Houghton: Publishing and Profits
09/25/2015 10:00 am EST
Peter Staas, of Capitalist Times, looks at a publishing company with strong prospects in education; as part of a long-term strategy, the company is expanding beyond print into digital distribution targeted at K-12 students.
Steven Halpern: Our guest today is Peter Staas of Capitalist Times. How are you doing today, Peter?
Peter Staas: I’m doing great. Thanks for talking to me, Steve. I appreciate it.
Steven Halpern: Now, today we’re going to talk about a company that you said you’ve been considering for a long time and have just recently decided to recommend. That firm is publisher Houghton Mifflin Harcourt (HMHC), which you consider to be an underappreciated turnaround idea. Could you give our listeners some background on this situation?
Peter Staas: Sure, Steve. One of the things that I think is one of the greatest opportunities that’s in the market today—or at least the most interesting—when a lot of people think about technology, they think about very advanced stuff, who’s innovating and so on and so forth.
I think one of the more interesting things going on, and a way for people to really make money is, companies that are using existing technology to unlock value from their business.
We’ve kind of seen that with Adobe Systems (ADBE). It’s the company that makes the popular Creative Suite software program. They’ve switched from selling one-off sales of the program to...they sell a subscription where people access it online via the software of the service model.
Houghton Mifflin Harcourt, pretty much anything you read about it in the popular press, they will mention some of their authors that they’ve had. They’ve had Thoreau, Hawthorne, Emerson, and more recently, Phillip Roth. Trade publishing is only 10%, roughly, of the company’s revenue. Most of it comes from their education solution, which is primarily textbooks.
The company kind of traces its roots back to 2007 when an Irish investment banker who formally worked for Credit Suisse, he kind of put together a big leveraged buyout deal with private equity that combined Houghton Mifflin with Harcourt, which was part of Reed Elsevier. With that, the plan was that there would be great economy to scale from that.
Of course, this happened in 2007; in 2008, 2009 you’ve got the great recession. Being a highly leveraged company, not the best thing, especially when a lot of your revenue kind of depends on the public sector for textbooks.
The company ended up in bankruptcy. It emerged/re-IPO'ed in 2011 with a CEO named Linda Zecher, who came over from Microsoft. She’s done a great deal to kind of transform the company into something that’s worth owning.
Steven Halpern: Now the company—as you mentioned—is highly focused on the education market. Is that a market that, in general, is improving for the company?
Peter Staas: Yes, Steve. As the US economy strengthens, you’ve got a lot of districts...they’ve got more tax revenue coming into the coffers and a lot of them pushed back investments on new textbooks and that sort of thing.
They’re seeing a lot of major updates to the textbooks. For example, California is a big opportunity. They’re going to be adopting new instructional materials for reading in 2016 and 2017. Houghton Mifflin Harcourt, they’re really strong in reading, math, and science, which are really the important ones.
Although that kind of catch-up in spending on textbooks is part of the near term story, I really think the more exciting and longer-term story—and the important—what makes it a turnaround is really the shift into delivering educational content digitally.
Steven Halpern: So that really adds a high-tech aspect to an otherwise low-tech or perceived to be low-tech industry?
Peter Staas: It does, and I mean, it changes the business model dramatically. One of the things that Zecher has done is she has...instead of designing everything for print, so you’re working on a new textbook, it’s a multi-year process, so on and so forth. Here, it’s shipping; the design is all based on digital delivery of the product it makes for a robust learning experience.
You can add video elements to demonstrate things. It’s not just purely a textual one. You can incorporate testing elements into the reading so that you can get a sense of how students are interacting with the product and then make adjustments and send out that update to everybody.
It’s moving more away from this, like, very, very lumpy revenue stream that was, kind, of feast or famine, based on the textbook update cycle and various jurisdictions.
They’re moving more towards a subscription model, which is going to result in a more steady stream of revenue which—as we’ve seen in other companies in the software business especially—that shift holds a lot of appeal for investors.
I think in the case of Houghton Mifflin Harcourt, that’s something that’s going to take place over a longer time frame. That’s not going to happen overnight, but they’re making incremental progress and it seems promising.
Steven Halpern: I was very interested when I read in your in-depth report that when you suggest textbooks many people might first think of a college calculus book, but they run the whole gamut all the way back to a digital version of Curious George. Could you explain really the whole market that they’re looking to address?
Peter Staas: Actually, they’re primarily K-12. They control more than 40% of the US market for reading, math, and science. I think with the focus on developing standards, and that sort of thing, and all the kind of confusion around that, that creates a real opportunity. They also appear to be winning market share in that core market.
The other thing that Zecher has done is to look at—in the trade publishing business—what intellectual properties they have there. One of the more exciting ones is Curious George, which, you know, I have a young daughter and now I read Curious George books to her.
They’re trying to leverage that intellectual property in as many ways possible. They’ve created this online app, this educational app which is sort of an emerging market. It’s called Curious World and it’s all based around the world of Curious George.
Parents, when they’re looking through the App Store, or whatever, to find some sort of program to keep their child entertained on a car trip, or whatever, but also have them learn something, they’re going to gravitate toward intellectual properties and brands that they have experience with. Curious George, that’s a very strong brand.
They also have some...they’re also looking to some of their other intellectual properties, again, from trade publishing, how they can monetize those in different ways, developing TV programming around that in conjunction with production firms. All sorts of things. It’s nice to see them trying, making a concerted effort to unlock value from some of those things.
Steven Halpern: We only have a second left, but in terms of the time perspective of an investor in this situation, is this the kind of idea that you would suggest opening a position that possibly they could hold in a portfolio for years?
Peter Staas: Yeah, I think this is a multi-year story. It’s going to play out over multiple years and I think just looking at the macro picture right now, in terms of, we’re in the seventh year of a bull market, some of the technicals look like we’re going to have more volatility. I think it’s a position that’s worth scaling into.
At the company’s Investor Day, they are calling for revenue to grow at a CAJR of 5% over the next five years or so. When you consider what they’ve got going on, and their progress thus far, I think that looks conservative, it’s safe to say. I think it’s a name you might nibble on now and just sort of add to your position incrementally as opportunities arise.
Steven Halpern: Again, our guest is Peter Staas of Capitalist Times. Thank you for your time today.
Peter Staas: Thanks again, Steve. I appreciate it.