Could it be beginning of the end for Reed Elsevier?

The digital whirlpool will claim some big corporate scalps over this next few years. Consumer-facing media companies across newspapers and television risk being caught in the headlights of Apple, Google, Facebook, Twitter and more. But there will be casualties too from the aristocratic ranks of the world’s leading business and professional information companies.

We may need to look no further than the giant Reed Elsevier, where some institutional shareholders are now calling for breakup. It’s easy to see why.

The Anglo-Dutch company has failed to grow either revenue or profits across the last three years. Pearson Plc, its traditional business and professional media rival, has done much better, increasing pre-tax profit by 18% during the same period. Perhaps it’s a reflection of the performance of Pearson’s US-led education business which contributes 50% of Pearson profits, relative to the scientific and healthcare operations which account for the same proportion of Reed’s. Or perhaps, it’s something else.

Marjorie Scardino, the indefatigable Pearson CEO has announced her retirement at end-2012 after a consistently impressive 16 years. During her time, the rival Reed Elsevier has had no fewer than 5 CEOs. It is not difficult to imagine the management trials of a major corporation that has spat out CEOs as frequently as Reed Elsevier. There are some graphic examples:

From zero to hero

  • The Reed Business Information subsidiary had £1bn turnover back in 2001, more than 50% of it in the US. Fast forward 10 years and profits are down by one-third, with just 25% from the US. By the time it sells the legendary Hollywood trade newspaper Variety next month, RBI will have completely exited the US B2B magazine-centric market and divested a total of more than 150 print titles in 14 countries that just four years ago represented almost 50% of its portfolio. Phew! But this is not a planned migration from ‘print to digital': it is Reed walking away from markets it once had dominated in order to concentrate on a small number of increasingly global, database-led services primarily in banking, chemicals and property.  But then this consolidation has been the sequel to a ‘will-they, won’t-they’ bid  by the parent company to sell off the whole of RBI.
  • In a model lesson of ‘how not to motivate your managers’, Reed Elsevier started an auction for RBI in the dogdays of  2008. By the end of a year during which the financial markets were in constant turmoil and the profligate private equity buyers of near rival EMAP could have warned off would-be suitors, Reed withdrew in the worst way. It would instead try to sell Reed Business Information again “in the medium term,” when conditions were more favourable. So the talks and scuttlebutt continued for the best part of a further year. That was two CEOs ago. Now, it’s all changed. Last year, the increasingly impressive RBI quietly became the Reed Elsevier star with profit growth of 23%. The reward was the £343m acquisition of banking database group Accuity, effectively doubling RBI’s value. And the UK-based operation also managed to extract a bumper £110 price by selling its smart but low-margin Totaljobs.com service to Germany’s hungry-to-be-here Axel Springer. RBI’s self-effacing global boss Mark Kelsey has gone from zero to hero in the space of two Reed Elsevier CEOs.

‘Strategic whimsy’

  • In 2001, Reed made a so-gutsy $5bn push into education publishing with the acquisition of Harcourt Brace. After six years of  sliding profits and competitive pummelling, it suddenly quit the sector that has since burnished Scardino’s reputation at Pearson.  For Reed, the education flip-flop was but a more expensive version of a £1bn US-based travel information strategy which had once accounted for 9% of Reed Elsevier’s revenue. Then, disaster struck. Reed owned up to advertising fraud and was forced to write off  millions of dollars and airbrush itself out of another international market. Other Reed strategic whimsy has included the hundreds of millions of dollars written off on US consumer magazines about brides, babies and boats.  You couldn’t make it up. But that was many CEOs ago.

Stagnant profits

As always, the most recent numbers tell the story. The past three years have seen Pearson settling into its role as the world’s favourite learning group – and producing strong revenue and profit growth. But Reed’s profits have stagnated:

  2011 2010 2009 
  Reed Pearson Reed Pearson Reed Pearson
Revenue -2% +3.5% +2% +5% +17%
Profit +10% +22% +4% -1%
Operating margin 27% 16% 26% 15% 26% 14%

This performance talks volumes to shareholders comparing these two £6bn turnover businesses. But they might only recently have reflected on the significance of the one area in which Reed Elsevier consistently outperforms Pearson: operating profit margins.

The prime driver of those margins is the Elsevier scientific-technical-medical  (STM) journal business. The Dutch-based business, which accounts for almost 50% of Reed profits, has a profit margin of 47%. Shareholders have been purring for years about Elsevier whose merger with the old Reed International brought earnings solidity to a London-based company then so heavily dependant on the advertising cycle. Back then, executives were unable to contain their enthusiasm for a business based on academic papers which depended on (unpaid) peer review in STM journals, with universities virtually compelled to subscribe to them. It seemed like the ultimate “must have/ must buy” information with uniquely low content costs. But not any longer.

Reed is facing a backlash from more than 10,000 academics across the world who have joined a boycott against Elsevier journals. The academics are refusing to submit or peer-review papers for the company’s almost 3,000 scientific journals which include the American Journal of Medicine, The Surgeon, The Lancet and the Journal of Aging Studies.

‘Monopoly power’

The academics simply believe that Reed Elsevier is profiteering from their (mostly unpaid) work and they object also to the group’s practice of bundling journals so that university libraries have to spend on unwanted titles. The boycott is gathering momentum, as evidenced by a recent Reed decision finally to cut journal prices after years of nothing but increases. That move was an abrupt reversal of earlier intransigence by Erik Engstrom, the Reed Elsevier CEO who had previously been directly responsible for Elsevier.

The risk to the longterm reputation and earnings of Reed’s largest business can be gauged by the reaction to its cut in the annual subscription price of Explorations in Economic History from £58 to £31 after editor Dr Tim Leunig’s public criticism. Reed seemed to get it all wrong even then, with CEO Engstrom describing the boycott as merely  “a misunderstanding” with its contributors, editors and subscribers. Leunig tore back: “He should be honest and state that, in many cases, his journals have an element of monopoly power.”

The trouble is that years of above-inflation increases have stained Reed’s reputation in academia. In 2010, just as budget cuts were battering academics everywhere, the company increased its prices by an average of 5% (The Lancet increase was actually 10%) . Worse, Reed boasted to stock analysts that the increase was 2% “better” than had been budgeted. Thick skinned or what?

Complacent pricing

The heavy-handed corporatism  has motivated formidable figures including Warren Buffet, George Soros, Wikipedia’s Jimmy Wales and the influential Wellcome Trust to fund the resistance with “open access” online channels. These have already changed the whole publishing business in some scientific disciplines and seem set to expand further and faster. Smaller STM companies like Springer have rushed to embrace “open access”. But Reed Elsevier is, to say the least, stuck between a rock and a hard place. The Elsevier profits are crucial to its whole profitability.  Even continual price reductions (which would slash profits) might not be enough now to halt the boycott. The “open access” movement threatens eventually to return STM publishing to the academic world from which it sprang. It feels eerily like a lose-lose for the once high-flying publisher.

The key to the Reed Elsevier problems lies, of course, in those 25%+ operating margins. But the company is, err, just not good with pricing. Look at what’s coming down the road in another key market. Bernstein Research, a close observer of Reed, is urging the company to sell its under-pressure Lexis-Nexis legal business to Bloomberg before the privately-owned financial information company “steals” it. Bernstein criticises the way that Reed has sought to maintain its profit margins while failing to invest in the core content necessary to compete with Thomson Reuters’ Westlaw – and new competitor Bloomberg Law.

More significantly, Reed  (belatedly, preparing to invest in Lexis content improvement) is planning to charge customers for the enhancements. This contrasts with the traditional Bloomberg approach (which they have taken into the legal market) of an “all you can eat” price. As in academia, Reed is finding itself now having to discount prices to get renewals. Another vicious spiral is beginning in a market where Reed’s customers are feeling far from friendly.

‘The 5 Ps’

If Reed Elsevier was a publisher of something slightly less esoteric than information for lawyers, scientists and doctors, Variety readers might now be lining up to make the movie. Even before the botched strategy on business publishing and trashed operations in the US, the original Reed International yielded plenty of comic fodder. Reed had started life as a UK-based newsprint manufacturer. Under subsequent ownership, it crossed the spectrum to cover everything from wallpaper, paint, printing, packaging, and publishing. Even its publishing range seemed absurdly broad: mass market, scientific, technical special interest, newspapers, books, directories, magazines, and business journals. This was the rambling conglomerate that sold The Sun to the emerging Rupert Murdoch – so he could compete with their own Daily Mirror. Once damaged,  Reed then sold the Mirror too, to one Robert Maxwell.

In the early 1980s, Reed International CEO Les Carpenter had regaled executives with  his “5Ps” strategy: Paper, Paint, Packaging,Printing, and Publishing. He was not joking in proud defence of a business whose killer brands included Crown, Polycell, Sanderson, Halsbury’s Laws, Country Life, TV Times, the Daily Mirror, Computer Weekly and a host of printing plants.

Caught by a £500m octopus

In 1986, Carpenter was succeeded by ex-Sainsbury’s Marketing Director Peter Davis. The 1980s and 1990s brought an infusion of strategic sense with the disposal of paper making, building materials, printing, packaging, consumer magazines, newspapers and books. But not before a sudden blood-rush had sparked the acquisition of legendary publisher Paul Hamlyn’s Octopus Group for an extraordinary £540m, across a single, ‘due diligence-free’ weekend in 1987. Octopus was a largely loss-making bunch of book publishers, some of which had been bought and sold by Reed at least twice before. It was a deal which would have wrecked many listed companies. But Reed kept moving and former Octopus chief Ian Irvine, who eventually succeeded Peter Davis as CEO, managed later to palm off criticism of the deal by saying he had sold the egregiously over-priced company not bought it!

Within a few years, Davis had bounded into what he thought was a safe merger with Elsevier. The Amsterdam-based business had a single-focus pedigree by contrast with the Reed International mongrel. Elsevier had been almost exclusively involved in STM journals since its formation in the 19th century. The company had expanded substantially with the acquisition of Pergamon Press, the highly successful journals business built by Maxwell in pre-delusion days. Elsevier had become the subscriptions-rich business coveted by  publishers everywhere.

In the event, Reed won the prize. Nobody was thinking too much of the cultural fit of these two quite different companies. The resulting Anglo-Dutch, twin-company structure aped those of Shell and Unilever, which reassured investors. But the deal ushered in more than a decade of in-fighting – and the loss of three CEOs including the dealmaker Davis himself.

‘We don’t like you’

The Reed Elsevier story is stuffed with irony. In 1999, the new CEO Crispin Davis was asked in his very first week: “Is this the first company to be destroyed by the internet?” The next day, meeting one of the biggest customers of his academic journals, he was greeted with the words: “We do not like you.” Davis was credited with many things in his 10 years at the helm of Reed Elsevier, not least unifying the management and suppressing the Anglo-Dutch rivalry. But he might not want to be reminded of those 1999 warning noises from the STM community, now reaching a crescendo all these years later. Has the company really been ignoring its customers’ accusations of greed for more than 10 years?

Reed’s snowballing market problems are compounded by the systemic challenges. Nothing in this digital age is straightforward. The migration from print would be easy if it was just that: a switch from one medium to the other. But it’s a bumpy, jerky journey with plenty of overlap, misleading signs, lost profit – and competition from new baggage-free companies. Reed Elsevier has suffered grievously from the lack of the management consistency that has, by contrast, given Pearson strength, focus and a real theme during this past 15 years.  Reed’s conveyor belt CEOs have had the average longevity of a UK prime minister and, arguably, the focus to match. It is tempting to conclude that, like the politicians, Reed Elsevier bosses have been prone to: do a big deal, make a splash, and seek a quick result. But the absence of consistent, strong leadership has had other serious impacts on the company.

Tribal tug of war

Tribalism is nothing new in listed businesses that become hooked on M&A. In the 1980s and 1990s, when those billions of dollars were being “invested” in publishing activity that is now gone without trace, Reed suffered from UK-US powerplay. There was a tug of war for investment across the Atlantic. Forward into the 21st century, Elsevier became the high-growth, high-margin kingpin. The erratic leadership has been visible in the on-off earnings record across several decades. Now, Reed Elsevier is set to pay the price: the threatened STM and legal divisions last year accounted for more than 60% of its operating profit.

I would not recommend reading 10 years of Reed Elsevier annual reports. They’re not that exciting. But they do give a clear view of a very large, undeniably asset-rich business with a seemingly ever-changing strategy. It is easy to believe that the revolving door of CEOs has motivated the company’s senior managers just to “make the numbers”. The toppy margins are not an accident. In 2005, Reed investor relations executives were smug about Elsevier’s “must have” subscriptions that could “forever” be priced ahead of inflation.  That preoccupation with profit margins has helped Reed executives to avoid facing up to a basic truth of the information age which today exposes the company: customers of information services all become price-sensitive. They expect – over time – to pay less money for more functionality, increased flexibility and greater choice. Any attempt to obstruct that gravitational pull will invite new-wave, low-price competition which may humble even the largest corporate beasts. Just watch.

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