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Introduction

The educational market has been undergoing a few but significant transformations, including moving from print to digital, local to global, and standardized to personalized and interactive. There are a number of innovative entrants, but the established companies have been able to keep ground and offer good investment opportunities. This article will discuss three such established companies in the education industry. Pearson plc (PSO), Thomson Reuters (TRI), and McGraw-Hill (MHP) all have attractive valuations, are undergoing corporate restructurings aimed at increasing shareholder value, and also pay a significant dividend or allowance.

Valuation and Performance

Based on their current fiscal years, Pearson, Thomson Reuters, and McGraw-Hill trade at price to earnings ratios of between 14 and 15, compared to 13.7 for the S&P 500. While their shares appear more expensive than the stock market, this is justified as both Pearson and Thomson Reuters have betas (or volatility) lower than that of the market. McGraw-Hill has a beta of one, which implies a volatility similar to that of the market. However, once McGraw-Hill Education and McGraw-Hill Financial are spun-off into two companies (discussed below), the educational part will have even lower beta. A major reason is that when the economy is doing poorly, people tend to study more and when the economy is doing well, stocks of educational companies tend to move up along with it.

In addition to reasonable price to earnings multiples, Pearson, Thomson Reuters, and McGraw-Hill have solid balance sheets. Their long-term debt to equity is under 0.5 and significantly lower than that of the market's 0.8. However, McGraw-Hill is the only company that has price to book value ratio (8.2) that is larger than the market's 3.7. This is likely due to the premium associated with its higher-growth financial products.

On a market value to EBITDA basis, Pearson has the richest valuation with a multiple of 9.5, followed by McGraw-Hill with 7.7 and Thomson Reuters with 7.1. These multiples are at or below the market average of 9.5 but can rise significantly if these companies are subject to a takeover or improve their performance. Recently, companies have been acquired at EBITDA multiples of around 11.1 (according to Thomson Reuters data), a significant premium to Pearson, Thomson Reuters, and McGraw-Hill valuations. A cash rich company such as Apple (AAPL), Amazon.com (AMZN), and Oracle (ORCL) could be interested in one of these companies in order to add growth to their content, technology, and/or corporate services. In fact, Pearson, Thomson, and McGraw-Hill are already partnering with companies and non-profit organization as well.

Pearson, Thomson Reuters, and McGraw-Hill had strong results in their latest 6-month periods, despite economic headwinds. For its fiscal half-year ending July 27, 2012, Pearson reported 7% revenue growth to $4.09 billion, which was mostly due to acquisitions. Its earnings per share were slightly lower from the comparative period in 2011. The Penguin publishing division, which is still mostly printing, had the worst performance, with a 4% decrease in sales and a 48% decrease in operating profit, but is expected to improve due to a strong pipeline.

Similar to Pearson, Thomson Reuters recorded an increase in revenues, but a decline in operating profits due to implementing changes. The company had a single-digit increase (3%) in revenue in the first half of 2012 to $6.38 billion and a 4% decline in operating profit. McGraw-Hill Education had a 8% decrease in revenues and 11% decrease in its operating expenses compared to the first six months of 2011. Looking forward, Pearson expects to reach its 2012 goals, and so does Thomson Reuters. Only McGraw-Hill raised its 2012 earnings estimate to the upper range of its previously announced range from $3.25 to $3.35 per share.

Corporate Events

The most significant event is the splitting of McGraw-Hill into two publicly traded companies by the end of 2012. The finance division will be a growth company and the educational a value one. In similar spin-offs, shareholders have benefited (see this recent Forbes article). In addition to spinning-off the education business, the company is acquiring a number of education and technology-related businesses which should provide future growth. A recent acquisition that McGraw-Hill Education has made, Key Curriculum, would allow the company to develop technology for learning math. While McGraw-Hill is focusing on financial and educational products, it is also expanding in China via a joint venture with New Oriental that will deliver educational products to China's workforce. As part of a larger restructuring and cost-saving plan, McGraw-Hill also sold its broadcasting business last year.

Similar to McGraw-Hill, Thomson Reuters is selling non-core businesses and acquiring companies that will allow it to grow sales. Earlier in 2012, Thomson Reuters announced the sale of its health-care business to Veritas Capital for $1.25 billion, and it intends to use the proceeds to acquire growth businesses. Later in the year, The Intellectual Property & Science business of Thomson Reuters acquired MarkMonitor, a company that protects brands on-line. This should boost the growth of this segment due to increase use of the internet, and companies' changing needs in protecting their intellectual properties.

Pearson, comprised almost entirely of publishing and educational businesses, has been the most active in acquiring other companies. Among the acquisitions Pearson has made recently are PT Efficient for $16.3 million (an operator of English language courses in Indonesia), Author Solutions for $116 million (a self-publishing company), GlobalEnglish for $90 million (a provider of courses to business customers who want to improve their English), and Certipot for $140 million (a provider of test solutions). In addition, Pearson has recently partnered with a Chinese company, JJL Overseas Education, to offer its PTE Academic in the country. While the valuation of these acquisitions is a subject to another article, it appears that Pearson is committed to the global publishing and education market and is investing heavily in diverse areas and regions.

Allowance

Even though the educational business is undergoing a significant change (requiring capital) and sales are highly seasonal (done mostly from July through September), Pearson, Thomson, and McGraw-Hill pay a regular dividend. Pearson pays about $0.40 dividend in April and a $0.25 in August for a dividend yield of about 3% per year. Thomson Reuters and McGraw-Hill issue a quarterly dividend of $0.32 and $0.255 for annual dividend yields of 4.4% and 2.1%. The decent dividend yields help further the case for investing in these three education oriented companies.

Conclusion

Based on valuation, corporate events, and their dividend yields, Pearson, Thomson Reuters, and McGraw-Hill offer good investment opportunities with below market volatility. While the education industry is undergoing significant changes, these three established companies are reinventing themselves and should have the flexibility and financial resources to reward their long-term investors.

Source: 3 Stock Picks For The Back-To-School Season (Allowance Included)