RUK: The Maturing Threat of Open Access
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" We all face the same paradox. We faculty do the research, write the papers, referee papers by other researchers, serve on editorial boards, all of it for free ... and then we buy back the results of our labour at outrageous prices ." That sentiment, expressed in April by Robert Darnton, the director of the Harvard library, is the reason why the rich profit margins enjoyed for so long by publishers like Reed Elsevier will prove unsustainable in the face of technological change.
Reed Elsevier (RUK) is the world's largest publisher of academic journals, with more than 1200 scholarly titles. The publishing division operates at a 36% profit margin - an outstanding margin for any business - but the basis for that profitability looks increasingly vulnerable as the open access movement matures and academics become increasingly aware of viable alternatives. Because profits from the Elsevier publishing division accounted for nearly half of the company's adjusted operating profit in 2011, downside risks to margins could have a significant impact on the overall profitability of the company. The analysis of changes in the open access movement, below, explains why the stock can be expected to underperform its peers. In the following section, we explain why RUK is so dependent on revenues from the core Elsevier division and the obstacles to any future margin expansion. Then, we review the "old" open access movement, the recent move to boycott Elsevier journals, and the new threat posed by competing open access publishers.
Reed Elsevier is dependent on profits from scholarly journals, but while the upside in that business appears limited for the foreseeable future, downside risks are not adequately discounted. Consider the outlook for the other major divisions of the company:
- LexisNexis Risk Solutions (22% of 2011 operating profit) is the brightest spot: growth in operating profits for the risk management services and analytics division has been stable, although momentum has slowed and overall revenue has been flat for several years.
- LexisNexis Legal (14%) is under significant pressure. The division has been losing market share to the Westlaw product from Thomson Reuters, and the successful entry of Bloomberg Law into the field has only intensified competition. The sell-side outlook for this division seems uniformly negative.
- Exhibitions and RBI (17% combined) - these divisions have proven to be cyclical and somewhat unstable, as they are so small that management is not expected to devote significant capital or attention to them. Deutsche Bank noted in a recent report that neither of these businesses seemed to have a "natural home" in RUK.
A major source of pressure on Elsevier is the decline in university library budgets. The global recession caused widespread reductions in the spending of both public and private universities, and there is little indication that library budgets will resume rates of increase seen in recent decades. Additionally, the political climate in the United States is becoming more hostile to public research and education: Republican state legislatures have made aggressive moves in recent years to slash public university budgets, resulting in the closing of entire departments and university presses and increased pressure on library budgets. It has even become de rigueur to ridicule public spending on research and medicine, with anecdotes appearing in GOP presidential campaign speeches in the last two cycles. The climate of fiscal austerity, in short, is unfavorable for any company that depends on well-funded public academic institutions.