Reed Elsevier: Need for a progressive divestiture?

In February Reed Elsevier announced higher than expected pre-tax profits for 2009 of £1,279 million. Commenting on the results, Anthony Habgood, Chairman of Reed Elsevier, said, "We are pleased that our 2009 results were relatively robust given the depth of the global recession. In addition, during the second half we substantially strengthened our balance sheet both through an equity placing and through good cash generation … The late cycle nature of some of our markets makes for a tough environment in 2010 but the fundamentals of our businesses are strong, our balance sheet is in good shape and new management is in place with the background, experience and ambition to drive the business forward.”

Most analysts appear to agree with this assessment, and according to the Financial Times web site Reed Elsevier has a current overall rating of A (the highest).

One analyst, however, takes a more gloomy view of things. In two recent equity research reports on Reed Elsevier, Claudio Aspesi — an analyst based at the sell-side research firm Sanford Bernstein — argues that the company is "in denial on the magnitude of the issue potentially affecting scientific publishing", and suggests that it is time to "pursue a progressive break-up of the company". I emailed Aspesi to find out more.

Claudio Aspesi

RP: Can you say something about Bernstein Research, your role in the company, and the purpose of the equity research reports you produce?

CA: Sanford Bernstein is widely recognized as Wall Street's premier sell-side research firm. I am the Senior analyst covering European Media, and my reports are aimed at institutional investment professionals (portfolio managers and analysts) who are interested in investing in European media stocks.

RP: You seem to take a much gloomier view about the future of Reed Elsevier than most analysts, and certainly a gloomier one than the company itself. Would you agree? If so why do you think you out of sync with other analysts?

CA: I am probably more pessimistic than other analysts and than investors. I think that, to some extent, analysts and investors tend to extrapolate the future from their observation of the past. "Noise" about changes to the STM publishing industry has surfaced before, and nothing happened: the publishers continued to raise their prices and the academic and research libraries continued to subscribe.

I am increasingly concerned that we are on the cusp of a moment when many things change, and people need time to adjust. The UK press reported yesterday David Cameron's words on decisions that would "affect our economy, our society — indeed our whole way of life"; many companies and people, on the other hand, are still in denial.

RP: In a report you published in March you said, "Reed Elsevier seems in denial on the magnitude of the issue potentially affecting scientific publishing and we would welcome a more thoughtful approach to this issue". Can you say more about the issue you refer to?

CA: If — and I need to emphasize if — the outcome of the budget constraints on academic libraries is a few years of slow or no revenue growth, the publishers will have, at the very least, to take costs out aggressively.

If budget constraints lead to massive cancellations of "big deal" contracts and the offer to sign new contracts at 20/30% lower spending, the publishers will be under severe strain to adapt.

As long as management seems to believe (at least judging from their public statements) that the probability of flat revenues for many years to come is virtually zero, one has to worry about whether there is a Plan B, who is in charge of it and what type of events would trigger it.

Also, the arguments which Elsevier has put forward in the past regarding why OA cannot succeed are unconvincing: for example, when Reed Elsevier argues that OA cannot succeed because of the need for Peer Review, it ignores the fact that most proponents of OA support peer-reviewed dissemination.

RP: Essentially I think you are saying that the company is in denial about Open Access (OA), and the likely impact of OA on its future profitability. Why is OA a threat to Elsevier's future?

CA: OA does not need to be a threat. In fact, I would argue that a shift to Gold OA may be beneficial to Elsevier: if its journals were able to charge submission fees which, in aggregate, are as high as their subscription revenues, they would have same revenues and probably lower costs.

The real threat comes from self-archiving of Peer Reviewed articles [Green OA]. That is why the SCOAP³ model put forward by the High Energy Physics community is so disruptive: it downgrades the role of the publishers to the management of the Peer Review process and perhaps some editorial service. This requires lower spending and effectively negates the value of the impact factor.

Nub of the problem

RP: So what is the nub of the problem Elsevier faces?

CA: That they built a business model predicated on annual revenue increases supported by the steady launch of new titles to justify the increases. It worked well (at least for them) as long as the librarians were able to find the money (regardless of their growing agitation over the increasing spending). It cannot go on if the libraries' budgets continue to be under pressure.

RP: I think you are arguing that the fundamental problem the company faces is that the current global financial crisis means that research libraries will no longer be able to afford to keep paying scholarly publishers like Elsevier the sums they have historically paid them for their journals. In fact, the so-called "serials crisis" is decades old new, and yet libraries have always found the money somehow. Why do you think the situation is different now?

CA: I referred earlier to David Cameron's words. The world is changing, and there will be less money to spend, as well as increased scrutiny on how the money is spent.

For example, will the funders of research (governments, foundations and corporations) continue to allocate funding on the basis of the prestige of the publications on which research is published, or will they start rewarding the impact of individual research?

At the APE Conference in Berlin in January 2010 there were several presentations on article-level impact metrics — it is at least plausible to imagine a world in which the value of the franchise of each individual journal decreases and the value of the franchise of the individual articles increases.

RP: If you are correct, how should Reed Elsevier respond?

CA: It is for management to decide. Ultimately, they will need to balance several factors: shareholders' demand for growing revenues and profits, what competition does, the different needs of the various constituencies within the academic world.

Even within the academic world, different constituencies have different interests: librarians need to manage budgets and free up resources, researchers need to publish in the most prestigious journals, and administrators need to have established mechanisms to evaluate and reward intellectual contributions.

RP: Is there any way in which Elsevier could leverage current interest in OA and turn it to its advantage?

CA: I doubt that shifting to supporting OA would work for them, since they would probably insist on maintaining or increasing profits to do so. In a challenging funding environment, I am not sure that any OA model that Elsevier could support would meet the funding issues of the academic world.

Progressive break-up?

RP: In a more recent report — published last month — you suggested that the company "should pursue a progressive break-up of the company"? Would that not be an overly drastic strategy to adopt? What is your logic for suggesting it?

CA: A progressive divestiture of the assets of Reed Elsevier would effectively lead to what I call a "creeping IPO (Initial Public Offering)" of Elsevier.

In early 2008, the then CEO Crispin Davis singled out for disposal RBI (the business to business magazines division). Had management completed that divestiture in a timely manner, the Exhibitions division would have probably been next.

Since the divestiture of RBI failed, management has started to sell it in smaller pieces, but I would still expect RBI to be eventually divested entirely; at that point Exhibitions would probably follow. LexisNexis (the legal research business), finally, has significant competitive issues in North America.

On top of all this, there are almost no synergies among all these operating units. A progressive divestiture of all these assets, with the proceeds returned to shareholders, would leave Reed Elsevier operating only Elsevier — at that point the market would find a valuation that reflects the prospects of that division.

RP: Do you think that Elsevier is uniquely challenged by the forces at work in the scholarly publishing market today, or are other large publishers like Springer and Wiley-Blackwell equally threatened?

CA: The same issues affect every publisher, and in fact scale could — in theory — help a larger company fund the investments required to be better equipped for the future.

On the other side, smaller companies are often more willing to innovate because the status quo is not as attractive to them.

Disruptive technologies

RP: Could one perhaps argue that the Internet represents a disruptive technology that could trip up Elsevier? In other words, could Elsevier be confronting a similar situation to that faced by the computer company Digital Equipment Corporation (DEC) in the 1990s? DEC was sideswiped by the arrival of the microcomputer and cheap hard drives, and after failing to respond adequately was eventually broken up and sold off.

CA: There is no question that STM journals are probably the legacy of a cost-effective mechanism to disseminate research when print was the only technology available and that, if we could redesign dissemination from the ground up, we would do so differently.

For example, why should a peer-reviewed article approved for publication have to wait until there is a critical mass of articles to be published two or four times a year? Why should it wait even longer because an issue is already "full"? What does "full" mean in an electronic world?

Many academics I talk to argue that they are well acquainted with the research in their field anyway, as the increasing specialization means that they all know each other, meet at congresses, and exchange regularly their thoughts.

More and more people in the academic community argue that the journals provide primarily an informal but necessary qualitative ranking of research. Can this be better accomplished in other ways? More and more people think so.

RP: From your comments I am thinking that you expect the impact factor to be replaced by alternative tools for measuring the quality of research, and at that point the very concept of the scholarly journal will become redundant (with scholarly communication presumably moving to some form of Web 2.0 model)? If that happened, publishers would be left with little to do but manage the peer review process; and since one could expect that to have a very significant impact on their revenues we could presumably anticipate that there might no longer be sufficient incentive for commercial companies to play in the pond?

CA: I am saying that the impact factor could be replaced — I do not have a crystal ball, of course. If the journals were to lose importance and the publishers would be left competing for administrative fees to manage peer review, both revenues and margins would decline.

Commercial companies could still try to tap additional sources of revenue, from search tools to value added services. It is not inconceivable, for example, that primary articles could become OA, but the dissemination and interaction of underlying data sets could be a pay function still provided by the commercial publishers.

RP: In what kind of timescale do you expect to see this all playing out?

CA: Much depends on the severity and the length of this funding crisis. The crisis is now, and the risk of librarians cancelling the "big bundles" would only increase with time.

More radical change, like a transition to OA, would probably take many years, even if it happens at all.

RP: Thank you for your time.