Ex-FT owner Pearson on course for turnaround?

While not many people will look back on 2018 with much affection, John Fallon will.

Pearson (Xetra: 858266 - news) , where he is chief executive, was the fifth-best performing stock in the FTSE-100 index last year with a gain of 28%.

It represented quite a turnaround in fortunes for the publishing giant after a lousy few years in which, beset by a string of profit warnings delivered on a seemingly regular basis, Pearson's shares fell by 11% in 2014, by 38% in 2015, rallied by 11% in 2016 but then fell by 10% in 2017.

Today's trading statement, though, unfortunately feels like a return to form.

Shares (Berlin: DI6.BE - news) of Pearson have slumped by up to 7% at one point following news of a drop in sales in one of its key US businesses.

Pearson is one of those rare beasts - a British company that, like Diageo (LSE: DGE.L - news) and Compass, is the world's biggest player in its field. That field is publishing educational materials but, unfortunately for Pearson, it is one that has been upended by the internet.

Pearson's big strategic challenge in recent years has been to protect revenues from publishing physical school text books while trying to migrate its customers into a digital environment.

The strategy was summed up by Mr Fallon in August 2017 as "combining our world-class content and assessment capabilities powered by innovative services and technology to support more effective teaching and deliver a richer learning experience to many more people".

But it has not been easy: the former has been hit as school and college budgets have come under pressure as governments in developed markets seek to keep a lid on their spending while debt-ridden students, seeking to save money, try to buy or rent second-hand course books - a task that has become easier thanks to the rise of online platforms like eBay and Amazon.

That has shown up in the numbers. It is perhaps significant that, from 2014 to 2017, sales fell in three of those four years. The one year of growth, 2016, was the only one of those in which Pearson's share price also ended the year higher.

Today's trading statement highlights that. Pearson admitted that total sales for 2018 were down 1% on an underlying basis with falls in US higher education courseware - which make up just under a quarter of total sales - down by 5%.

Meanwhile, moving schools and colleges away from using traditional textbooks and embracing new forms of education, notably developing interactive learning modules, in which pupils and students enjoy real-time support and feedback, is costly and particularly at a time when Mr Fallon has been trying to reduce the company's borrowings.

His solution has been to cut thousands of jobs - around 4,000 employees, or one in 10 of the workforce, left in 2014 alone - reduce other overheads and embark on a series of asset sales.

The most high-profile of these saw the Financial Times, which Pearson had owned since 1957, sold in July 2015 to the Japanese media group Nikkei for £844m. This was followed a month later with the sale of Pearson's 50% stake in The Economist to Italy's wealthy Agnelli family for £469m.

Meanwhile, in November last year, the FT's London home for the last 32 years, at 1 Southwark Bridge, was sold to fund managers M&G (Shanghai: 603899.SS - news) for £115m.

Pearson has also injected Penguin, the book publisher it previously owned, into a joint venture with Random House and in 2017 sold a 22% stake in that joint venture to the latter's German owner, Bertelsmann, for £761m.

That has worked to a degree. The cost-cutting means that, according to today's trading statement, adjusted operating profits for 2018 will come in at between £540-£545m - smack in the middle of the £520-£560m towards which Pearson had been guiding the market.

Analysts noted that, without the cost-cutting, Pearson would probably have missed that earnings guidance.

On the borrowings side, Mr Fallon has made appreciably more progress, cutting net debt from just over £2bn in mid-2014 to "around £200m" by the end of 2018.

To that extent, today's sell-off in the shares looks slightly harsh. Debt is down, underlying earnings will be in line with expectations and the migration from print to digital is continuing.

Getting on for three-fifths of sales now come from digital sources while two-thirds of the business is growing.

The big problem is that investors who have stuck with the company have yet to see a rise in underlying sales and an increase in underlying earnings derived by that sales growth rather than by cost-cutting.

Only when that happens can Pearson say with justification that its turnaround is complete.