Students Aren't Buying Books. That Shouldn't Be a Surprise.

(Bloomberg Opinion) -- Just as it seemed Pearson Plc was close to exiting the woods, it has taken a sharp turn back into the undergrowth.

The U.K. education company surprised investors on Thursday with an  update that highlighted a drastic downturn in its U.S. business. The shares fell as much as 19%, the most in 18 months.

Pearson was quick to point to market-wide declines in the U.S. as the primary reason why profit would come in at the lower end of its full-year target range. But analysts including Macquarie’s Giasone Salati and Berenberg’s Sarah Simon said that was compounded by the firm losing market share to U.S. rivals Cengage Learning Inc. and McGraw-Hill Education Inc.

What’s more, Chief Executive Officer John Fallon is parting company with the head of Pearson’s North American business. The move suggests that Fallon recognizes there have been missteps in the firm’s biggest market.

Pearson has been slower than its main competitors to adapt to the new realities of students spending less on new textbooks, preferring to download materials, preferably for free, and buy second-hand books. Cengage Unlimited, which offers students course materials online and other benefits for a subscription fee, is a particular thorn in the London-based firm’s side.

The announcement that Kevin Capitani, the president of Pearson’s North American operations, will depart early next year is a tacit acknowledgement that there must have been operational failures. His responsibilities will be divvied up between two other executives. They better get a handle on the market quickly — according to a study commissioned by Pearson itself and released last week, some 75% of Americans think textbooks will be obsolete by 2025, with 59% believing YouTube will become a primary learning tool.

Investors have every right to feel disappointed. Analysts have grown steadily more bullish as it appeared that Pearson had turned a corner in North America, where the courseware business accounts for about a quarter of total global sales. For most of 2018, analysts had an average 12-month target price below the level at which the shares were trading. But, while almost half of the analysts covering the stock still recommend selling it, this year the target price had started to exceed the stock as a handful predicted major surges. That confidence now appears misplaced.

To be sure, the U.S. market is tough. Higher education courseware sales will fall by between 8% and 12% this year, Pearson said, more than the decline of as much as 5% that it had previously predicted. But there are clearly other underlying operational challenges there that have either been addressed too slowly, or not communicated effectively enough to investors.

Those failures have erased much of Fallon’s work to rebuild investor confidence, according to Bloomberg Intelligence analyst John Davies. Given the pace of the U.S. revenue decline, a cost-savings program means he’s pedaling hard just to keep profit steady. So as long as Pearson’s stuck in the woods, it better work on growing some deeper digital roots.

To contact the editor responsible for this story: Melissa Pozsgay at mpozsgay@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Alex Webb is a Bloomberg Opinion columnist covering Europe's technology, media and communications industries. He previously covered Apple and other technology companies for Bloomberg News in San Francisco.

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