the online education sector & pearson equity story

8/11/2019 The Online Education Sector & Pearson Equity Story

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Table of Contents

Executive Summary

Markets Overview

Education Industry Analysis

Company Considerations

Recent Corporate Actions (eg. M&A, Strategy reviews)

Share price performance

Operating Performance

Valuation

Trade Idea


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EXECUTIVE SUMMARY

This presentation evaluates the education sector and within it, the global leader in thepublishing industry - Pearson PLC.

Through my analysis, I have identified the fundamental drivers of the industry and

company; to evaluate the intrinsic price of Pearson shares (PSOL). To do this I used a

fully integrated financial statement forecast model and discounted cash flow valuation.

I have observed the following key drivers with respect to the companys operatingperformance. Documenting assumptions for PSOLs growth, I have observed:

The global E-learning market is valued at 91bn - with projected p.a. growth of 23%.

This sector is dominated by education training & software companies.

The future for Pearson is a progressive transition to digital products and services.This allows Pearson to access fast growing content segments primarily in theedtech space.

Pearson has made significant investments in growth through both M&A and organic

channels. Since 2006, 0.5bn has been invested in organic through digital channels

such as Pearson Access (Content), MyLabs (Formal testing) etc.

2.5bn has been invested in acquisitions; increasing Pearsons market presence inthe E-learning markets.

On a DCF basis, the company is fundamentally valued at 965p. Pearson PLC shares arecurrently trading on the London Stock Exchange (LSE) at a premium: 1153p per share.

Applying different assumptions for terminal growth and WACC, the fundamentalshare price valuation ranges from 7211,035p


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Investor Sentiment Quotes

They (Pearson) have been acquiring teaching systems and administrationsystems that are incremental and new to Pearson. Its not straightforwardand there are bound to be bumps.

Steven Liechti (Investec Securities)

We still think the US is ahead of other countries in the economic cycle andthat relatively strong growth, and higher interest rates will lead to further

dollar gains. (Pound Sterling Live)

Under Scardino (Previous CEO), Pearson had a halo and it performed welland delivered earnings growth.With the new CEO, earnings growth has

gone into reverse. Sales are irrelevant; - its about profit.

Alex DeGroote (Media analyst at Panmure Gordon

)

Pearson introduces a level of uncertainty over outcomes which has no parallel inthe recent history of the companyStill, we are confident the transition to digitaleducation represents a significant opportunity for Pearson.

Claudio Apesi Sanford C. Bernstein Analyst)


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EDUCATION INDUSTRY

ANALYSIS


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Education Industry Overview

1.4bn students out of 7.1bn world pop

North America & Europe are the biggestconsumer markets

4,435bn global education expenditure

7.4 p/a growth in education exp till 2017

Education costs have risen 84 since 2000

E-Learning is set to grow at 23 p/a

Education Expenditure by

region

Growth by education markets

rowing education sectors

7.90%

25.20%

16.60%32.60%

3.10% 14.60%

Latin America

Europe

Emerging Asia-Pacific

North America

Middle East & Africa

Developed Asia-

Pacific

23%

41%

30%

20%

E-learning Social Serious Gaming Language

2.2 2.52.8

1.4 1.7

1.90.4

0.60.8

0.4

0.6

0.8

0

1

2

3

4

5

6

7

2012 2015 2017

Other

Corporates

Post secondary

K12


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E-Learning Market Overview

E-learning global market valued at 91bn

Smartphone penetration highest with18-34year olds

Asia has the fastest growth rate of 17.3

32 of sector is comprised of education& training software companies -Europe

UK has the 2ndlargest number of E-learning companies in Europe

Growth in smartphone sales

(m)

E-learning companies by sector

Growth rate by region (2011-16)

297468

631792

953

1200

2010 2011 2012 2013 2014 2015

!"#

%&'%("

)%"

#

#*&

5.0%

14.6%

6.6%

16.9%17.3%

8.9%

15.2%

0.0% 5.0% 10.0% 15.0% 20.0%

North America

Latin America

Western Europe

Eastern EuropeAsia

Middle East

Africa


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Competitive Landscape

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'"()*+%,-.$+-/01"#


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COMPANY

CONSIDERATIONS


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Strategic Considerations

The future for Pearson is a progressive transition to offer digital productsand services. This allows Pearson to access fast growing content segments

mainly in the edtech sphere.

Pearsons sales are expected to fall again in 2014. This is a direct result of

weakness in its underlying business trends, negative headwinds from FXand the disposal of Mergermarket. The share price performance outlines

this modest performance with respect to its traded peers.

Post 2015, the company looks set to gain traction once again with salessteadily rising. Structural risks still exist and will mostly display a mix of

headwinds and tailwinds.


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There is currently heavy investment in organic growth and M&A. Since2006, 0.5bn has been invested in organic growth through digitalchannels such as LabLearning.

2.5bn has been invested in acquisitions; increasing Pearsons marketpresence in the E-learning markets.

Current geographical focus lies in the developing markets such as theSouth Africa, China; where total emerging market revenue stands at819m (14%) of total sales. This strategy involves entering markets earlyand building scale.

Given Pearsons position and strategy, target firms are unlikely to belarge scale transactions (>200M). Early innovation and software-basedfirms are of increasing relevance to the firms desired direction. In theUS/Europe the McAfee institute is a prime example of such a nichesegment.

Financial Considerations


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Share Price Performance vs

Competitors (Last 12 Months)

50.0

70.0

90.0

110.0

130.0

150.0

170.0

190.0

26-Jul-13 26-Aug-13 26-Sep-13 26-Oct-13 26-Nov-13 26-Dec-13 26-Jan-14 26-Feb-14 26-Mar-14 26-Apr-14 26-May-14 26-Jun-14

Pearson Apollo group John Wiley


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Pearson Financial Forecasts

EBIT & Margin (14-18)

Profit & Margin (14-18)

Sales & Growth (14-18)

50165185 5325

5600

5900

-11.8%

3.4% 2.7%

5.2%

5.4%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

4400

4800

5200

5600

6000

2014E 2015E 2016E 2017E 2018E

Sales Growth (%)

539.6600.2

659.9 680.5 701.1

10.76%

11.57% 12.39%

12.15%11.88%

9.50%

10.00%

10.50%

11.00%11.50%

12.00%

12.50%

13.00%

0

200

400

600

800

2014E 2015E 2016E 2017E 2018E

Profit Margin (%)

730850

932 958 984

14.6%

16.4%

17.5%

16.2%

16.7%

13.0%

14.0%

15.0%

16.0%

17.0%

18.0%

0

200

400

600

800

1000

1200

2014E 2015E 2016E 2017E 2018E

EBIT Margin (%)

Top line sales is forecasted to growbetween 3-5 after accounting for

Penguins restructuring

International education division is

expected to generate 31 of sales inFY18 vs 27 in current year

EBIT margin is expected to grow from

15 to 17 . Net income margin is set togrow to 14 due to restructuring andoperational improvements.


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Key Financial Metrics - Gearing

Without planned transformative

acquisitions, Pearsons leverageratios are expected to fall as thebus inesses focuses on cashgeneration and optimises for its lineof acquisitions

Pearson is forecast to attain a netcash position in FY18E adding debt

capacity in future acquisitions

Net Debt / EBITDA

Debt / Equityet Debt / (Cash) - M

2469

1318.9

875.2 563.3242.5

-73.52013A 2014E 2015E 2016E 2017E 2018E

1.54x

0.90x

0.54x0.23x

-0.07x

2013A 2014E 2015E 2016E 2017E

54.0%

29% 28% 27% 25% 24%

2013A 2014E 2015E 2016E 2017E 2018E


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Headline Operational Metrics

International education divis ion;emerging markets such as China and

Brazildeliver significant growth

Digital and services stream is now 60of company revenue as opposed to printFY13

North Amer ican MyLab usagecontinues to expand with graded

submissions up 15 on 2012

Digital revenue as of sales (m)

MyLab registrations (m)ales by division (3Yrs)

0%

20%

40%

60%

80%

100%

2013 Y1+ Y2+ Y3+

Penguin

FT Group

Professional

InternationalEducation

NorthAmerican

37%40%

45%50%

60%

0%

10%

20%

30%

40%

50%

60%

70%

2009 2010 2011 2012 2013

7.3

8.9

9.9

11

0 2 4 6 8 10 12

2010

2011

2012

2013

No of registrations (m)


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Acquisition History

Since 2007, Pearson has acquired 15 businesses; investing a total amount of 2.5bn.Pearsons main strategy has been to invest in digital based/E-learning businesses. The

company has invested across the whole E-learning environment, including content, LMSand analytics.

This has provided Pearson with superior reaction capabilities to the changing marketenvironment. In addition to this, Pearson has been able to build scale in fast-growing

markets such as emerging economies.

M&A Transaction History

Announced Date Target Description Deal Value

16-Oct-2012 EmbanetCompass

Strengthen Pearsonsposition in educationalservices

404m

25-May-2012 Global English Build English Languagetraining business

58m

15-Sept-2011 ConnectionsLearning

Product extension invirtual school market

254m

26-Apr-2011 Schoolnet Product extension indiagnostic tools

140m


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TRADE IDEA


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Valuation Considerations

In order to calculate the intrinsic value of Pearson stock, I used a 5-year

discounted cash flow forecast for the FY14-18E. These projected figures weredesigned to incorporate assumptions I made about Pearsons futureprospects.

Key assumptions used include:

WACC: 8.4%

Long-term growth rate: 2.5%

Net Debt Position as at 30 June 2013: 2,469m

No. outstanding shares: 808m

On a DCF basis, the company is fundamentally valued at 965p. Pearson PLC

shares are currently trading on the London Stock Exchange (LSE) at apremium: 1153p per share. (Downside of 19.4%)

This implies FY15 EV/EBITDA multiple of 10.6x

Applying different assumptions for terminal growth

and WACC, valuation ranges from 7211,035p

LT Growth Rate

965.4 1.5% 2.0% 2.5% 3.0%

W

7.5% 990 1,081 1,190 1,3238.5% 810 874 948 1,0359.5% 675 721 774 83610.5% 570 605 644 68911.5% 485 512 543 577


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Discounted Cash Flow Analysis

Financial Year (Dec. Year end) 2013 2014 2015 2016 2017 2018 Terminal Period

Total Turnover 5,690 5,016 5,185 5,325 5,600 5,900

growth (%) -11.8% 3.4% 2.7% 5.2% 5.4%

EBIT 458 730 850 932 958 984

margin (%) 8.0% 14.6% 16.4% 17.5% 17.1% 16.7%

Depreciation & Amortisation 617.0 128.3 117.8 112.5 110.2 110.9

Tax @ 30.0% (137.4) (219.1) (255.1) (279.6) (287.4) (295.3)

Capital Expenditure 199.0 100.3 103.7 106.5 112.0 118.0

Capex/Sales (%) -3.5% -2.0% -2.0% -2.0% -2.0% -2.0%

Working Capital (493.0) 200.6 185.1 4.6 (12.8) (35.4)

Working Capital / Sales (%) 8.7% -4.0% -3.6% -0.1% 0.2% 0.6%

Free Cash Flow 245.6 739.7 794.4 662.9 656.2 646.6 646.6

Discount Factor 0.9224 0.8508 0.7848 0.7239 0.6677 0.6677

Terminal Value 11,206

Present Value 682.31 675.91 520.25 474.99 431.70 7,482Enterprise Value (m) 10,267

Net Debt as at (Dec 2013) 2469

Market Capitalisation (m) 7,798

No. Shares (m) 808

Share Price (p) 965.4


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APPENDIX


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Operating Assumptions

Sales Actual Actual Actual Forecast Forecast Forecast Forecast Forecast

2011 2012 2013 2014 2015 2016 2017 2018

North American education 2584 2658 2779 2612 2634 2665 2761 2861

International education 1424 1568 1539 1570 1623 1694 1773 1857Professional 382 390 410 485 572 603 641 681

FT Group 427 443 449 349 356 363 370 378

Penguin 1045 1053 513 0 0 0 0 0

Total 5862 6112 5690 5016 5185 5325 5600 5900

Divisional Revenue Split

North American education 44% 43% 49% 52% 51% 50% 49% 48%

International education 24% 26% 27% 31% 31% 32% 32% 31%

Professional 7% 6% 7% 10% 11% 11% 11% 12%FT Group 7% 7% 8% 7% 7% 7% 7% 6%

Penguin 18% 17% 9% 0% 0% 0% 0% 0%

Divisional Revenue Growth

North American education 2.9% 4.6% -6.0% 0.8% 1.2% 3.6% 3.6%

International education 10.1% -1.8% 2.0% 3.4% 4.4% 4.7% 4.7%

Professional 2.1% 5.1% 18.3% 17.9% 5.4% 6.3% 6.2%

FT Group 3.7% 1.4% -22.3% 2.0% 2.0% 1.9% 2.2%

Penguin 0.8% -51.3% -100.0% 0.0% 0.0% 0.0% 0.0%

Operating Profit (EBIT) Actual Actual Actual Forecast Forecast Forecast Forecast Forecast

2011 2012 2013 2014 2015 2016 2017 2018

EBIT 1226 487 458 730 850 932 958 984

EBIT Margin (%) 20.9% 8.0% 8.0% 14.6% 16.4% 17.5% 16.2% 16.7%

EBIT Growth (%) -60% -6% 59% 16% 10% 3% 3%


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Financial Assumptions

Pearson

Hist. Hist. Hist. Proj. Proj. Proj. Proj. Proj.

Financial Assumptions

31-Dec-11 31-Dec-12 31-Dec-13 31-Dec-14 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18

Income statement

Sales growth 4.3% -6.9% -11.8% 3.4% 2.7% 5.2% 5.4%

COGS as % of sales 44.8% 35.8% 40.6% 40.6% 40.6% 40.6% 40.6% 40.6%

Annual depr. as % of previous PPE 20.9% 25.1% 37.5% 37.5% 37.5% 37.5% 37.5%

SG&A as % of sales 34.3% 49.0% 42.3% 0.0% 0.0% 0.0% 0.0% 0.0%

Amortization of other intangibles amount 518.0 553.0 535.0 0.0 0.0 0.0 0.0 0.0

Non-recurring items amount 124.0 31.0 3.0 0.0 0.0 0.0 0.0 0.0

Effective tax rate 15.5% 35.3% 22.8% 30.0% 30.0% 30.0% 30.0% 30.0%

Shareholder info

Diluted weighted average shares outstanding 800.2 804.3 807.8 809.1 809.1 809.1 809.1 809.1

Dividend per share growth rate 7.9% 7.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Balance sheet: current assets

Accounts receivable as % of sales 23.6% 18.1% 20.6% 20.8% 19.8% 20.4% 20.1% 20.3%

Inventori es % of COGS 0.0% 53.6% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Other current assets % of sales 18.2% 15.3% 20.8% 20.0% 20.0% 20.0% 20.0% 20.0%Balance sheet: non-current assets

Capital expenditu res % of sales 2.7% 2.5% 3.5% 2.0% 2.0% 2.0% 2.0% 2.0%

Other assets % of sales 8.8% 8.4% 10.7% 10.0% 10.0% 10.0% 10.0% 10.0%

Balance sheet: liabilities

Accounts payable and accruals % of COGS 66.3% 25.5% 26.4% 26.0% 26.0% 26.1% 26.0% 26.0%

Accrued income taxes % of tax expense 131.5% 210.9% 188.5% 180.0% 180.0% 180.0% 180.0% 180.0%

Other long-term liabilities % of sales 20.9% 19.1% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0%

Balance sheet: equity

Common stock amount 3,131.0 3,265.0 2,870.0 2,676.0 2,676.0 2,676.0 2,676.0 2,676.0

Share repurchases amount (show as positive) (46.0) (5.0) 0.0 0.0 0.0 0.0 0.0

Debt / amount)

Loans due for repayment 78.0 55.0 47.0 0.0 0.0 0.0 0.0 0.0

Other long-term debt repayment 1,973.0 2,217.0 2,179.0 0.0 0.0 0.0 0.0 0.0

Interest Rate ( )

Short term debt 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%

Loans due for repayment 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%

Other long-term debt repayment 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%

Cash 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00%


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Income Statement

Pearson

Hist. Hist. Hist Proj. Proj. Proj. Proj. Proj.

Income Statement


Net Sales 5,862.0 6,112.0 5,690.0 5,016.0 5,185.0 5,325.0 5,600.0 5,900.0

COGS 2,624.0 2,187.0 2,312.0 2,038.1 2,106.8 2,163.7 2,275.4 2,397.3

SG&A 2,012.0 2,996.0 2,407.0 2,121.9 2,193.4 2,252.6 2,368.9 2,495.8

EBIT 1,226.0 487.0 458.0 730.3 850.3 931.9 958.1 984.4

Depreciation 70.0 80.0 82.0 128.3 117.8 112.5 110.2 110.9

Amortization 518.0 553.0 535.0 0.0 0.0 0.0 0.0 0.0

EBITDA 1,814.0 1,120.0 1,075.0 858.6 968.1 1,044.4 1,068.4 1,095.3

Non-recurring items 124.0 31.0 3.0 0.0 0.0 0.0 0.0 0.0

Interest Income 11.0 10.0 9.0 5.5 6.0 9.7 12.9 16.1

Interest Expense 66.0 75.0 82.0 114.8 84.7 84.7 84.7 84.7

Profit before taxes 1,047.0 391.0 382.0 621.1 771.6 857.0 886.4 915.8

Taxes 162.0 138.0 87.0 141.5 231.5 257.1 265.9 274.7

Profit after tax 885.0 253.0 295.0 479.6 540.2 599.9 620.5 641.1

Discountinued Operations (Profit) 71.0 61.0 244.0 60.0 60.0 60.0 60.0 60.0

Net income 956.0 314.0 539.0 539.6 600.2 659.9 680.5 701.1

Shareholder information

Diluted weighted average shares

outstanding 800.2 804.3 807.8 809.1 809.1 809.1 809.1 809.1Diluted earnings per share 1.19 0.39 0.67 0.67 0.74 0.82 0.84 0.87

Dividends per share 0.40 0.43 0.46 0.46 0.46 0.46 0.46 0.46

Dividends 319.0 346.0 372.0 372.6 372.6 372.6 372.6 372.6


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Balance Sheet

Balance Sheet Hist. Hist. Hist. Proj. Proj. Proj. Proj. Proj.


Cash and cash equivalents 1,369.0 1,062.0 729.0 374.1 817.8 1,129.7 1,450.5 1,766.5

Accounts receivable 1,386.0 1,104.0 1,173.0 1,042.0 1,027.5 1,086.4 1,126.1 1,196.3

Income Tax refund 0.0 1,172.0 0.0 0.0 0.0 0.0 0.0 0.0

Other current assets 1,066.0 937.0 1,183.0 1,003.2 1,037.0 1,065.0 1,120.0 1,180.0

Total current assets 3,821.0 4,275.0 3,085.0 2,419.3 2,882.3 3,281.1 3,696.7 4,142.8

Net PP&E 383.0 327.0 342.0 314.1 300.0 294.0 295.7 302.8

Goodwil l 183.0 15.0 1,092.0 1,092.0 1,092.0 1,092.0 1,092.0 1,092.0

Other intangibles 6,342.0 6,218.0 5,801.0 5,801.0 5,801.0 5,801.0 5,801.0 5,801.0

Other assets 515.0 513.0 611.0 501.6 518.5 532.5 560.0 590.0

Total assets 11,244.0 11,348.0 10,931.0 10,128.0 10,593.8 11,000.6 11,445.4 11,928.6

Short term debt 136.0 262.0 533.0 0.0 0.0 0.0 0.0 0.0

Accounts payable and accruals 1,741.0 1,556.0 1,505.0 1,304.2 1,346.5 1,391.9 1,458.0 1,536.9

Accrued income taxes 213.0 291.0 164.0 254.6 416.7 462.8 478.6 494.5

Total current liabilit ies 2,090.0 2,109.0 2,202.0 1,558.8 1,763.2 1,854.7 1,936.7 2,031.4

Total long-term debt 1,964.0 2,010.0 1,693.0 1,693.0 1,693.0 1,693.0 1,693.0 1,693.0

Other long-term liabilit ies 1,228.0 1,165.0 1,136.0 1,003.2 1,037.0 1,065.0 1,120.0 1,180.0

Total liabili ties 5,282.0 5,284.0 5,031.0 4,255.0 4,493.2 4,612.7 4,749.7 4,904.4

Common stock 3,131.0 3,265.0 2,870.0 2,676.0 2,676.0 2,676.0 2,676.0 2,676.0

Retained earnings 2,980.0 2,902.0 3,128.0 3,295.0 3,522.6 3,809.9 4,117.7 4,446.2

Treasury stock (149.0) (103.0) (98.0) (98.0) (98.0) (98.0) (98.0) (98.0)

Total equity 5,962.0 6,064.0 5,900.0 5,873.0 6,100.6 6,387.9 6,695.7 7,024.2

Total Liab.& Equity 11,244.0 11,348.0 10,931.0 10,128.0 10,593.8 11,000.6 11,445.4 11,928.6

Balance? OK OK OK OK OK OK OK OK


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Cash Flow Statement

Pearson

Hist. Hist. Hist. Proj. Proj. Proj. Proj. Proj.

Cash Flow Statement


Net Income 956.0 314.0 539.0 539.6 600.2 659.9 680.5 701.1

Depreciation 70.0 80.0 82.0 128.3 117.8 112.5 110.2 110.9

Amortisation 518.0 553.0 535.0 0.0 0.0 0.0 0.0 0.0

Change in OWC 0.0 304.0 (493.0) 200.6 185.1 4.6 (12.8) (35.4)

Change in other assets 0.0 2.0 (98.0) 109.4 (16.9) (14.0) (27.5) (30.0)

Change in other liabilities 0.0 (63.0) (29.0) (132.8) 33.8 28.0 55.0 60.0

Cash from Operating Activities 0.0 1190.0 536.0 845.0 919.9 791.0 805.5 806.6

Capex 156.0 152.0 199.0 100.3 103.7 106.5 112.0 118.0

Cash from Investing Activities -156.0 -152.0 -199.0 -100.3 -103.7 -106.5 -112.0 -118.0

Change in Common Stock 0.0 134.0 -395.0 -194.0 0.0 0.0 0.0 0.0

Change in Treasury Stock 0.0 46.0 5.0 0.0 0.0 0.0 0.0 0.0

Dividends (319.0) (346.0) (372.0) (372.6) (372.6) (372.6) (372.6) (372.6)

Long Term Debt Repayment 0.0 2010.0 (317.0) 0.0 0.0 0.0 0.0 0.0

Cash from Financing Activities (319.0) 1844.0 (1079.0) (566.6) (372.6) (372.6) (372.6) (372.6)

Net Cash Flow (475.0) 2882.0 (742.0) 178.1 443.7 311.9 320.9 316.0

Beginning Cash 0.0 1233.0 800.0 196.0 374.1 817.8 1129.7 1450.5

Ending Cash 1233.0 800.0 196.0 374.1 817.8 1129.7 1450.5 1766.5


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