John Wiley & Sons (NYSE: JW-A ) is an 84% durable, 16% non-durable business. But you wouldn’t know it based on how the stock market views the company.
The stock market currently prices Wiley as though even the durable aspects of its business will soon disappear. Meanwhile, peers Reed Elsevier (NYSE: RUK ) andPearson (NYSE: PSO ) trade inline with their actual business prospects. That Wiley trades at a discount is a head-scratcher — and indicates that a bargain is available.
John Wiley operates in an oligopoly with Reed Elsevier and others
Most laypeople know Wiley as a book publisher. They may have read a “For Dummies” book or used a Wiley textbook for a college class. Although it derives 43% of its revenue from book and textbook publishing, Wiley earns only 16% of its profit from these business lines.
This means that the book- and textbook-publishing businesses are of small importance to shareholders.
The bulk of Wiley’s profits — 84% — come from its research division. The research division is comprised of academic journals and associated niche books and databases. Wiley, Elsevier, and a handful of others dominate the academic journal market.
Wiley’s journals include Space Weather Quarterly, System Dynamics Review, and Journal of the Peripheral Nervous System. These are extremely niche; there are only one or two journals of significance in many of these niches — and Wiley publishes them.
In his 2012 letter to shareholders, Warren Buffett argued that local newspapers tend to have wide moats because most cities and towns can only support one newspaper. Academic journals are like local newspapers — most niches can only support one top journal. So there competitors do not pose a threat Wiley’s journals.
Moreover, Wiley bundles its journals into an online offering called Wiley Online Library. Reed Elsevier and other publishers bundle their offerings too. This means that if a customer wants access to one journal, that customer needs to subscribe to the entire bundle.
Wiley’s academic journal clients are predominately libraries and government institutions. University and public libraries need access to journals; if a library was to not purchase any one of the major publisher’s bundles, its patrons would be unable to access top journals across many different fields. No library of consequence can afford not to subscribe to Wiley’s bundle. This gives the company tremendous pricing power.
In summary, Wiley’s journals have wide moats because they dominate niches and Wiley’s bundle has tremendous pricing power because it contains must-have journals. This makes up 84% of Wiley’s profits; so the vast majority of the company’s profits are protected by a wide moat.
Wiley’s less-protected businesses can be sold to Pearson at a premium
Wiley has two other segments: education and professional development. Education consists of textbooks (print and digital) and related multimedia aimed primarily at the college level. Professional development is Wiley’s book business, which includes the “For Dummies” series. Education accounts for 15% of companywide profit and professional development accounts for 1% of total profit. The two combine for 43% of total revenue.
Neither business is nearly as good as Wiley’s research segment and both have an uncertain future. Wiley’s books are primarily technical non-fiction; there tends to be many substitutes for these books. For example, Pearson’s “Idiot’s Guides” series often publishes books similar to Wiley’s “For Dummies” books. In addition, the proliferation of digital books puts downward pressure on prices, which negatively affects profits.
Wiley’s education segment is a better business than professional development, but is still not nearly as good as research. Some textbooks go through many editions and are clearly better than others, but most have direct substitutes. Although professors are not as price-conscious as the students who must purchase the textbooks, one textbook cannot sell at a much higher price than a substitute textbook. Moreover, grumbling about the cost of an education may prompt Congress to implement price controls or other forms of regulation. In any case, the future of the textbook business is uncertain.
Since textbooks and technical non-fiction books tend to have many substitutes, both segments are essentially commodity businesses. The only way to make out-sized profits in a commodity industry is to be the low-cost producer. Pearson, which has much greater scale than Wiley, can earn higher profits in the same businesses. Therefore, management could unlock value by selling its education and professional development businesses to Pearson.
Margin of safety
Even if Wiley does not sell its less-profitable divisions, the stock trades at a cheap price. Over the last five years, Wiley averaged $315 million in free cash flow. If you chop off 16% of that — which writes off all but the research segment — the company averages about $265 million in free cash flow. A wide-moat business that grows as quickly as inflation is worth about 15 times free cash flow. That puts Wiley’s intrinsic value at close to $4 billion. Divide $4 billion by 59.4 million shares outstanding and arrive at a value of $67 per share.
In the worst of all possible scenarios, one in which Wiley’s un-moated businesses suddenly close down tomorrow morning and never open again, the stock is worth 25% more than it trades for today. That is a stock worth owning.