The High Cost Of Education

Pearson's $2.5 billion deal for NCS is raising eyebrows

Investors used to blast Pearson PLC for lacking direction. But since Texas-born Marjorie M. Scardino took the helm in 1997, she has rapidly reshaped the London-based giant with a fast-paced series of acquisitions and asset sales. Her latest move: The $2.5 billion purchase of Eden Prairie (Minn.)-based National Computer Systems on July 31.

While the acquisition of NCS, the leading U.S. commercial supplier of assessment tests, fits Scardino's overall strategy of focusing Pearson on education and proprietary content, the deal surprised investors. Not only did the price seem high, but the method of financing the transaction also is controversial. The company will raise $2.5 billion through a rights issue--a required procedure when a British company raises new equity that amounts to more than 5% of the outstanding shares. But existing stockholders will be offered three new Pearson shares for every 11 shares they own at a deep discount--about $15 each. That's half the price at the time the deal was announced.

"VERY POSITIVE VIEW." News of the discount, and the 26% premium Pearson was paying, knocked Pearson's stock price down by 9%. It has since recovered half of the loss as investors more fully digested the deal. Underwriters say the discount was the cheapest way to raise money because it almost guaranteed shareholders would take up the offer. That meant there was little risk to the underwriters. So the investment bankers are charging minimal fees of about 0.5%, vs. a standard 2.0%. "This amounts to a hybrid stock split and equity issuance," says David Mayhew, a partner at London's Cazenove & Co., which is handling the deal with Goldman, Sachs & Co.

Scardino wasn't used to such skepticism from the markets. Up until now, she was cheered for shedding units considered noncore businesses, freeing up cash to fuel the international expansion of the Financial Times and its online platform. She also was able to start a business daily in Germany. And all along, Pearson has been turning in credible results. For the year ended June 31, operating profits were up by 32%, to $220 million, on sales of $2.3 billion. "Shareholders have a very positive view of [Scardino]," says one London-based institutional investor.

If there's a concern, it's that she has overpaid for acquisitions. Some analysts thought the $463 million price she paid for British trade publisher Dorling Kindersley in May was high. Her biggest deal, the 1998 purchase of Simon & Schuster's education business for $4.6 billion, was also considered pricey. A Pearson spokesman says both companies are performing above expectations.

While the Financial Times is driving earnings now, Scardino believes education is the company's future. Her online plans are particularly ambitious. This fall, Pearson expects to launch its Learning Network, which aims to be the Internet destination for training and education in the U.S. And NCS is the leading U.S. commercial company in the fast-growing and profitable business of providing tests for schoolchildren. It also furnishes software that tracks attendance and monitors school finances.

The NCS purchase is part of Scardino's drive to extend Pearson outside Britain. Once the deal is done, two-thirds of Pearson's revenues will come from North America, and the company hopes to list on the New York Stock Exchange soon. Scardino is firmly planted on both sides of the Atlantic. She wants Pearson to be, too.

Before it's here, it's on the Bloomberg Terminal.