Hungering for Earnings
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Scholastic Corporation (NASDAQ: SCHL) reports again on September 20. It had a big move based on the sales and licensing of the popular Hunger Games trilogy when it reported Q4 earnings in July. Revenues rose 14% and earnings per share doubled. The company also reported more robust FY 2012 free cash flow of $147.6 million compared to FY 2011 $120.5 million.
But can Katniss, heroine of the Hunger Games, hit a bullseye for them again?
Hungering for More Games
Over the entire book industry the children and young adult category books have driven growth upward by 12%. But is the Hunger Games and Harry Potter enough for Scholastic? They sell their trade books and other books through bookstores, web sites and the Scholastic Book Fairs we all remember. Is that still a viable model for the 21st century?
On the call CEO Richard Robinson said they did not expect to recreate the record earnings of 2012 again in 2013. They expect to have to invest more in Storia, a recently debuted children’s e-book app and book system and Read 180 Next Generation, an electronic initiative to help teachers meet the new Common Core State Standards in reading and math. Robinson said they expected a downturn in Hunger Games sales in the next few quarters.
CEO Richard Roninson and the board obviously have confidence in the company as Robinson owns 4,352,609 shares and the board had authorized a share buyback program of which it has already purchased 475,672 common shares. The company has over $31 million left to be deployed for the rest of the buyback authorization.
Surprisingly, performance was solid from the school Book Fairs and international sales were up as well, especially in the UK and Asia. One thing that puzzles me is their purchase of The Weekly Reader from Reader’s Digest earlier this year. The Weekly Reader will no longer be published as an independent children's news source but will be incorporated into Scholastic News. I can see that The Weekly Reader was kind of retro and out of touch but I was still sad to see it go. I just don't know that it's particularly accretive to Scholastic.
There are three big drivers for sales for Scholastic right now: The Hunger Games, Harry Potter and all its iterations, and Clifford The Big Red Dog. Right now, there’s no new big thing on the horizon. The Storia apps for Apple and Windows are promising but probably not enough to offset the decline in their marquee names.
Scholastic is currently involved in a state sales tax brouhaha and is taking it to the Supreme Court. Some states are so hungry for tax revenue (Connecticut, I mean you!) that they are claiming that teachers are now "salesmen" of the company at the school Book Fairs even though they’re not paid in anything but books for their classes. They claim that the teacher salesforce constitutes a "nexus" and thus they can tax Scholastic. It’s similar but not identical to the Amazon.com cases working their way through courts.
A Supreme Court opinion on the nexus question could have significant effect on the Scholastic bottom line with millions saved or expended in these state sales taxes. Just my humble opinion, calling teachers sales agents is ridiculous and I hope Scholastic prevails. The case also involves Tennessee and Illinois and could take some time to be decided.
Competing Against the Big Dogs
There are some big players in publishing and media competing with Scholastic. Those are The McGraw-Hill Companies (NYSE: MHFI), Random House (not publicly traded), Rupert Murdoch’s News Corporation with its HarperCollins publishing subsidiary, and Pearson (NYSE: PSO) publisher of the Financial Times, the Economist, and educational media. To these competitors, Scholastic is Clifford the little red underdog.
McGraw-Hill is the big name most directly competing against Scholastic and is set to split into two divisions, the financial media segment and the education segment. McGraw-Hill's stock price has been moving up lately on bullish sentiment on the split much like Kraft Foods. The P/E of Scholastic is 10.43 compared to McGraw-Hill at 17.08 and Pearson at 10.15. The industry average is 14.45. Pearson also has a 2.40% yield compared to Scholastic’s 1.50% and McGraw-Hill’s 1.90% yield.
Scholastic has a large short interest of 17% and a 1.85 debt/cash ratio. The stock has sold off since its high in March of $40.18 shooting down to the mid 20’s in June.
Without a new Hunger Games movie to drive new sales and a looming important court decision Scholastic will likely tread water until the six months or so before the next Hunger Games movie and the hype machine is in full swing. For investors interested in this name it wouldn’t hurt to look at Lions Gate Entertainment Corp (NYSE: LGF) for any headline tidbits about the next sequel.
I very much admire Scholastic. As a fourth grader I had my own lending library of Scholastic titles that I made available to my classmates. I fondly remember reading Scholastic books every week to my daughter’s third grade class as a guest reader.
Yes, Scholastic had a record 2012 and the CEO admits that they will have trouble matching those kinds of numbers, so why buy before earnings on September 20. Wait until Scholastic boards the Hogwarts Express next year in search of more e-book exposure and the next huge book that captures our imaginations.
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