Should I Buy Pearson PLC (PSO)?

A tale of three divisions
While Pearson is best known as the owner of the Financial Times and Penguin, two-thirds of its revenues come from its lesser-known educational division. Its share price has suffered a turbulent 12 months, due to rising fears over its growth prospects, and I’m wondering whether this could be a good entry point.

Education, education, education
Pearson’s recent trading update, published in January, disappointed the market. Its share price fell 3% after it warned that a slack Q4 would hit 2012 earnings from higher education, consumer publishing and corporate advertising, and 2013 looks set to remain weak. Its profits were also dented by the sale of FTSE International, which contributed 20 million pounds in 2011, and its decision to close adult educational business Pearson In Practice, which it acquired in 2010 for around 100 million pounds.

Them and U.S.
But it wasn’t all bad news. Pearson reported steady revenue growth and a 935 million-pound operating profit last year. It anticipates “modest revenue growth” in its U.S. education business, where it generates around 60% of its sales, and strong market share growth. That’s more impressive than it sounds, because these are tough times for the U.S. educational materials industry. If sterling continues to fall against the dollar, Pearson could enjoy a boost in currency adjusted earnings from this division in 2012. Its educational arm is also growing strongly in emerging markets, although maybe not strongly enough to compensate for weakness elsewhere.

Pick up a Penguin?
Penguin enjoyed a strong fourth quarter, defying the doom-mongers, who have been exaggerating the death of the physical book retail market for years. Newspaper publishing is another industry that has been written off, and the news here wasn’t so good, with the Financial Times suffering a drop in full-year profits. I happen to think the Financial Times is better placed than any other U.K. newspaper to make the shift from print to digital. Its readers should be more willing to pay for its specialist premium content, especially since many will be able to claim it as a business expense. But the short-term cost of making that shift has hit profits. Last autumn, there was plenty of press talk about Pearson selling the FT. Since denied, a sale would raise around 1 billion pounds, which would boost the stock. So it may be worth hanging on for that.

Pearson is a well-run business, but it clearly faces a lot of challenges. Earnings per share growth of 5% this year and 9% next year would be a solid return, given the various headwinds the company faces. The big brokers have been reducing their target prices and downgrading the stock from buy to hold, and it isn’t hard to see why. Trading on a FTSE 100 average yield of 3.5% and a slightly below average valuation of 13.9 times earnings, Pearson looks like reasonable value, but management has a battle on its hands to deliver crowd-pleasing growth.