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January 18, 2012
Half-Empty, Half-Full: Each on Its Own Just One Side of the Reed Elsevier Financial Story
So .... whenever an investment house thinks share price for a company is trading too low, two types of reports are going to be produced. Type One will argue that the Company should divest itself of certain assets usually deemed by the investment house as a drag on the company's potential market capitalization. A Type Two report typically recommends that investors should buy the company's stock because the stock market is undervaluing the company based on a sum-of-the-parts evaluation. I guarantee you will see both types of reports from different investment houses for viable companies. Both will be based on the same trailing financial data. Where they will differ is on their internally produced forecasts grounded in financial and non-financial information-based evaluations and forward-looking financial assumptions.
I bring this up because each type of investment research report has been recently published about Reed Elsevier.
Bernstein published a Type One report on Jan. 11, 2012 which calls for selling off LexisNexis Legal and Professional (L&P) first, then Exhibitions, then LexisNexis Risk Solutions "soon", followed by Reed Business Information (RBI) when market conditions are ripe, while also warning that Elsevier's STM organic revenue growth "continues to look challenging." The text of the report, "Reed Elsevier: Voices Calling for Asset Divestutes Should Grow Louder, and Perhaps Fall on Less Deaf Ears," was uploaded with Bernstein's permission to AALL's Members Open Forum ("By default, all current AALL members will automatically be set to receive messages from this eGroup as a daily digest." See AALL's Biggest Blunder of 2011). See Jean O'Grady summary of the report with respect to Lexis L&P. More generally, see the London Evening Standard's drum beating story.
Exane BNP Paribas published a Type Two report on Jan. 9, 2012 which in a nushell views Reed Elsevier one of its "Top Picks in Media in 2012" because the Company's STM publishing line is "an underrated asset with best-in-class defensive growth." (On Jan. 16, 2012 another European investment house called attention to Elsevier being the most well-established S&T publisher in the growing Chinese academic information market and on that basis reiterated its opinion that Reed Elsevier remains that investment house's top defensive pick in Media.)
Interesting that while Bernstein calls for the sale of Read Business Information (RBI), Exane considers RBI "a transformation overlooked."
Since the failed attempt to dispose of RBI in 2008, we believe this asset has dimmed the allure of the Reed Elsevier equity story. Yet, the transformation of RBI (c.12% of group revenues 2012 and 8% of group EBITA12e) is progressing well, a factor which does not appear fully captured in the stock valuation.
RBI databases offer steadily growing and high margin revenues, deserving a better rating in our view. Most of RBI’s databases have seen consistent mid to high single digit organic revenue growth CAGR07–11e and are likely to continue to see good growth over the next three years.
While Bernstein calls for the sale of Lexis Legal & Professional and points to Bloomberg as a possible buyer, Exane takes the following view:
We do not expect Reed Elsevier to sell its Legal & Professional division ... As far as [Lexis Legal & Professional] is concerned, we see two hurdles to a disposal: the technological integration of Risk Solutions, Elsevier and LexisNexis, and Bloomberg’s recent acquisition of BNA (making it an unlikely buyer for the next two years).
Bernstein observes that TR Legal's WestlawNext has gained "greater recognition" (read but not adoption) from protential customers" than Lexis Advance. In this context the report characterizes the December 2011 launch of Lexis Advance R2 as a "supplementary launch." Bernstein references "Lexis Advance (Associates)" as if Lexis has continued its market segmented approach for Lexis Advance. That simply is not the case. See Evan Koblentz's Law Technology News article, Lexis, Westlaw Update Research Services (Dec. 6, 2011)("Originally called Advance for Associates, Lexis decided to simplify the name and combine it with Advance for Solos, distinguishing roles by pricing rather than brand. That decision was influenced by senior lawyers who didn't want an associates' product and by small firms that wanted large-firm features, [Clemens Ceipek, vice president and managing director, New Lexis division] added.)
Bernstein has a point in so far as WestlawNext has been around longer than Lexis Advance but Exane's perspective corrects Bernstein's myopia:
We note that since its creation the electronic US legal information research industry has gone through various investment cycles. Print publishers embraced computer-assisted legal research in the mid-70s (and probably saw a spike in their investments and a related fall in margins then). The move from dedicated terminals to a PC environment in the late 80s was another major technological change requiring increased investments. The move to the internet in the late 90s triggered a new wave of investments. The recent spike in investments at Westlaw and LexisNexis has to be seen in that historical context. Sometimes LexisNexis led the charge; at other points in time, Westlaw moved first. Historically, operating profit margins did improve following an investment peak (e.g., LexisNexis margins falling from 31% in 1989 to 20% in 2000 before rebounding to 23% in 2003).
So what does Exane have to say about Lexis. Quoting at length (text heading in bold as published) and with permission:
A better invested business
We ... argue that following increased investments at the US legal business (in product development, technology as well as sales and marketing) since 2009, the L&P division is a better invested asset than it was in 2008. In our view LexisNexis has passed the peak of its investment cycle in 2011 and should gradually be able to see its operating margin recover.
With a better invested product and a more aggressive pricing policy, we believe LexisNexis is in a better competitive position against Westlaw than in late 2008. We estimate that large US law firms spend on average 40% less with LexisNexis than with Westlaw as price points differ. While LexisNexis has halved the rate of annual price increases for its print products in recent years, Westlaw has maintained annual double digit price increases for its similar products.
We believe this more accommodative pricing policy may help LexisNexis gain some market share from Westlaw. We note that Westlaw core research revenues fell by 3% in Q3 11 while Reed Elsevier’s US Legal & Professional posted 1% growth (core research revenues account for an estimated 60% of US L&P revenues).
A better managed business
We also view the group to be better managed now than it was in 2008–2009. The management vacuum seen in 2009 has been filled and divisional heads are in place throughout the group. In particular, we would like to highlight the fact that one of the first internal personnel changes made by Erik Engstrom was to move the head of Elsevier Operations to LexisNexis in order to improve operating efficiency. This suggests there will likely be operating efficiency gains at LexisNexis.
In a discussion about how further cost efficiency gains support a margin growth forecast for Lexis L&P, Exane writes
[W]e believe that the L&P cost base is likely to benefit from greater offshoring and outsourcing of operations. We believe that up to 300 positions could be moved from the US to the Philippines next year in the LexisNexis Global Customer Services and Production departments. LexisNexis is in the process of building up its offshore centre in the Philippines (which currently has around 200 people) and is currently looking to recruit local legal editors (to create summaries of US case law opinions) as well as content operation specialists and possibly customer service representatives.
At an average labour cost savings of 50%, we estimate that moving 300 positions from the US to the Philippines could save L&P GBP10m pa, or add 60bp to margins. This project underpins our assumptions of adj. operating profit growth at L&P rising from 14.1% in FY11 to 14.6% in FY12.
Do note that Exane issues a cautionary note about Lexis L&P. In its "Where could we be wrong?" section Exane observes
LexisNexis faces challenges in the US legal information market, both structural (law firm billings) and competitive (long term impact of Bloomberg). This could put prices under pressure. An unexpected organic revenue decline in US L&P revenues (c.18% of group revenues, 8% of group EBITA12e) would probably hurt the performance of the stock.
Of couse, the challenges identified in the above statement for the US legal market are just as applicable to TR Legal and Wolters Kluwer as they are to Lexis L&P.
Bernstein calls for divestiture of assets like L&P sooner rather than later. But one has to ask, does the current economic climate make the timing ripe to do so? Why buy now when the collapse of the Euro in 2012 or 2013 and its recessionary consequences is a distinct possiblity?
In terms of market cap here and now, Thomson Reuters, Reed Elsevier and Wolters Kluwers have experienced similiar share price declines on a percent basis over the last five years. Buyers of TRI stock have been paying a premium but is it deserved? Based on relative performance of all three for the last 12 months TRI is the worst performing stock.
(Anyone have any doubt why David Thomson executed the management changes at TRI? But I digress... .)
Do note that Bernstein rates Thomson Reuters "market-perform" and Reed Elsevier "underperform" while Exane rates the former "neutral" and the latter "outperform." (Bernstein rates Wolters Kluwer "market-perform" and Exane rates the company "outperform.")
Finally, on one important point, selling Lexis L&P, both Exane and Bernstein agree. Quoting from the Bernstein report:
[W]e think that [Reed Elsevier] management is unlikely to pursue more than minor adjustments to the portfolio (such as continuing the divesture of RBI's assets and selling the Exhibitions business in the next year or two).
(Emphasis added; As noted above, Exane has a different opinion on the value of RBI.)
So why are we seeing both types of reports being issued now? Besides for the fact that one will always see both types of reports, all three major players will be releasing their year-end financial reports soon. Here's the calendar:
- Feb. 9, 2012: Thomson Reuters
- Feb. 16, 2012: Read Elsevier
- Feb. 22, 2012: Wolters Kluwer
Both investment houses are offering their best advice to their clients. At the same time both are identifying issues corporate executives may (or may not) address in their year-end financial report presentations (or in "investor call" sessions typically scheduled afterwards). What matters is the actions taken or not taken by large share block investors. They typically do not react solely on the basis of any one investment house analysis. Neither should law librarians.
While we tend to focus on all three companies' legal product lines, both Reed Elsevier and Wolters Kluwer have substantial assets outside of law and their asset mix is better balanced than Thomson Reuters. At the moment TRI's Markets is in trouble, TRI has taken the For Sale sign down for Health and TR Legal remains the company's cash cow, albeit not at the profit margins it "enjoyed" before the recession. (Remember the "buzz" back in October when TRI was listed as one of 12 at-risk stocks that "could tumble in a hurry," that TRI's balance sheet was deemed so weak to be verging on bankruptcy? It's kind of hard to go bankrupt when you have something like a $12 billion credit line.)
As law librarians, we should ask, during the US legal industry recession, which company, TR Legal or Lexis L&P, cut pricing to retain its subscription base and which did not? Which company experienced the greater loss of revenue from cancellations of high profit margin print, and which did not? Which company launched its new online legal search platform to stay competitive while trying to charge a premium to current license holders to acquire it and which did not. Based on those answers, which company (and its parent) is willing to respond to its customer base's current fiscal situation by taking a longer term perpective and which is not?
I certainly have no crystal ball but I will be surprised if any major player in the legal publishing industry does anything more than make bolt-on acquisitions in 2012. If anything is likely to happen, my hunch is Lexis L&P will bolt on ALM for its legal news properties and its specialist treatises. Why? Well, one reason might be L&P needs ALM's specialist treatises to compete in the enhanced eBook market with TR Legal's ProView-ing of its long neglected but now deemed valuable specialist treatises published by companies it acquired years ago.
Of course I may be dead wrong. Perhaps BLaw would acquire Lexis L&P if for sale. If BLaw really is a threat to WEXIS in the generalist market, perhaps TRI should seek to acquire Wolters Kluwer's US legal assets if for sale. The Company made an attempt to acquire BNA last year, but that's a story for another day.
We live in interesting times... . [JH]
I would be surprised if even Lexis would silly enough to buy ALM Media. As Thomson and Bloomberg have shown with BLaw and Westlaw, Lexis could create their own editorial content for 1/10th of what ALM would cost as an entity. ALM is burdened with legacy print revenue (classified, display and legal notice advertising) that a.) is not sustainable b.) Lexis, or any other data driven business, has no interest in. ALM has never successfully monetized their data products. ALM sold for $630 million in 2007. When the new owners could not meet their interest payments, the Royal Bank of Scotland took a bigger slice of ownership in 2009. While RBS and Apax Partners are motivated to get out,(private equity starts to get antsy after 5 years and Banks don't want to be in the print publishing business) who would want to pay anywhere near the multiple they would be looking for for a declining business when creating one's own editorial content is way more efficient and effective.
Posted by: Mark Moskow | Jan 18, 2012 8:55:08 AM