McGraw Hill Financial Inc (MHFI), Apollo Group Inc (APOL), Pearson PLC (ADR) (PSO): Is the Textbook Market a Sustainable Business?

A popular chart going around shows that since 2001, college textbooks have increased in price more than 100% while recreational books have fallen in price by a little more than 1%. The consumer price index, meanwhile, has only increased about 30%. Have writing, printing, and supplying higher-education materials increased in cost so much that producers are just trying to pass on the expenses? Likely not.

The fact is that consumers of college textbooks typically don’t have a choice, making the demand inelastic and allowing publishers to charge prices well above what the consumer may value. While fantastic for publishers’ margins, is this bubbly business sustainable?

Let’s analyze it.

The rotating roster of publishers
McGraw-Hill Education, now owned by Apollo Group Inc (NASDAQ:APOL), Pearson PLC (ADR) (NYSE:PSO), and Houghton Mifflin Harcourt make up the three largest educational publishers. The previous owner of McGraw-Hill Education, McGraw Hill Financial Inc (NYSE:MHFI), completed the sale of its textbook segment in March for $2.4 billion in cash, which it is using for share buybacks.

Why did McGraw Hill Financial Inc (NYSE:MHFI) want to divest from its education segment? The company’s press release positions the slimmer group as “a high-growth, high-margin benchmarks, content and analytics company.” And since completing the sale in March, McGraw Hill’s stock has outperformed the S&P 500 by 14%. But was the segment that big of a drag?

Not too much. In 2011, its education business brought in 37% of its total revenue, with a 14% operating margin — what could be considered a healthy business. However, compared to its other businesses, like the S&P Ratings segment, which packs an operating margin of more than 40%, the education segment was the slowest and least flashy of them all.

Pearson PLC (ADR) (NYSE:PSO), meanwhile, takes in 50% of revenue from its North American Education segment, at an operating margin around 17%. In its annual report, Pearson trumpeted its 2% increase in this segment’s revenue compared to the industry’s total decline of 10%. However, being the best player in a losing industry is never an enviable position.

Digital trends: Boon or boondoggle
The focus now for textbook publishers is to attempt to control the industry shift toward digital solutions. Both McGraw Hill Financial Inc (NYSE:MHFI) Education and Pearson PLC (ADR) (NYSE:PSO) offer a bevy of digital products. This includes McGraw-Hill’s Connect, Learnsmart, Cinch Learning, and Acuity, and Pearson’s eCollege, MyLab, and OpenClass. The summary of all of these products is increased interactivity and engagement and more modular and bite-size chunks compared to the all-encompassing textbook.

However, even with a litany of catchy brand names, the digital market may never replace the revenue from pulp books. In an interview with Education Week, one school district superintendent states, “We used to invest hundreds of thousands of dollars every year in the textbook cycle, but we don’t do that anymore.”