If Pearson shareholders are irked that the offer on the table looks pretty stingy, they know where they should direct their ire. Successive management teams have made it easy for private equity to launch a low-ball offer.
The emergence of two bids for the education specialist from private equity firm Apollo Management poses a multitude of questions for investors: is the strategic overhaul convincing enough to drive a turnaround in profit growth? Should they hold out for an improved offer from Apollo? Might a rival bidder emerge?
Apollo is a logical suitor. It has form not just in owning an education business, but in bringing it into the 21st century via its acquisition of McGraw Hill Publishing in 2012. It increased its digital income from less than 25 per cent of revenue in 2013, to more than 60 per cent by the time it sold to its private equity peer Platinum Equity for $4.5 billion, almost twice what it had paid.
But investors would be right to think that Apollo’s second cash bid of 854p a share, which Pearson argued “significantly undervalued” the company, looks a tad mean-spirited. That offer represented a 31 per cent premium to the — beaten up — closing share price the day before news of Apollo’s interest emerged. But an implied valuation of £7 billion, including Pearson’s £500 million in debt, represents just over 11 times forecast earnings before interest, taxes, depreciation and amortisation this year, down from a seven-year high of more than 14 at the start of last year and is in line with the average multiple since 2013, when a string of harsh profit warnings began.
How might Apollo justify stumping up more? A break-up of the group could add 30p to 50p on the value Apollo might bid for Pearson, reckons Exane BNP Paribas, the investment bank estimating that more than $200 million of cost synergies would be available from engineering a split.
Advertisement
However, Pearson has sold off most of the family silver, including the Financial Times and its remaining stake in Penguin Random House. Obvious targets for disposals are not as clear as they have been. A more scrupulous owner might pick out the English Language Learning business, from remaining divisions focused on occupational and academic learning, Shore Capital’s Roddy Davidson reckons.
Before the bid emerged, Davidson estimated Pearson’s fair value at 822p a share, but reckons the Apollo bid “would have to begin with a nine to have a good shout of convincing investors” to agree to a takeover that aligns with successful UK takeover deals in recent years.
Yet a torrid performance over the past decade means the education specialist is hardly deserving of a beefy premium. Investors could well take the safety of a cash offer with little premium, over the risk that management fails to deliver on yet another turnaround strategy.
Sales last year beat market forecasts for the first time in years, thanks to rising underlying revenue for the assessment and qualifications division, now the largest segment, and virtual learning. But the former was against a weak comparator and the latter benefited from a pandemic shift by students online.
Attempts to focus on distributing educational materials directly to consumers, rather than mostly via schools and colleges, ushered in by Andy Bird, chief executive and ex-Disney International boss, make sense. But exposure to the declining market for print textbooks is a thorn in its side. Last year, underlying sales in the US higher education business, the second largest contributor to sales, fell by 5 per cent.
Advertisement
Apollo might have to part with more cash to win over investors, but it shouldn’t take too much extra.
ADVICE Hold
WHYAn improved offer for Pearson could present a good opportunity for shareholders to exit
Softcat
The software reseller has the premium rating to match the deftness of its earnings stream. Over the past five years, shares in the FTSE 250 constituent have risen more than fourfold, earning an enterprise value of just over 24 times forecast earnings before interest, taxes, depreciation and amortisation.
Scale is one of the Softcat’s advantages in what is a competitive, but highly fragmented market. It estimates that there are about 10,000 software resellers in the market, but as the No 1 player it has only a 4 per cent share. The company reckons the breadth of its product base and offering value-added services including planning the design of technology used in large data projects, gives it an edge.
First-half trading figures bear that out. Gross profit, its key financial metric, grew ahead of market expectations at almost 12 per cent. That led Numis, the brokerage, to increase its operating profit forecasts for this year and the next by 8 per cent and 5 per cent respectively, to £129 million and £139 million.
Taking market share and selling more products to existing public sector, mid-size and large corporate clients are the avenues for further growth. There is plenty more ground to go for, reckons Graeme Watt, the chief executive, because the market is growing at roughly 6-7 per cent a year as more organisations overhaul their IT systems for hybrid working and cybersecurity has higher priority.
Advertisement
The potential challenges? Component shortages have contributed to a backlog in hardware orders, which is expected to persist through the financial year. Like other resellers, Softcat doesn’t hold inventory so supply chain shortages could bite hard. But it’s not been a material issue yet, said Watt, and hardware sales were more than 50 per cent higher in the first half.
Travel and entertainment costs, curtailed during the worst of the pandemic, are also set to return in the second-half of the year. But neither of these factors is expected to progress on the bottom line — management has pegged gross profit growth at a stronger rate of 15 per cent over the latter half of this year.
The valuation might be too rich for some, but there should be plenty of upside for existing shareholders.
ADVICE Hold
WHY Reliable gross profit growth is priced in
