Pearson

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Pearson is a global learning company, providing educational content, assessment, and online services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Pearson PLC (PSO) operates in the global education market, delivering products and services across a variety of learning segments:

  • Assessment & Qualifications: This segment includes Pearson VUE, US Student Assessment, Clinical Assessment, UK GCSE, A Level, and International academic qualifications which comprises 31.9% of its revenue in 2022.
  • Virtual Learning: This business provides fully online learning programs for schools, universities, and employers such as online program management, direct-to-consumer learning, and Virtual Schools and Online Program Management which compromises 25% of its 2022 revenue.
  • Higher Education: This division includes courseware and digital learning materials, course management systems, and learning services for universities and higher education institutions. 23% of its total revenue comes from this segment.
  • English Language Learning: The English language learning business provides programs, assessments, and services for learners of English and educational institutions, constituting 20.2% of their revenue in 2022.
  • Workforce Skills: Focuses on delivering solutions for workforce development. This business segment is the smallest, creating 2.9% of 2022 revenue.

Here are a few key things to note about Pearson:

  • Geographic Reach: Pearson has a strong international presence. A significant portion of their revenue comes from international operations, including the UK, Europe, Asia and Latin America.
  • Shift Towards Digital: The company is increasingly focused on digital learning products and services, such as online courses, e-books, and digital assessment tools. This aligns with trends in education where online, convenient platforms are becoming important for students.
  • Strategic Partnerships: Pearson seems to focus heavily on developing strategic partnerships for new growth opportunities. As a result, the company does not have the biggest market share, and is often not mentioned as a clear leader in many of the segments that it operates.
  • In 2022, the company’s major strategic partnership was with Microsoft using AI-driven learning tools.

The education sector is undergoing rapid transformation:

  • Digitalization: The move to online learning has been accelerated by advancements in technology and changes in consumer preferences, and Pearson is trying to position itself for this trend.
  • Personalized Learning: The focus has shifted from a “one-size-fits-all” approach to education, as institutions are exploring custom learning tools that can adapt to the students’ capabilities.
  • Lifelong Learning: With an increasingly competitive global job market, there is more emphasis on constant learning. This is great for companies like Pearson that can tap into lifelong learning courses.
  • Competition: The education industry features a diverse mix of players: traditional publishers, technology companies, and niche providers. Many of Pearson’s market segments are increasingly competitive, as there are more and more companies that are emerging.

Financials in Detail

Let’s delve into Pearson’s financial performance. The most recent data is the annual report of 2022 and the trading update from January 2023.

Revenue:

  • Revenue in 2022 totaled £3.7 billion, a 4% decrease on a headline basis, due to some revenue losses in its print business, but a 5% increase on an underlying basis.
  • Underlying sales growth is strongest in its Assessment and Qualifications division, which was up by 13%. Underlying sales growth was also strong for English Language Learning and the Virtual Learning division, at 10% and 5%, respectively. Higher Education saw a 1% decline in sales, and Workforce Skills declined by 25%.
  • The company plans to grow its business in 2023 with new AI-powered tools in its product portfolio.

Profitability:

  • Statutory operating profit stood at £498 million in 2022, a significant increase year-over-year. Adjusted operating profit was £573 million, up 31%.
  • The company is aiming to improve and grow operating profits by focusing on higher-growth areas of business, particularly in its online services, digitalized offerings, and strategic partnerships. As a result, there may be some decline in profits during the transition phase as the company restructures its workforce and focuses on new areas of growth.

Cash Flow:

  • Free cash flow came in at £387 million in 2022.

Capital Structure:

  • The company has net debt of £1.2 billion.

Recent Concerns:

  • Pearson has been affected by declining sales in its print-book businesses and has had to make adjustments to refocus on digital products and services.
  • There were concerns over revenue losses in higher education due to low enrolment rates at colleges and universities. The company is proactively working on mitigating this and growing in the areas with higher student traffic such as English-language learning and certifications.
  • There is fierce competition in areas where the company does not have a unique product offering, and hence management will need to focus on areas with more defensibility and higher scalability to see consistent, long-term growth and profit.

Moat Rating: 2 / 5

Pearson’s moat is Narrow.

  • Intangible Assets (Brand and Regulatory Approvals): Pearson possesses strong brands in its respective learning categories. These can provide some pricing power and customer loyalty. They are also regulated in certain sectors. The level of accreditation and regulatory approval required to operate in higher education could be a barrier of entry in that specific sector.
  • Switching Costs: While the company is increasingly trying to create high switching costs, these are not consistent across all of its segments. For some of its business services, switching costs are quite high due to the level of integration required, but for its offerings to students at colleges/universities, the switching costs are quite low.

However, despite some barriers to entry, the company’s moat remains narrow for these reasons:

  • Replicable Product Offerings: The courses, books, and other products offered by Pearson are not too hard to replicate by other educational institutions, publishing houses, or technology companies.
  • Market Competition: The education industry is incredibly large, and even small players have the ability to focus on a niche. This makes it hard for any single company to achieve a dominant position.

Therefore, while Pearson has some elements of a moat, they are not substantial enough to be classified as a wide-moat business.

Business Resilience & Risks to the Moat

While the company is a global leader in its field, some key risks can harm the moat:

  • Technological Disruption: Technological advances, new methods of learning, and new market entrants can reduce the demand for the company’s products. Moreover, other companies could develop a new technological solution that can obsolete its current operations.
  • Changes in Government Regulations: Laws, rules and regulations in the education sector can change, which can affect Pearson’s business. For example, changes in education funding or accreditation requirements can affect profitability.
  • Shift in Customer Preferences: Demand for digital learning solutions and new formats of testing are accelerating, while traditional print books sales are dwindling. If Pearson cannot adapt to changing customer preferences, the profitability of their business may be affected.
  • Economic Slowdowns: Slow economic growth could lead to lower enrollment in post-secondary education and reduced budgets for corporate training. This could negatively affect Pearson’s revenue and profitability.
  • Poor Acquisitions: Historically, many companies that pursued acquisitions to grow had difficulty generating profits, and sometimes also decreased the company’s overall value. Even though acquisitions can improve long-term market position, poor acquisitions can backfire, especially when they cost an excessive premium.

That said, Pearson also has some great business resiliency that can withstand these challenges. The company is a globally recognized player, with a strong brand name and a wide reach that may protect it against some market downturns. Pearson also has a vast product portfolio, and is actively investing into new technologies to diversify its revenue streams. Finally, the company is proactively managing its finances and focusing on more profitable areas, making it more resilient.

Understandability: 3 / 5

Pearson’s business is relatively understandable, but not extremely so. They are primarily a publishing company which produces educational materials. Then, the company is also making a transition into digital educational tools and services, which add complexity. Also, the company has many operations in different countries and segments, which adds layers of complexity to the business model. While the core concept of delivering educational products is quite easy to comprehend, understanding the nuances of its different operational segments makes it slightly more challenging to fully grasp the business. Hence, the understandability rating is a 3.

Balance Sheet Health: 4 / 5

Pearson has a good balance sheet health overall. While it does have some debt obligations, they are well-covered by the company’s assets and operations. The company’s cash balance is slightly above average for a company of its size, but this does provide a good cushion for future investments or unexpected downturns. That said, a large amount of the company’s investments are in intangibles, so some investors may find this concerning. As a result, the company receives a “4 out of 5” for balance sheet health.