider partnering up with several major universities to provide online learner programs. As CEO John Fallon said on their most recent half year results in July, "In trading terms, 2013 has begun much as we expected. In general, good growth in our digital, services and developing-market businesses continues to offset tough conditions for traditional publishing."

The company operates in two other divisions, its financial press division which includes the Financial Times and its trade publishing division which houses its recently merged Penguin Random House.

BKS Chart

BKS data by YCharts

Barnes & Noble, the world's largest bookseller (according to the company) continues to struggle along, with two of its three divisions, the retail stores and NOOK devices, less relevant every day under the onslaught of Amazon.

The company currently has a net profit margin of -3.00% and a share price that is virtually flat over five years. Its third operating division, the 692 college bookstores, reported the only rise in revenue for the first quarter of 2014 of the three divisions. However, college store EBITDA showed a loss of $19 million.Most of that EBITDA loss was due to its efforts to offer more higher education digital products as it partners up with Pearson.

Time to hit the books
Of these, Pearson has the best chance to prosper short term but longer term the textbook case for textbook publishing, bookstores, and even book rental is challenged. Students are ever more unwilling to pay outrageous prices for textbooks and will go for free or cheap every time.


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