Pearson Sinks as Investors Pan Dividend Plans After Penguin

(Bloomberg) -- Pearson Plc will allocate fewer resources to its dividend than some investors expected after a partial sale of its stake in book publisher Penguin Random House, raising concerns that the U.K.-based company may require more funds to prop up its balance sheet.

The shares fell as much as 8.3 percent, reversing earlier gains following the announcement that Pearson agreed to sell a 22 percent stake in the publishing venture to majority owner Bertelsmann SE for about $1 billion. While Pearson will use almost $400 million to buy back stock, its plans for an ongoing dividend struck investors as overly cautious. The share drop was the biggest in three months for the company, which has been struggling with its main education testing and textbook publishing business.

Pearson executives are signaling a lack of faith in the company’s financial strength, Liberum analyst Ian Whittaker said in a research note. Based on comments from a conference call, he expects an annual distribution of about 16 pence to 17 pence, which would generate about a 2 percent yield.

A payout that low “will deter income investors but also would seem to suggest that Pearson is concerned over the need to protect its balance sheet moving forwards,” Whittaker said.

Pearson fell 4.6 percent to 659 pence at 3:59 p.m. in London. It had advanced as much as 3.3 percent earlier.

“We are 100 percent focused on setting a future dividend that is sustainable, progressive and comfortably covered by earnings,” said Tom Steiner, a Pearson spokesman. “Ultimately this will drive long-term value creation.”

The company said Tuesday that the share buyback would return about 300 million pounds ($386 million) of surplus capital to shareholders after the Penguin sale, while Pearson keeps a 25 percent stake in the iconic book publisher.

Pearson Chief Executive Officer John Fallon has been unable to shake skepticism in his plan to transform the education company to a digital-first strategy. The company sold the Financial Times and its stake in the Economist to invest in the education business, which focuses on testing and textbook publishing. The business has faced challenges in the U.S., where college enrollment has fallen and online learning and rentals are putting pressure on textbook sales.

“What’s become painfully clear is that education is one of those sectors where it’s harder to go digital and make money out of it,” Jonathan Helliwell, an analyst at Panmure Gordon, said by phone. “It’s taken them a long time to realise that they should just focus on commercial parts of the market, rather than trying to do everything.”

Shareholders suffered the biggest drop on record in January, when Pearson issued a profit warning and forecast years of gloom in the U.S. market. Pearson has since announced plans to cut costs by 300 million pounds by 2019.

Pearson’s biggest problem is in its U.S. higher education business, which will be responsible for a higher share of profit generation once the sale of the Penguin stake and the company’s U.S. K-12 business is completed, said Whittaker, who rates the company sell. 

“Structural problems effectively driven by students refusing in greater numbers to pay very high prices for materials will put continued pressure on what has historically been a very high margin business for Pearson,” Whittaker said.

The company won’t use the income from the remaining Penguin stake to calculate its dividend, Chief Financial Officer Coram Williams said on the call. That suggests a payout at a bit less than half of the 37 pence a share Pearson’s other businesses will generate, he said.
“We’ll confirm the number when we get to half-year results” next month, he said.

“This is disappointing versus our estimate of 2017 dividend of 26 pence and at the low end of the range would imply a dividend yield of only 2%,” Chris Collett, an analyst with Deutsche Bank, said in a note.

Pearson had said in January that it planned to sell its entire 47 percent stake in Penguin Random House, or recapitalize the business and extract a dividend. The deal that resulted, valuing the Penguin Random House at $3.55 billion, blended both options. The venture, which publishes books from writers including John Grisham, Ken Follett and George R. R. Martin, will be recapitalized, distributing dividends to both partners.

“When we sat down with Bertelsmann, it quickly became apparent there was a third option not specifically provided for in the shareholder agreement that made much more sense for both parties,” Fallon said on an earlier conference call. The company will use proceeds from the sale to invest in its digital transformation, he said.

Pearson combined Penguin with Bertelsmann’s Random House in 2013, leaving the British company owning just under half of the venture. The merger created the world’s No. 1 book publisher and in 2015 it increased sales to 3.7 billion euros ($4 billion) from 2.7 billion euros in 2013. That was driven by a foothold in fast-growing markets such as India and blockbusters like Paula Hawkins’s thriller “The Girl on the Train” and E L James’s “Fifty Shades” series.

--With assistance from Kim Robert McLaughlin

To contact the reporter on this story: Joe Mayes in London at jmayes9@bloomberg.net.

To contact the editors responsible for this story: Anthony Palazzo at apalazzo@bloomberg.net, Benedikt Kammel