Reed Elsevier is a diversified publisher and information services company. Elsevier and LexisNexis possess competitive advantages that give the firm a narrow economic moat; however, its other businesses face challenges.
Fair Value Estimate: 525p ¦ Uncertainty Rating: Medium ¦ Economic Moat: Narrow
Thesis (Last updated 17/09/10)
Elsevier's publishing unit has the strongest competitive advantage among the firm's four segments. Elsevier has a market share of around 25% in the niche science, technology, and medical publishing industry, and is about three times larger than its closest competitor. Health Sciences is the largest medical publisher in the world, with doctors, nurses, and medical researchers using its content to make decisions and improve medical outcomes. For example, Gray's Anatomy, the number-one selling medical reference in history with 40 editions over 152 years, is essential content for medical professionals and there is no viable substitute product. The science and technology portion of the business publishes more than 200,000 new research articles in more than 1,100 journals on an annual basis. Access to this research is crucial for customers, including academic and professional libraries, which sign multiyear contracts for the rights to the valuable content. The subscriber base for many of the journals is relatively small, so there is minimal appeal for creating a substitute product which makes the popular journals mini-monopolies.
The LexisNexis segment enjoys competitive advantages in the legal information business. The firm faces a formidable rival in Thomson Reuters, but these two companies enjoy a combined 78% of the U.S. legal information market. There has been overlap between the two competing services at major law firms, which usually subscribe to both, given the must-have nature of their content. Although the environment in Europe is more competitive, LexisNexis still captures close to 20% of the legal research market. Offsetting the competitive pressure in Europe are the growth opportunities in the region, as fewer lawyers in the region access research online than in the United States.
Two of Reed Elsevier's segments face significant competition, given the fragmented nature of the industries. Reed Exhibitions generates most of its revenue through the sale of exhibition space for major events. The firm is the largest player in this niche industry with less than 10% share and competes with other international exhibition companies as well as smaller industry trade associations. Reed Business Information owns a portfolio of business information publications and data service providers that compete in specific niche markets. Reed Elsevier was unsuccessful in its attempt to sell this business in 2009 because of the frozen credit markets, but we expect it to try again within the next few years.
The company has done a fair amount of asset shuffling over the past few years, with mixed results. The sale of its education publishing unit was positive for shareholders, as the firm was able to fetch an attractive price for noncore assets. However, Reed Elsevier overpaid for its acquisition of ChoicePoint in 2008. In our view, shareholders would be best served if the company focused on bolstering its two core businesses though internal investment and returned capital to shareholders through dividends.
Valuation
We are raising our fair value estimate to 525p from 463p per share primarily based on slightly higher revenue growth expectations. This new fair value estimate implies forward fiscal-year price/earnings of 13 times, enterprise value/EBITDA of 8.6 times, and a free cash flow yield of 8.7%. Our fair value estimate assumes an exchange rate of $1.56 per £1. We expect sales to increase at a 2.5% annual clip (compared to our previous 2% forecast) during the next five years, led by 3.5% growth in the Elsevier publishing unit, 2.5% growth in LexisNexis, and roughly flat growth for the two combined smaller segments. We project the company's operating margin to average about 15% during the next five years, a bit lower than the 16% average margin earned from 2007-09. In particular, we expect some margin pressure in the LexisNexis business given the higher level of investment necessary to compete with its main rival.
Risk
Reed Elsevier operates in highly competitive and rapidly changing markets. Its operations depend increasingly on technology. Certain businesses depend on public funding, which can fluctuate, and on the cyclical nature of advertising and promotional spending.
Management & Stewardship
Reed Elsevier came into existence in 1993, when Reed Elsevier PLC (London) and Reed Elsevier NV (Netherlands) combined their businesses. The two companies have retained separate legal and national identities, and each has a board of directors that come together to constitute a joint board of directors. Erik Engstrom replaced Ian Smith as CEO in November 2009. Engstrom has served as CEO of the Elsevier publishing segment since 2004, and the segment has generated solid results during his tenure. Most of Engstrom's 2009 salary was based on his prior role. He received total compensation of £1.8 million, with about half coming from a bonus. Elsevier invested heavily in additional technology and infrastructure to effectively compete in an industry that has become more dependent on the electronic distribution of content.
Overview
Growth: The company posted an internal revenue decline of 6% in 2009, and we forecast a 1% decline in 2010 as we expect LexisNexis to weigh down sales growth.
Profitability: We forecast returns on invested capital to average 14% over the next five years, higher than our cost of capital assumption of 10.3%, supporting our view that the firm has an economic moat.
Financial Health: The company has decent financial health. Its debt maturities are spread out, with half of its outstanding debt due over the next five years. We expect EBITDA to cover interest expense 5 times on average over the next five years.
Profile: Reed Elsevier is a diversified publisher and information provider. A majority of the company’s revenue is generated in North America (55%) and Europe (31%). The firm's various segments include Elsevier (44% of sales), LexisNexis (42%), and Reed Business and Exhibitions (16%). In 2008, the company acquired ChoicePoint, whose main enterprise provides data and analytics software to property and casualty insurers. The company folded ChoicePoint into its LexisNexis segment.
Strategy: At Elsevier, the company seeks to expand its business by meeting the demand for scientific research by publishing scholarly articles and research in its portfolio of journals and publications. At LexisNexis, the company is focused on integrating the ChoicePoint acquisition. The company continues to invest in enhancing the electronic delivery of its services across each of its segments.
Bulls Say
1. The Elsevier publishing unit enjoys about 25% share in its niche market and has almost 3 times the sales of its nearest competitor.
2. The company's revenue is diversified globally, with 45% of revenue coming from outside North America.
3. Elsevier has successfully digitised its legacy journal holdings, which should provide incremental revenue in additional to its traditional subscription-based model.
Bears Say
1. Some scholarly journal users have been taking more of a stand against the prices charged by publishers for content. As a result, publishers like Reed Elsevier may have to take smaller price increases from academic libraries in future years.
2. A healthy portion of Elsevier's sales are derived from businesses that rely on academic or state budgets. Cuts in funding could lead to pressure on revenue and pricing.
3. Profitable growth in new markets such as India and China may be more difficult than the company expects.
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