E-books are becoming increasingly popular with readers. According to the annual BookStats study published in May 2013, e-book sales saw a 45-fold jump from 10 million copies in 2008 to 457 million copies in 2012. Traditional publishers of books in print format fear that e-books will reduce their pricing power, level the playing field for new entrants, or change distribution models to their disadvantage. That is not what I observe with this group of listed publishers: John Wiley (NYSE: JW-A), Scholastic Corporation (SCHL +0.23%) and Pearson (PSO 0.99%)
Not all book categories are equal
While most people will be familiar with Wiley as the publisher of the "For Dummies" series of books, this category of technical non-fiction books is surprisingly not the main revenue generator for Wiley. Wiley should be rightfully seen as a publisher of academic journals, having generated 84% of its fiscal 2013 operating profits from this segment. If you have doubts about the pricing power of academic journal publishers, look no further than Wiley's peer Reed Elsevier.
In February 2012, a few thousand academics joined a boycott against Elsevier over issues with the high prices of journals and Elsevier's practice of selling journal subscriptions in bundles. Despite this, Elsevier's financial performance was unaffected and it reported the highest profit in its two decade history a year later in March 2013.
This is because libraries are cautious about cancelling journal subscriptions with leading players in the market like Wiley and Elsevier. For example, more than three quarters of Wiley's journals are regarded as high quality based on the frequency of citation by researchers, according to the Thomson ISI 2011 Journal Citation Reports, or JCR. Denying access to such journals because of price increases will inadvertently impact the quality of professors' and students' research.
Pearson, a publisher of textbooks, is also different from a publisher that rolls out fiction books in bookstores given that textbooks are not perfect substitutes for each other. If you need your weekly dose of adrenaline, Tom Clancy's spy thrillers and Ian Fleming's James Bond series of spy novels could be equally appealing choices. However, students enrolled in university courses do not have the luxury of choosing their favorite textbooks. The real decision makers are professors who tend to go with the tried and tested choices which favors incumbents like Pearson with its library of classic textbooks.
If you are not into specialty publishing such as academic journals or textbooks, the next best option is to find a profitable niche within the consumer book industry. Scholastic found its niche as the largest publisher and distributor of children's books globally with its domination of a unique sales channel, school-based book fairs, giving it an edge.
There are two key reasons why such book fairs will stay popular with schools. Firstly, book fairs form an integral part of community building which provides an opportunity for parents and school staff to mingle. Secondly, schools like their students to read more books to improve their language proficiency and broaden their horizons, but not all books are recommended or deemed appropriate.
Organizing book fairs with trusted publishers like Scholastic allows a school to play the role of curator and filter out undesirable content. The high barriers to entry in this sales channel are reflected in Scholastic's customer retention rates. About nine in 10 schools which hired Scholastic to run book fairs in 2012 are doing the same for 2013.
Technology as an enabler, rather than a disruptor
While the advances in technology are generally perceived as detrimental to traditional publishers of books in print format, some publishers have already chosen to embrace the digital revolution instead.
Today, a university student working on a final project no longer has to pore through hard copies of Wiley journals in the library to find articles relevant to the research thesis. The student can simply search and browse on Wiley Online Library, an online database of the company's academic journals and research articles. Besides justifying price hikes through greater value-add, Wiley has also diversified its revenue streams through online advertising and pay-per-view options.
The Babson 2012 Survey of Online Learning showed that 32% of higher education students now take at least one course online. Textbooks remain relevant, but schools are shifting a large part of their budgets to online learning. Pearson is not standing still. It bought EmbanetCompass, an online learning solutions provider for university programs, in October last year. In fact, textbook sellers, like Pearson, have an edge over new start-ups in cross-selling their digital learning services because of their long-standing relationships with their customers. Hence, it comes as no surprise that Pearson now derives about a third of its revenues from digital learning services.
Similarly, Scholastic is devoting efforts toward growing its Educational Technology and Services business, which sells technology-based learning products for children under 12. In the first quarter of fiscal 2014 alone, it rolled out five new Education Technology programs which included foundation reading programs like iRead and mathematics programs such as Math 180. Results have been encouraging, with revenue and operating profit for the educational technology and services unit increasing by 19% and 46%, respectively, during the same period.
Conclusion
Publishers that focus on niche categories and have already made their foray into digital publishing will be least affected by the sea of digital-led changes in the industry. Of the three publishers listed here, Wiley is my top pick because of the pricing power of its academic journal publishing business. However, it is not cheap at 15 times forward P/E and 11 times trailing twelve months EV/EBITDA, and I advise investors to wait for a better entry price.
