Reed Elsevier: Boring But Profitable

| About: Reed Elsevier (ENL)

Reed Elsevier (RUK) is not exactly a household name. They are (to quote their annual report) "a world leading provider of professional information solutions". What this means is that they do things like publish The Lancet (a major medical journal), run LexisNexis (computer assisted legal research), and organise major events like New York ComiCon. More formally, the business is divided into five segments (from largest to smallest): Scientific Technical and Medical [STM] Legal Risk Solutions, Business Information, and Exhibitions.

The STM segment publishes primary research (usually in the form of journal articles in one of their almost 2,000 journals) and provides database and workflow solutions to scientists and medical professionals. Many of these journals such as The Lancet are among the most well established and well respected in their field. In academic fields especially it is important for researchers to be published in the best journals if they want to be respected. So the best journals have their choice of the best papers and the journal that publishes the best papers is the best journal. This is a significant competitive advantage as it is a strong virtuous cycle.

The Legal segment primarily operates the Lexis family of legal research and management tools. They were one of the first companies to organise legal information into electronic databases and they have the largest legal database in the world. While not as dominant as they are in the STM segment, RUK have a strong moat here. The database itself would be expensive to duplicate but more importantly they have long relationships with their customers and switching systems would be time-consuming and unpopular.

The Risk Solutions segment provides data and analysis services to business and government to help them evaluate risks. The segment is a combination of insurance analytics and identity verification / fraud prevention, This might seem like an odd combination but what they both have in common aside from being growth industries is attempting to model an individual's specific characteristics based on the general information available. While RUK is not dominant here (as they are in STM and Legal) they have carved out a very profitable niche. In fact, Risk's 42% operating margin is the highest of all segments.

The Exhibitions segment organizes and runs exhibitions and conferences from Batimat (an international building exhibition) to Batman (or rather the New York ComiCon). RUK are the world's largest events business (although the industry is heavily fragmented so their market share is less than 10%) and are focusing on growth industries and growth geographies. For example in 2012 they launched 30 new events, including the International Luxury Travel Market exhibition in Mexico and an electronics manufacturing event in Chengdu. Exhibitions is a strong growth segment for RUK growing revenue 21% last year (15% after correcting for biennial events) and profit 26% (20% after biennials). 2013 will be a weaker year for the segment but even the corrected growth is still impressive.

The Business Information segment is also targeted on the provision of data. Its products include ICIS (a chemical pricing service), BankersAccuity (payment routing and anti- money-laundering information), and New Scientist magazine. This segment is more competitive, but RUK have a solid market position and have been gradually divesting themselves of non-core holdings (such as the TotalJobs group of websites they created internally). Business Information accounts for 11% of revenue and 7% of profit (a slightly low margin of just 13%). Profit was up 8% last year so there is potential here for even better performance.

RUK have a relatively diverse portfolio of businesses, but not so diverse that they are likely to lose focus. There are certain synergies between the segments - all involve providing professional services. The corporate structure is slightly confusing as ownership of these businesses is split (not entirely evenly) between Reed Elsevier PLC and Reed Elsevier NV (NYSE:ENL). Fortunately another author has produced an excellent analysis of the differences. Prices of the two shares are very closely (~98% over the last 30 days at the time of writing) correlated because the underlying assets are almost identical. This article has assumed the reader is interested in RUK because it is usually better for US investors to own. If you decide to invest in the Reed Elsevier group you should investigate which of the two stocks is better for you. Since the business segments all individually look promising the next step is to look at the group's financial statements.

The gross profit margin is currently 65%. It has been slowly rising over the last four years (from 63% when the current CEO was promoted to his position in 2009). This has been accompanied by a decrease in SG&A expenses from 80% to 67% over the same time period. Operating margin is up from 13% to 22% and RUK's net profit margin is the highest of all comparison companies in Google Finance.

RUK net borrowings are 96% of annual revenue. The annual interest cost is just under 20% of operating profit. Both of these numbers are slightly higher than I like to see but I am very anti-debt. Most (74%) of the debt is at fixed rates, average interest rate is 6.1%, and average time to maturity is 5.6 years. RUK have relatively conservative policies related to debt and spreading the maturity (a potential risk is when too much of a company's debt is due in one year).

Gross revenue for the group has been fairly flat for the last five years although this is due to sales of non-core assets. Net Revenue has been growing steadily and the businesses they are focusing on have all been performing well. Return on equity and return on assets were both 48% for last year.

RUK offer a 3% dividend yield (ENL offer 3.5% but the difference is significantly reduced by different tax treatment). The dividend is just 35% of earnings which leaves some room for growth and they have raised the dividend for five of the last six years. These raises are usually significant (they average 6.5%). PE ratio is a little bit expensive at 16.12. The H model that I use suggests that RUK may be over-valued by between 10 and 20%. The H model values companies based on their dividend yield and prospects of future dividend growth (a past article I wrote about the model).

Overall, RUK (or ENL) is likely to be a solid but unspectacular performer. The dividend yield looks safe since the balance sheet is in good shape and the businesses are well established. However, the downside of this is that there is limited growth potential and the gains from efficiency improvements over the last few years are unlikely to be duplicated. I do not see significant upside from the current price (mid 40s for RUK) but at the same time I do not see much downside.

Disclosure: I am long ENL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Tax reasons for ENL over RUK but they're almost the same stock

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