Pearson to Merge Penguin With Bertelsmann’s Random House

Pearson Plc (PSON) agreed to combine its Penguin unit with Bertelsmann SE’s Random House to create by far the largest book publisher in the U.K. and the U.S.

The joint venture, named Penguin Random House and to be based in New York, will be 53 percent owned by Guetersloh, Germany-based Bertelsmann, with London-based Pearson holding the remainder, the companies said today. The venture’s chief executive officer will be Markus Dohle, now CEO of Random House, and Penguin CEO John Makinson will be its chairman.

As print sales drop and electronic books give authors greater control over where their work appears, publishers are seeking ways to combine to lower costs. Large booksellers, such as Amazon.com Inc., have gained more negotiating power over prices. Rupert Murdoch’s News Corp., owner of the HarperCollins publishing house, has also expressed interest in buying Penguin, according to a person familiar with the matter.

“The joint company will have more resources to push forward the digitalization toward the e-book and new distribution channels,” Bertelsmann CEO Thomas Rabe said in a phone interview. “We want to increase our exposure to growth markets. Penguin is well established in Brazil, India and in first steps also in China.”

Smaller Competitors

The venture between 77-year-old Penguin and 87-year-old Random House will control about 25 percent of the industry, Rabe said in a conference call today. The two companies controlled a combined 29 percent of U.S. publishing sales and 26 percent of the U.K. market, according to this year’s sales data through Oct. 6 compiled by Nielsen BookScan.

That would make the venture more than three times bigger than its nearest competitor HarperCollins in the U.S. and more than twice as large as French-owned Hachette Group in the U.K., according to the data.

Pearson rose 0.3 percent to 1,224 pence at 3:31 p.m. in London, giving the company a market value of 10 billion pounds ($16 billion). Bertelsmann is closely held by the Mohn family, descendants of Carl Bertelsmann, who founded the company in 1835.

Bertelsmann CEO Rabe, who took over in January, has been looking for acquisitions to reduce the company’s dependence on Europe and expand its digital businesses. Pearson is seeking to boost its education unit and has selected that division’s chief, John Fallon, to succeed CEO Marjorie Scardino, who will step down by the end of this year.

First Refusal

Bertelsmann isn’t obliged to increase its stake in the venture should Pearson decide to exit, Rabe said on a conference call. The German company has the right of first refusal in such a case, meaning Pearson would have to offer its stake to Bertelsmann first before approaching other interested parties.

Pearson and Penguin only discussed non-cash combinations, and an acquisition of one publishing house by the other was never discussed, Rabe said.

“Pearson was not a seller of Penguin,” Rabe said.

Random House had a boost this year from carrying the “Fifty Shades of Grey” books, which have spent 32 weeks on the New York Times best-sellers list. Penguin carries popular titles such as the “Diary of a Wimpy Kid” series and “The Help.”

Penguin and Random House had combined sales of about 2.5 billion pounds and operating profit of 272 million pounds last year. A merger could reduce the publishers’ estimated combined cost base of 2 billion pounds by 2 percent to 3 percent, according to Alex DeGroote, a media analyst at Panmure Gordon & Co. in London.

Pearson will nominate four directors to the venture’s board and Bertelsmann five.

Regulatory Issues

“Penguin was always going to be a drag on organic growth, no matter what,” said Claudio Aspesi, an analyst at Sanford C. Bernstein Ltd. in London with an “outperform” rating on Pearson shares. “Pearson through this structure is not able to totally divorce itself from the risk, but probably this is as good a deal as they could hope to get.”

Rabe said Bertelsmann had discussed potential regulatory issues internally and “we are confident that we will get approval for the transaction in the second half of next year.” Bertelsmann hasn’t discussed the deal with competition authorities yet, Rabe said.

No breakup fee is included in the Penguin-Random House agreement, and the partners are prohibited from selling their holdings for three years, according to a statement. After five years, either company can ask to carry out an initial public offering of the venture.

News Corp. (NWSA) Bid?

“After five months of detailed discussions both sides are firmly committed to this transaction and saw no need for” a breakup fee, said Christian Steinhof, a Bertelsmann spokesman.

Still, this could leave a window of opportunity for rivals. News Corp.’s HarperCollins has expressed interest in acquiring Penguin and is preparing an offer for the business, said a person familiar with the matter, who asked not to be identified because the discussions are private. Penguin is valued at 1 billion pounds by News Corp., the Sunday Times reported yesterday. The newspaper is owned by New York-based News Corp.

Rabe said News Corp. hasn’t contacted him.

“Do you want 1 billion pounds today or potentially 47 percent of an enterprise years down the line?” said DeGroote. Shareholders would prefer a clean exit from an acquirer, such as HarperCollins, he said.

Piracy Threat

The venture will exclude Bertelsmann’s trade publishing business in Germany and Pearson will keep rights to use the Penguin brand in education titles.

Pearson said sales increased 5 percent in the first nine months of the year, while profit declined 5 percent. The company reiterated its full-year forecast for growth in sales and profit at constant exchange rates.

The popularity of e-books will make the industry more vulnerable to piracy and has led to fewer print sales of some genres, such as thrillers and romances, Bernstein’s Aspesi said. Deals such as this give publishers more control over content, he said.

Other publishers “all probably would have liked to merge with Penguin and they didn’t understand the urgency,” Aspesi said. “You can really be very late to the dance floor if you’re not involved in the first deal.”

To contact the reporters on this story: Amy Thomson in London at athomson6@bloomberg.net; Joseph de Weck in Berlin at jdeweck@bloomberg.net

To contact the editor responsible for this story: Kenneth Wong at kwong11@bloomberg.net

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.