All the Latest on Random Penguins: Part II

The big news in the world of publishing this week had nothing to do with Jordan Peterson. Penguin Random House, the world’s biggest publisher of consumer books, got bigger, buying Simon & Schuster for $2.1 billion in cash.

I have a few things to say about this but best to review the handwringing first.

There’s been a lot said about how the Big Five publishers, which includes the above two plus HarperCollins, Hachette, and Macmillan, are now a Big Four and that’s a disaster for all concerned. (In the interests of time, I’m mostly going to look at this deal in an American context.)

I’ll pick on Franklin Foer at the Atlantic, only because he was more comprehensive than most who wrote about the sale.

Foer says the deal “is deplorable and should be blocked. As book publishing consolidates, the author tends to lose—and, therefore, so does the life of the mind.”

He says competition to sign writers and the size of advances to writers will shrink, making it “harder for authors to justify the time required to produce a lengthy work.”

He expects publishing to become ever more corporate, more risk-averse, and lose its sense of a higher purpose. It will become like the movie world and gravitate to sequels and established stars.

And, says Foer, the size of Penguin Random House S&S, which will control roughly 33% of US consumer book sales, will invite curiosity from regulators and induce political caution in the firm in deciding which writers to publish.This is mostly tripe. The same arguments were trotted out to protest the Penguin and Random House merger in 2013. Advances for big-time writers have skyrocketed since then (look at the Obamas and their $65 million). Yes, there is a disparity between rich and poor authors, and the middle-class author is dying, but that all started well before the latest rounds of consolidation in book publishing. The whole of the entertainment world and, indeed, the whole of the American economy has been in winner-take-all directions.As for publishing becoming more corporate and losing its sense of purpose, I’d rather have S&S owned by another publisher like Bertelsmann than ViacomCBS, which is a cable and television outfit. More on that later.

The notion that publishing becomes more risk-averse and politically cautious because of this merger is not so much argued as asserted. I don’t see it. There wasn’t a single publisher in the U.S. afraid to take on the Trump administration, and if he’d won another four years, that wouldn’t have changed, merger or no merger.Sally Hubbard, the author of Monopolies Suck, says American discourse will be less diverse because of the deal: “We’re seeing this across the whole economy, whether it’s online speech and the consolidation of the control of speech with Facebook and Google or whether it’s the destruction of local news and journalism. You start having a less pluralistic society, more concentration of ideas through fewer gatekeepers.”I don’t buy this either. The Independent Book Publishers Association of America has 3,600 members. That’s an army of independent publishers. And there are now close to two million self-published books released in the US annually. The discourse will be fine.

Robert Thomson, chief executive of News Corp, Rupert Murdoch’s firm, which owns HarperCollins, rang the antitrust alarm. He said the willingness of Penguin Random House to outbid his firm for S&S indicates that it wasn’t simply buying another publishing asset, it was “buying market dominance as a book behemoth.”

This is mostly sour grapes. I expect antitrust regulators will look at the deal. I don’t think they’ll be any more inclined to get in its way than they were to block the Penguin merger eight years ago. Regulators are permissive about consolidation in low-growth industries, and an oligopoly of four major publishers isn’t much different from an oligopoly of five. The combined firm will only have about a third of the trade book market, which in the scheme of things isn’t an extraordinary degree of concentration (especially compared to the tech world). Depending on how the regulators frame the sale, how they define the new firm’s competitive set, it might be argued that PRHS&S’s market share is “below 20 percent” in the US, as Bertelsmann claims, citing data from the Association of American Publishers.The worst regulatory outcome I can see is PRHS&S being forced to divest of an imprint or two if it has a much larger market share in some particular publishing sector. Thomson, for instance, claims that the new firm will have 70% of the market for literary and adult fiction. If he’s right, that might raise eyebrows, but I don’t expect so.The one comment that rang true to me in all the complaints about the deal was made by the US Authors Guild which predicted editorial layoffs. That will almost certainly happen. More below.

I hope that relieves you of any fears that the world is ending. I don’t think the deal is great, but it’s not a disaster.

In fact, it may be worse for Penguin Random House than for readers, writers, booksellers, or other publishing companies.

Let’s take a look at what PRH bought. The 96-year-old Simon & Schuster (the original gents above) publishes the likes of Stephen King, Bob Woodward, Doris Kearns Goodwin, Mary Higgins Clark, and David McCullough. It is owned by ViacomCBS, which also owns Paramount Studios and Nickelodeon, and is doubling down on video streaming as the key to its future growth, a good reason to dump its book assets.You might wonder how a cable and television company ever got in the book business to begin with. The answer takes us back to the nineties, a time when big-thinking media types believed there was something magical about the convergence of broadcast and print assets. Bring them together and profits would explode. All kinds of deals were done – here in Canada, Global TV bought Hollinger’s newspapers and CTV took a piece of the Globe & Mail. The magic never happened. Convergence ended in tears just about everywhere.ViacomCBS was no exception. It waited for the convergence magic through the aughts. None came. One imagines it had lost hope for Simon & Schuster sometime around the financial crisis of 2008-2009. All of its businesses were hit hard. Simon & Schuster’s profits were a slim 6% in ‘09. It scratched its way back to a respectable 11% by 2011 but its place in ViacomCBS was never the same.

Ever since, S&S has been operated just as you’d expect a book company to be operated by a publicly-owned cable and television conglomerate that no longer believes in magic.

The people at the top of cable and TV companies are cable and TV people. They don’t read. They’re insecure around literary types. They think print is dead. They’re sure as hell not going to invest in it. Instead, they squeeze the living shit out of it, demanding ever higher profits to fund things the cable and TV guys care about, i.e., cable & TV stuff.

Since 2010, Simon & Schuster’s revenues have been steady as a rock, right around the $800 million mark. All that’s changed is the company’s operating margin or profitability. By 2015, it was up to 15%. All of the improvement came from reducing expenditures. That trend got worse as the decade progressed.It looks to me that ViacomCBS decided to unload S&S in about 2017. What you do when you want to sell a business is squeeze it even tighter, cutting every cost imaginable to make it look super profitable. Publishing companies are sold on a multiple of EBITDA, or pre-tax profits. The higher your profits, the higher the sale price.In 2018 and 2019, with revenues still around $800 million, S&S booked profits of 19% and 18% respectively, which is almost unprecedented in book publishing. To give you some perspective, Knopf-Doubleday, a prestige imprint at Penguin Random House with a phenomenal backlist of timeless literature that sells itself year after year, no marketing required, budgets for an 18% profit margin, the highest in the PRH universe.

It’s extremely unlikely that S&S’s margins have ever been in the high teens before. And, again, it wasn’t because of higher sales. The company was fiendishly grinding costs, probably in an unsustainable manner. No one at ViacomCBS would have cared if the profits were unsustainable—that’s the buyer’s problem.

Industry observers, maybe talking to ViacomCBS, maybe talking to potential buyers, initially put a price tag of $1.2 billion on S&S. That was about eight times the company’s EBITDA of $145 million. An eight-times multiple is what you pay for a healthy business in a growing market. By comparison, a lot of newspapers were changing hands in the aughts, a time when the future began to look dicey, at four times. Given that book publishing isn’t a particularly fast-growing industry, one might consider eight times generous for S&S, especially given how it goosed its profits through vicious cost-cutting.

Along comes PRH. And pays $2.175 million cash. A multiple of fifteen. As though S&S is some high-octane tech startup.

Why?

Bertelsmann’s reasons for the purchase were almost identical to those it used to justify the Penguin acquisition eight years ago. Important to have size or scale when you’re dealing with megacorps like Apple and Amazon, and bookselling chains like Barnes & Noble. Being big makes it easier to develop direct-to-consumer book sales networks so the company is not as dependent on Amazon and Barnes & Noble.

Nonsense. PRH has all the size it needs to arm wrestle Barnes & Noble, and it will never be large enough to stand up to Amazon. As the New Republic noted this week, Amazon’s revenue is fifty times that of PRH, and its market capitalization is infinitely larger.

Adding S&S to PRH may so a little good here and there. Maybe a higher volume of direct-to-consumer sales. Maybe slightly better terms with Amazon. But nothing that would justify a $2.175 acquisition.

My best guess is that Bertelsmann bought and overpaid for Simon & Schuster out of fear.

Let’s look at what’s happened to Bertelsmann’s book business since it paid an even more ridiculous sum for Penguin.

Bertelsmann valued Penguin at $3.5 billion, which was about 25 times EBITDA. It bought 53% of the company in 2012, another 22% a few years later, and the rest early this year. To justify this price, Bertelsmann claimed that Penguin would bring the scale it needed to be more competitive and stand up to Amazon, etc. Also, it said that being bigger would attract better writing talent, more bestsellers, and allow it to develop new markets, offer new products, and find more efficiencies.

Did any of this happen?

Of course not. The first full year of a combined Penguin Random House was 2014. Revenues were €3.3 million (euros) and profits €452 million, for a healthy margin of 15%.

Revenues have been about €3.4 billion ever since except for a bump to €3.6 billion in 2019 on the strength of Michelle Obama’s memoir.

Profits have improved moderately to €528 billion in 2018 (and €561 in 2019, again courtesy of Michelle).Are the higher profits due to its increased size, greater competitive muscle, better writers, new markets, or new products developed since the Penguin purchase?Not as far as I can see. The improved profitability appears to have been achieved in the least imaginative way possible: the number of employees has shrunk from 12,812 to 10,300. Penguin Random House is exactly the sum of its parts, minus 2500 workers, almost half the number acquired from Penguin.

Bertelsmann overpaid for Penguin and has little to show for the deal. Its publishing division is not in great shape.

As a publicly held company, Bertelsmann needs to grow, otherwise its shareholders will sell their stock and take their money elsewhere. Penguin Random House has to contribute to that growth, preferably by producing more revenue. If it’s not able to grow its revenue, which seems to be the case, it has to cut costs and improve its profitability, and there are limits to how far you can cut costs without pulling down your revenues and getting yourself in deeper trouble.

I imagine that when S&S came on the market last year, Bertelsmann wasn’t so much interested in acquiring the company as it was concerned that someone like HarperCollins would buy it. The combination of HarperCollins and S&S would make a new firm, HCS&S, almost the size of PRH. That would be a real competitive threat to PRH, making its inability to grow an even bigger concern.

HCS&S, if it had happened, would have bid up the prices for the blockbusters that PRH so desperately needs. PRH’s dominance on the bestseller lists would have been under threat (a publisher’s share of bestsellers is a crude but still useful metric of financial success).

Far better to overpay for S&S than let HarperCollins grab it, setting yourself up for regular bidding wars with Rupert Murdoch.

So where does that leave us? I wish this deal had not happened. I would have preferred Rupert and HarperCollins to wind up with S&S. Two equal-sized book publishing competitors would have been better for authors and the rest of the literary food chain. The fact that the deal went Bertelsmann’s way is unfortunate but it’s not going to make the publishing industry much, if any, worse.One thing that’s bound to happen is that a bunch of the combined entity’s 11,800 employees (S&S brings 1500 to the table) will find themselves out of work in the next few years as the cutting continues at Bertelsmann. That sucks.In my estimation, the whole of the book publishing industry is nevertheless quite dynamic and a lot could change over the next decade or two. It was only thirty years ago that S&S was the biggest publisher in America. Just because Bertelsmann owns a lot of imprints now doesn’t mean that it always will, or that it will succeed with what it has, especially now that it will be under enormous pressure to justify two major and hellishly expensive acquisitions in a single decade.

I’ve just written a book about General Motors which in the mid-1960s had half the domestic car market in the US and one of every six jobs in America was related to automobiles. It looked invulnerable. It wasn’t. No company ever is. Down the line, buying S&S may prove to have been riskier for Bertelsmann than letting Murdoch have it.

A couple of final notes on the Canadian side of the acquisition. I promise I’ll look into this more in the weeks ahead but for now, this is all I’ve got.

The Big Five is a Big Three in Canada: PRH, HarperCollins, and Simon & Schuster. So, we’ll be going from a Big Three to a Big Two with this deal. The Bertelsmann group will become by far the larger of the remaining two, maybe with more than half the Canadian market (I haven’t been able to find good data on this today).

As a practical matter, PRHS&S will be the only show in Canada if you’re looking to sell a book for a sizeable advance (HarperCollins Canada is not especially active). PRHS&S will also have a lot of weight to throw around with agents, printers, booksellers, and everyone else in the publishing food chain. That could be unhealthy.

There is more cause for the PRHS&S deal to get regulatory attention in Canada than in the US. Our official cultural policy supports Canadian ownership. Strictly speaking, it should not be possible for Bertlesmann to purchase Simon & Schuster Canada unless the business is in financial distress, and it isn’t. Whether that’s enough to roust our sleepy regulators is difficult to say. I wouldn’t bet on it, even with a Liberal government.

Finally, Simon & Schuster has a large book distribution business in Canada. So does Penguin Random House Canada. The combination of these two entities will make them more powerful in the distribution space than the combination of their publishing operations make them in the book trade. It should be of more interest to regulators than the book part of the deal.

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