John Wiley & Sons: "Passing" in Sept. 2013
Traveling Through Time | 15 min read | What I learned from "passing" on Wiley in Sept. 2013
Originally published on midstoryventures.com in July 2021.
This is part four in a ten-part series. Before reading this segment in the Traveling Through Time case study series — please read the Introduction post here.
Essentially, I simulated an investment opportunity from many years ago based on Geoff Gannon’s Singular Diligence newsletter. The write-up below is a record of my thought process and a reflection on what happened.
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Simulating the Past: Arriving to a decision
WOULD I HAVE INVESTED 20% OF MY CAPITAL INTO JOHN WILEY ON SEPTEMBER 2013?
John Wiley & Sons is one of the largest publishers of professional books, textbooks, and academic journals.
In 2013, Wiley generated a total of $1.75B in sales at a 15% operating margin. It generates approx. 80% of its profit from academic journals, 15% from textbooks, and 5% from professional books. This system grew at 10% per year at an infinite ROIC.
I will take a different approach to this investment thesis.
Typically, I look at three aspects of an investment thesis.
Is it cheap?
Is it safe?
Is it good?
After having done quite a few of these already, I believe I can boil it down to just these two questions:
Is it safe?
Is it good?
There are six elements that analyze in order to synthesize an investment thesis. Those are:
Durability
Moat
Quality
Growth
Capital allocation
Value
The first two elements answer the question: is it safe? Durability refers to the evolving relationship with the customer and the company’s ability to control its destiny. Moat refers to the company’s ability to protect its customers from competitors.
The third and fourth elements answer the question: is it good? Quality and growth go hand-in-hand because: Intrinsic Value Growth = ROIC (quality) x Reinvestment Rate (capital deployment opportunities).
The last two elements are unique because different aspects of each element answer different questions:
Capital allocation
Safety — Will management put shareholder’s capital at risk through leverage, equity dilution, ROIC dilution, diworsification?
Goodness — Will management maximize shareholder returns through leverage, buybacks, dividends, growth opportunities?
Value
Safety — What is the lowest multiple the stock could re-rate to?
Goodness — What is the highest multiple the stock could re-rate to?
This “development” in my approach should help me simplify my decision-making process as I evaluate an opportunity’s risk-reward ratio.
Wiley’s stock price and core business is extremely safe.
The following list outlines Wiley’s aspects of safety (from strongest to weakest):
Margin of safety
Industry demand
Competitive position
Capital allocation
The average business trades at a 10x owner earnings multiple. Wiley trades at 10x owner earnings. Wiley’s existing business is far superior than the average business.
Wiley trades at lowest multiple in the peer group, despite being arguably one of the best in the peer group. The next peer, Scholastic, trades at a 9.5% yield (higher multiple). Wiley is much more superior than Scholastic, since Scholastic focuses on book publishing whereas Wiley focuses on academic journals.
The demand for Wiley’s main products (journals and textbooks) is also very stable. Academics are required to publish research each year. Students will continue to buy textbooks. The demand for professional books should be stable, though they do not have the same rock-hard certainty as journals and textbooks.
Wiley’s competitive position in journals is extremely safe. Wiley operates in an oligopolistic industry structure where the four largest participants coordinate. Wiley, Elsevier, Springer, and Taylor & Francis bundle their products together so that universities have to buy from the largest publishers. The smaller publishers get cut out. Its competitive position will automatically deepen through powerful network effects. The journals that get seen the most are the ones that are cited the most. And the ones that are cited the most are the ones that get seen the most.
Wiley’s position in the other businesses that make up 20% of profits is not as strong of a position. The company’s position in textbooks should be stable since new editions of the same textbooks are used year after year. Wiley’s position in professional textbooks depends on the longevity of books for each “niche profession.” So it is generally less durable.
Capital allocation is the riskiest part for a buy-and-hold investor who is buying into today’s existing business. The company has been family-run for almost a century. In the last 20 years, new management has taken over. The Wiley family continues to control the company, new management has been brought into the fold to grow the company.
New management may very likely enter a period of diworsification. Management specifically refers to acquisitions of technology-based companies as their main priority for capital deployment. The books business is also a large, fast-growing, and sexy market to play in. Management might want to grow its book exposure from 5% of earnings to a much larger contribution of earnings based on the larger market.
Acquiring technology companies is not a bad strategy. There are acquisition targets that (currently) have good competitive positions and promise a future of very high margins and high growth. I anticipate more venture-capital money to allow new companies to enter the market.
I am less concerned about Wiley choosing the wrong acquisition targets and more worried about the multiples that Wiley pays for the targets. Last year, the company acquired three different companies that traded at an average multiple of 3-4x sales. I expect these multiples to continue increasing as this space gets more competitive.
It is also concerning that nearly all of Wiley’s free cash flow every year will be spent on acquisitions. Wiley finances their M&A with debt, which adds another layer of risk.
Lastly, a greater exposure to book publishing would lead to worse returns. It offers very low profit margins because it is much more competitive. It also requires more assets (working capital and PPYE). So Wiley’s infinite ROIC may be diluted,
Wiley’s core business at this price offers very attractive returns.
Wiley’s closest peer in journals, Reed Elsevier, trades at a 7.50% owner earnings yield. Its closest peer in textbooks, Pearson, trades at a 6.85% yield. Wiley’s re-rating could add 5-10% annual return in addition to today’s yield of 10%.
We can measure it, but we won’t count on that. As a buy-and-hold investor, we want to bet on the business performance, not a multiple re-rating.
If the stock trades at this multiple at the end of the holding period, it could definitely provide a 12-15% return per year.
The company has only compounded its sales by 1% over the last 5 years and profit by 2%.
The company does not significantly grow its customer count. The company’s main source of organic growth is pricing power. The company could leverage its pricing power to increase revenue by 3% per year.
And this sales growth automatically drops down to return since the company generates an infinite ROIC. Though, there are industry participants that are trying to reduce the four largest journal publishers' pricing power at all costs, since that is a growth rate faster than university budgets allow.
The company also announced a cost control program that could reduce overhead by $80M. Free cash flow could grow up to 6% per year.
Wiley is very close to the type of investment in my strike zone.
I thought Tandy was a close bet. This was an ever closer bet.
The industry is good. The company’s position is superior. There are some chances to earn returns larger than today's current yield.
However, I believe there is significant risk to the acquisition strategy. EV/S multiples may reach double-digits figures due to the growing venture-capital space. Wiley is not a price-maker in its bids. It is a price-taker.
Wiley could very well take all its high-quality earnings and invest it into businesses that are hit-or-miss based on the prices they are willing to “accept.”
Buybacks would be a much more attractive use of capital. Their most recent acquisitions do not deepen Wiley’s moat (strengthen the company’s core business). Additionally, Wiley cannot really add value to these businesses. They serve completely different customers / decision-makers than their core business. Essentially, the company is paying very high prices for businesses that are not critical to their core intrinsic value.
There is also significant risk in the book publishing business. It only took six years for Barnes & Noble to diworsify to a point where it lost all its profits.
The stock could very well generate double-digit (maybe even 20% returns) for its investors over the holding period. I don’t think this is an opportunity where I would be as disappointed as I was with Collectors Universe. It is not obvious enough to be a no-brainer.
Back to the Present: What actually happened
HOW WOULD HAVE THE DECISION PLAYED OUT ON JULY 6, 2021?
First, let’s talk about how the business has performed.
The best way to analyze the performance of any stock you own is by first starting with the cash flow statement. Companies spend cash to generate earnings which turn into assets (cash) again. That’s what drives returns for investors.
In 2013, the company had $675M in debt and $334M in cash, a total of about $1B of capital ready to deploy. Over the next 8 years, the company issued another $5B of debt. The debt was paid off regularly so that the company looked more stable. When accounting for debt repaid, Wiley only issued $125M in net debt. Long-term debt only grew by 2% over this period.
The company used about half of the debt to invest into several initiatives ($2.15B). About 70% of that sum went towards acquisitions of companies or IP ($1.5B).
At the time of the Singular Diligence Report, Wiley had a book value of equity of $996M. Including debt, total capital amounted to $1.6B. The company spent $1.5B in M&A. At the end of fiscal year 2021, the company’s book value was $1.09B.
Over the 8-year period, the company’s acquisitions do not seem to have created much value, if any at all value. The company’s book value should be closer to $2.5b (beginning book value + capital spent on acquisitions) than $996M (beginning book value).
What does this look like on the income statement?
From 2014 to 2021, Wiley’s revenue grew by 1.2% annually and operating income declined by -1.0%.
Now, let’s see the return investors received at the investment date.
When the Singular Diligence Report was published in September 2013, the market cap was about $2.65B. With $572M in dividends and $278M in buybacks (net of issuances) and a market cap of $3.34B, total shareholder return (in dollars) has been $1.544B, or a 6.0% compounded return over an 8-year period.
Reflecting for the Future: On getting better
HOW WOULD I HAVE CHANGED MY PROCESS, GIVEN THE RESULTS?
Given the results, I believe I made the correct decision.
Investors would have earned a 6.0% compounded return over the 8-year holding period if they bought on September 9, 2013 and sold on July 6, 2021.
A lot of that is due to luck. The company’s market cap has only risen in the last three months. At the end of calendar year 2020, Wiley’s market cap was $2.4B ($200M below the original purchase price). Before COVID-19 hit America, the company’s market cap was $2.2B (400M below). Three years after September 2013, the market cap was $100M below the original purchase price. Most investors would have probably accepted the loss and sold by then. The pandemic has accelerated investor’s expectations of online education and academic disruption. Investors believe Wiley is positioned to ride that tailwind, which is why the stock has run up.
The business did not produce any meaningful economic value, which shows on the income statement and balance sheet. Without diving too deep into it (for the purposes of this case study), it seems to have been a combination of high acquisition prices (4x or more for the disclosed transactions), poor targets (more than ⅓ of the $1.5B acquisitions in impairments and amortization), and other things.
Even though I made the correct decision, I believe this case study forced me to develop new skills.
The simplification of my investment process (which I shared earlier on) dramatically improved my efficiency and effectiveness of the Wiley case study. This was critical because it was the toughest case study yet for a few reasons.
First, the publishing business is not very simple. There are a lot more details that I simplified for the purposes of the case study. It was probably simplified in the Singular Diligence report as well.
Second, it was the first time I had looked at a company whose sole business strategy was built on acquisitions. I didn’t have a framework for that.
Third, there was a new pattern: a business whose past might have looked very different from its future. This is what happened. The business had changed so much over the 8 year period that management had to restructure their reporting segments twice.
To overcome these challenges, I used a variety of techniques. But the underlying strategy was to simplify (a principle also known as Occam’s Razor).
I focused on the things that made the most money as well as the areas where management would spend the most money.
I settled the internal M&A debate in my mind by asking four questions:
#1 Will the “types” of acquired companies be better or worse in the future (given competition / durability)?
#2 Will the acquired prices for those companies get better (cheaper) or worse (more expensive) in the future?
#3 Therefore, will the returns for those companies be better or worse in the future?
#4 Additionally, do I think the company will deploy more or less capital towards acquisitions in the future?
And I ultimately came to a quick decision after asking myself three more questions:
So does that mean you think the company will be less valuable than it is in the future?
Will I regret missing out on the opportunity if the stock performs well?
And if it performs well, what do you think you would learn?
This was a perfect case study for situations that are complicated and/or have patterns that you have never seen before. You should aim to simplify as much as possible.
Use different mental models. Think about the business / stock in different ways. I think that’s what sets apparent good investors from great investors.
The case study took about 10 hours over the course of one week. 50% of the time was spent on actively reading and thinking about the Singular Diligence write-up, 25% analyzing the 8-year period after the publish date, and 25% writing the newsletter.
If you want to read write-ups similar to Geoff Gannon’s Singular Diligence newsletter, please visit focusedcompounding.com where Geoff and Andrew currently publish their content.