Publishers Merge in Adaptation to E-Reader Momentum

Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The year 2012 is witnessing the birth of a publishing giant as Pearson Plc (NYSE: PSO), the parent of the renowned Penguin Books, is joining forces with Bertelsmann AG’s Random House to create the largest book publisher in the English speaking world, which will control more than a quarter of the total market share of the U.S. and U.K. Bertelsmann will hold a 53% stake in the new joint venture, called Penguin Random House, while Pearson will take up the remaining 47%. The combined revenue of both the publishing houses last year was $3.9 billion.

The deal, a pure equity arrangement, is crucial for both firms. Earlier this year, Penguin reported a 3.5% decrease in its H1 revenues for 2012 to $707 million while profits dipped by 47.6% to $35.3 million despite having titles that won two Pulitzer prizes and secured the New York Times best seller spot 132 times. Random House, on the other hand, is operating in a continent that is seeing no end to its financial crisis, with consumers becoming increasingly picky in their purchases. Bertelsmann’s chief executive Thomas Rabe has been looking to reduce the business’s exposure to Europe while the company continues to digitize its titles.

Pearson bought the self-publishing industry leader Author Solutions (ASI) for $116 million. The former earned $100 million in revenues in 2011 and has a workforce of 1,600 located in the U.S. and the Philippines. The market dynamics of the traditional book publishing industry were completely changed when the founder of Project Gutenberg, the late Michael Hart, invented eBooks, which eventually opened up the avenue for writers to self-publish and for distributors to cut out the publisher. According to one estimate, 211,000 new eBooks were published in 2011, representing a 60% rise from the previous year. This also included the immensely popular Fifty Shades of Grey, which was initially self-published by E.L. James.

The new deals and mergers have now alarmed several writers who feel their bargaining power shrinking.  Like musicians, writers will have to become more adept at self-promotion. Advertising budgets from publishers have been shrinking for years as a new business model is being foisted upon them by technology and the demands of changing tastes.   

Sellers like Amazon (NASDAQ: AMZN), Barnes & Noble (NYSE: BKS), and  Apple (NASDAQ: AAPL) have been undercutting the dominance of paper publishing through their eBook readers and tablets, i.e. the Kindle series and iPad. Currently, the Kindle Fire HD is Amazon’s best selling product.   The tablet as a media consumption device has a number of advantages over traditional print, notably eye-strain and print size adjustment.  This has particular significance in marketing to older people, especially after age 40 when their eyes begin to change and reading for many simply becomes more physically challenging.  Traditional publishing houses are going to have to be more streamlined in their approach to bringing writers along and differentiating themselves from the self-publishing, profit-sharing systems like Kindle Direct Publishing and Barnes & Noble’s PubIt! program where authors can earn royalties that far exceed anything companies like Pearson and Random House can offer. 

What they still have is the access to traditional media outlets and the ability to push writers out into the media to cross-sell their work.  But self-publishing plus social media together give writers unprecedented access to their audience, if they take the time to find it.

Amazon sells the Kindle near cost and relies on sales of eBooks to generate profit. The company is incredibly secretive about providing actual sales numbers for its tablet, but in December 2011, about ten days before Christmas, the company revealed that Kindle sales were crossing 1 million per week. More recent statistics in August 2012 showed the Kindle reaching 22% of the total tablet sales in the U.S.

This razor and blades model which Amazon runs on razor-thin margins has the downside of being very unforgiving.  In its recent third quarter results, the online retailer reported losses of $274 million, down from a profit of $7 million in the previous quarter and $63 million in September 2011. But investors still believe in the Amazon strategy; the stock’s price, other than an early sharp reaction, has not been heavily affected.

Revenue was up 27% year-over-year to $13.8 billion, which has brought the old joke about Amazon selling dollars for ninety-cents and making up the profit on volume back from the dead.  Most of the loss came from the $169 million impairment of its 29% stake in LivingSocial that it acquired in late 2010.

<table> <tbody> <tr> <td> </td> <td> <p><strong>Stock YTD</strong></p> </td> <td> <p><strong>Beta</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>EPS</strong></p> </td> <td> <p><strong>Yield</strong></p> </td> <td> <p><strong>Profit Margin</strong></p> </td> <td> <p><strong>ROA</strong></p> </td> <td> <p><strong>ROE</strong></p> </td> </tr> <tr> <td> <p><strong>Amazon</strong></p> </td> <td> <p>37.6%</p> </td> <td> <p>0.82</p> </td> <td> <p>2836</p> </td> <td> <p>0.08</p> </td> <td> <p>N/A</p> </td> <td> <p>0.07%</p> </td> <td> <p>1.6%</p> </td> <td> <p>0.52%</p> </td> </tr> <tr> <td> <p><strong>Pearson</strong></p> </td> <td> <p>4.1%</p> </td> <td> <p>0.92</p> </td> <td> <p>10.5</p> </td> <td> <p>1.88</p> </td> <td> <p>2.5%</p> </td> <td> <p>15.6%</p> </td> <td> <p>4.4%</p> </td> <td> <p>17.0%</p> </td> </tr> <tr> <td> <p><strong>News Corp</strong></p> </td> <td> <p>33.3%</p> </td> <td> <p>1.21</p> </td> <td> <p>51.5</p> </td> <td> <p>0.47</p> </td> <td> <p>0.70%</p> </td> <td> <p>3.5%</p> </td> <td> <p>5.9%</p> </td> <td> <p>5.0%</p> </td> </tr> <tr> <td> <p><strong>Barnes&Noble</strong></p> </td> <td> <p>16.4%</p> </td> <td> <p>1.05</p> </td> <td> <p>N/A</p> </td> <td> <p>-1.27</p> </td> <td> <p>N/A</p> </td> <td> <p>-1.1%</p> </td> <td> <p>N/A</p> </td> <td> <p>N/A</p> </td> </tr> </tbody> </table>

Presently, Rupert Murdoch’s News Corp. (NASDAQ: NWS), the parent of the publishing firm HarperCollins, made noise about purchasing Penguin Books from Pearson. News Corp valued Penguin, ex-Random House, at $1.6 billion, almost one-third that of Penguin Random House. But since Penguin has already gone to Random House, Murdoch’s bid in its present form is unlikely to go anywhere.  Nonetheless, it highlights the mood of the industry that is feeling the downward pressure put on prices by Amazon.

The book publishing industry is expected to continue with consolidation and more M&A activity is expected in the future. Amazon is now going to face increasing competition as the industry consolidates. Rising traffic volume statistics on the Nook should give Amazon pause as the Nook generates nearly twice the web traffic as a the Kindle Fire does according to the latest statistics from marketing firm Chikita, and it is the second most used non iPad tablet behind the Samsung Galaxy tab 10.1.  While Amazon gets all of the headlines with the Kindle, the Nook is quietly building a reputation as a higher-quality alternative to the Kindle and a better all-around media and internet device.  Now with the Google Nexus 7 selling 1 million per month and iPad Mini hitting the market, the small tablet/reader space is even more crowded than ever before.    



PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Motley Fool newsletter services recommend Apple and Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

blog comments powered by Disqus