Capitalizing On The Digital Revolution

I am convinced that the ongoing shift from paper-based information to digital content is one of the major trends of the 21st century. While some companies this as a threat to their businesses, I have identified one company that is profiting from the “digital revolution”. That is Pearson group (LSE: PSON), the global publishing giant, which has been investing heavily in digital content, while its rivals haven’t.

And for the defensive investor, the company is a reliable dividend-paying giant. It boasts an impeccable dividend record — increasing dividends above-inflation for the last twenty consecutive years. Pearson currently offers a prospective yield of 3.8% and maintains a progressive dividend policy.

Digitally competent

After starting out as a construction company during the industrial revolution, Pearson is today a conglomerate made up of three world leading businesses. These are Pearson education, Penguin publishing and the FT Group.

Pearson is presently at the forefront of the transformation in educational provision, as teaching and physical content shift online. Its long-term investments in digital provision are beginning to bear fruit. For example, a significant slice of its earnings now come from digital sources. Across the group, digital revenues currently account for 33% of its sales. This is a substantial increase from 2007, when digital sales made up only 21% of revenues.

Furthermore, in 2011, Penguin saw the sales of eBooks double from the previous year to constitute 12% of the division’s revenues. At the FT, they were one of the first news providers to launch an app that uses HTML5 technology. Since June 2011, the FT Web App attracted over 1.3 million visitors and was awarded with the ‘Best Mobile Innovations for Publishing’ at the Global Mobile Awards.

Defensive qualities

Pearson’s Education division accounts for by far the largest proportion of operating profit, standing at 80% in 2011. Of this, 67% stems from its biggest market, North America. This therefore leaves Pearson dependant on US education spending.

But the growth in online education provision, on which Pearson has a clear lead over its competitors, should drive demand for its products. Moreover, Pearson’s growing exposure to the emerging economies, which accounted for 11% of total sales in 2011, should offset slower growth in its main market.

Paradoxically, sluggish economic growth in its core market can actually help Pearson. This is because a weak US economy coupled with an anaemic job market, encourages stronger student enrolment as they seek to protect themselves from the economy. This bodes very well for its North American education division, which constituted £493m of operating profit last year.

While the FT group only makes up 8% of adjusted operating profits, its digital investments are beginning to pay off. For example, adjusted operating profit grew by 27% from 2010 to 2011. The Financial Times and the Economist Group (of which Pearson owns a 50% stake) are being primarily driven by strong growth in digital subscription revenues.  Digital services now account for 47% of the FT Group’s revenue, up from 25% in 2007.

Furthermore, during periods of economic uncertainty, people will likely want to read all about it (especially given the fallout in Europe!). Therefore I expect these rapid growth rates to continue.

Currency exposure

On the other hand, Pearson’s exposures to the US market leave it vulnerable to currency risk, because approximately 60% of its sales and profits are earned in US dollars. However, the stock market is a discounting mechanism and will have likely priced its stock according to this exposure. Moreover, the explosion in shale oil and gas production should strengthen the US dollar going forward, providing a further positive to Pearson’s stock.

Financial strength

At the heart of investing is sharing in the profits of successful businesses through the distribution of dividends. Pearson is no different from any other defensive stock, at £11, its forecast dividend yield stands at a healthy 3.8%.

Moreover, despite the banking crash and global recession, Pearson has managed to consistently advance its operating profit by just over 80% from 2007 to 2011. And its balance sheet remains strong, carrying just £500 of net debt at the end of 2011.

Additionally, Pearson sold its 50% stake in FTSE International to the London Stock Exchange for £428 in December 2011, giving them a total cash pile of just under £1.5bn. This lovely cash pile gives it plenty of scope to seize future growth opportunities through selective acquisitions.

At a current forecast price-to-earnings ratio of 13.2, I believe Pearson’s financial strength and digital focus make it an attractive prospect. In these volatile times, Pearson is a dull dependable media stock.

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