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Publishers Merge in Adaptation to E-Reader Momentum

The year 2012 is witnessing the birth of a publishing giant as Pearson Plc (NYSE:$PSO), the parent of the renowned Penguin Books is joining forces with Germany based Bertelsmann AG’s Random House to create the largest book publisher in the English speaking world that will control more than a quarter of the total market share of the U.S. and U.K. Bertelsmann will hold 53% stake in the new joint venture called Penguin Random House while Pearson will take up the remaining 47%. The combined revenues of both the publishing houses last year was $3.9 billion.

The deal, a pure equity arrangement, is crucial for both firms. Earlier this year, Penguin reported a 3.5% decrease in its H1 revenues for 2012 to $707 million while profits dipped by 47.6% to $35.3 million despite having titles that won two Pulitzer prizes and secured the New York Times best seller spot 132 times. Random House on the other hand is operating in a continent that is seeing no end to its financial crisis with consumers becoming increasingly picky in their purchases. Bertelsmann’s chief executive Thomas Rabe, has been looking to reduce the business’s exposure to Europe while the company continues with digitizing its titles.

Pearson bought the self-publishing industry leader Author Solutions Inc (ASI) for $116 million. The former earned $100 million revenues in 2011 and has a workforce of 1,600 located in the U.S. and Philippines. The market dynamics of traditional book publishing industry were completely changed when the founder of Project Gutenberg, the late Michael Hart, invented eBooks that eventually opened up the avenue for writers to self-publish and for distributors to cut out the publisher. According to one estimate, 211,000 new eBooks were published in 2011 representing a 60% rise from the previous year. This also included the immensely popular Fifty Shades of Grey which was initially self-published by E.L. James.

The new deals and mergers have now alarmed several writers who feel their bargaining power shrinking.  Like musicians, writers will have to become more adept at self-promotion. Advertising budgets from publishers have been shrinking for years as a new business model is being foisted upon them by technology and the demands of changing tastes.   

Sellers like Amazon Inc (NASDAQ:$AMZN), Barnes & Noble (NYSE:$BKS), and  Apple (NASDAQ:$AAPL) have been undercutting the dominance of paper publishing through their eBook readers and tablets, i.e. the Kindle series and iPad. Currently, the Kindle Fire HD is Amazon’s best-selling product.   The tablet, in general, as a media consumption device has a number of advantages over traditional print does; notably eye-strain and print size adjustment.  This has particular significance in marketing to older people, especially after age 40 when their eyes begin to change and reading for many simply becomes more physically challenging.  Traditional publishing houses are going to have to be more stream-lined in their approach to bringing writers along and differentiating themselves from the self-publishing, profit-sharing systems like Kindle Direct Publishing and Barnes&Noble’s PubIt! program where authors can earn royalties that far exceed anything companies like Pearson and Random House can offer. 

What they still have is the access to traditional media outlets and the ability to push writers out into the media to cross-sell their work with the media network.  But self-publishing plus social media together give writers unprecedented access to their audience, if they spend the time to find it.

 Amazon sells the Kindle near cost and relies on sales of eBooks to generate profit. The company is incredibly secretive about providing actual sales number for its tablet but in December 2011, about ten days before Christmas, the company revealed that Kindle sales were crossing 1 million per week. More recent statistics in August 2012 showed the Kindle reaching 22% of the total tablet sales in the U.S.

This razor and blades model which Amazon runs on razor-thin margins has the downside of being very unforgiving.  In its recent third quarterly results, the online retailer reported losses of $274 million down from the profit of $7 million in the previous quarter and $63 million in Sep-2011. But investors still believe in the Amazon strategy as the stock’s price, other than an early sharp reaction, has not been heavily affected.

Revenue was up 27% year-over-year to $13.8 billion which has brought the old joke about Amazon selling dollars for ninety-cents and making up the profit on volume back from the dead.  Most of the loss came from the $169 million impairment of its 29% stake in LivingSocial that it acquired in late 2010.


 

Stock YTD

Beta

P/E

EPS

Yield

Profit Margin

ROA

ROE

Amazon

37.6%

0.82

2836

0.08

N/A

0.07%

1.6%

0.52%

Pearson

4.1%

0.92

10.5

1.88

2.5%

15.6%

4.4%

17.0%

News Corp

33.3%

1.21

51.5

0.47

0.70%

3.5%

5.9%

5.0%

Barnes&Noble

16.4%

1.05

N/A

-1.27

N/A

-1.1%

N/A

N/A

 

Presently, Rupert Murdoch’s News Corp. (NASDAQ:$NWS), the parent of the publishing firm HarperCollins, made noise about purchasing Penguin Books from Pearson. News Corp valued Penguin, ex-Random House, at $1.6 billion, almost one-third that of Penguin Random House. But since Penguin has already gone to Random House, Murdoch’s bid in its present form is unlikely to go anywhere.  Nonetheless, it highlights the mood of the industry that is feeling the downward pressure on prices put by Amazon.

The book publishing industry is expected to continue with consolidation and more M&A activity is expected in the future. Amazon is now going to face increasing competition as the industry consolidates. Rising traffic volume statistics on the Nook should give Amazon pause as the Nook generates nearly twice the web traffic as a the Kindle Fire does according to the latest statistics from marketing firm Chikita and is the 2nd most used non iPad tablet behind the Samsung Galaxy tax 10.1.  For while Amazon gets all of the headlines with the Kindle, the Nook quietly is building a reputation as a higher-quality alternative to the Kindle and a better all-around media and internet device.  Now with the Google Nexus 7 selling 1 million per month and iPad Mini hitting the market the small tablet/reader space is even more crowded than ever before.    

 

 

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Peter Pham is a capital market specialist and entrepreneur.  With expertise as a Head of Institutional Sales and Trading he closely watches the market and probes for investment opportunities utilizing a unique blend of quantitative trading experience and macro trend analysis… (read more)

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