Pearson Plc (PSON) is in talks to combine its Penguin book-publishing unit with Bertelsmann SE's Random House as the media companies seek to bulk up in response to a surge in providers of electronic books.
The merged entity would have combined revenue of about 2.3 billion euros ($3 billion), based on 2011 annual reports. No agreement has been reached and the discussions may not lead to a transaction, Pearson said yesterday. Christian Steinhof, a spokesman for Bertelsmann, referred to Pearson's statement and declined to comment further.
Bertelsmann Chief Executive Officer Thomas Rabe, who took over in January, is looking for acquisitions to reduce the Guetersloh, Germany-based company's dependence on Europe and expand its digital businesses. Pearson is seeking to boost its education unit and has selected that division's chief John Fallon to succeed CEO Marjorie Scardino, who will step down by the end of the year.
"It is a defensive deal that helps reduce costs and restore profitability but does not solve the problem of sales growth," said Alex DeGroote, a media analyst at Panmure Gordon & Co. in London. "It does not seem that any money is changing hands, but that it is just a joint venture."
Merging the units could reduce their estimated combined cost base of 2 billion pounds by 2 percent to 3 percent, DeGroote estimates. Bertelsmann will probably have a bigger stake in the entity to reflect Random House's greater revenue, he said.
Pearson rose 1.7 percent to 1,233 pence at 9:53 a.m. in London, giving the publisher a market value of 10.1 billion pounds ($16.3 billion). The stock has gained about 3 percent in the 12 months through yesterday. Bertelsmann is closely held by the Mohn family, descendants of Carl Bertelsmann, who founded the company in 1835.
Penguin, which published its first books in 1935 including works of Ernest Hemmingway and Agatha Christie, reported a 3.5 percent decline in sales to 441 million pounds for the first half. Profit fell to 22 million pounds from 42 million pounds a year ago even as its books won two Pulitzer prizes and 132 made the New York Times (NYT) bestsellers list.
"Strategically it makes sense for Pearson as there are synergies to be gained from the merger," said Ian Whittaker, an analyst at Liberum Capital Ltd. in London. "In an industry that is facing structural problems, the easiest way to get profits are synergies and cost cutting."
The combined heft of Random House and Penguin could give the companies more control over the market as book publishers face pressure from big buyers such as Amazon.com Inc. (AMZN) who are able to drive down prices, Whittaker said.
Penguin, publisher of "The Help" and "Diary of a Wimpy Kid" series, is valued at about 750 million pounds, based on 7 times earnings before interest and taxes for "mature" publishers, according to DeGroote.
Random House's revenue increased 20 percent in the first half to 947 million euros. Bertelsmann's publishing unit profited from sales of international bestseller "50 Shades of Grey" and rising e-book sales. Earnings before interest and taxes rose by 64 percent to 113 million euros.
Random House's e-book sales accounted for 25 percent of its revenue in the first half. Penguin, lagging behind in this business, is catching up as its e-book sales grew by 33 percent in the first six months, bringing the unit's revenue from digital books to 19 percent.
Still, the talks with Random House are "not a game changer" for Pearson, Whittaker said. Penguin accounts for about 17 percent of sales at Pearson, whose business is dominated by its educational software, books and services.
Pearson, which also owns the Financial Times newspaper and a stake in the Economist magazine, has been bulking up its holdings in the more lucrative education business.
Outgoing CEO Scardino had addressed the company's declining print businesses by moving them into digital formats such as e- books and online subscriptions. While those new products have grown, some analysts, including Claudio Aspesi of Sanford C. Bernstein, have said the transition to a new CEO may lead to a restructuring or sale of the publishing businesses and help the company streamline itself around education.
The education business's sales grew 10 percent to 1.93 billion pounds in the first half from a year earlier.
"Some of the items that will be part of the agenda of the new CEO should include what to do with the remaining assets which are not directly supporting the growth of education," Aspesi wrote in a note this month after Scardino announced her retirement. "This may lead to unlocking value hidden in those assets."