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Rating Action:

Moody's changes outlook on Pearson's Baa1 ratings to negative from stable; affirms ratings

Global Credit Research - 24 Jan 2014

London, 24 January 2014 -- Moody's Investors Service has today changed to negative from stable the outlook on the Baa1 long-term issuer and senior unsecured ratings assigned to Pearson plc and its subsidiaries. Concurrently, the rating agency has affirmed the Baa1 ratings and the P-2 short-term rating.

The rating outlook change follows Pearson's second profit warning for 2013, announced on 23 January 2014. In its announcement, Pearson said that the year had seen weaker-than-expected trading in its two largest markets, the US and the UK.

"We are changing the outlook to negative as Pearson's debt protection metrics for fiscal year 2013 are likely to weaken considerably," says Gunjan Dixit, a Moody's Assistant Vice President-Analyst and lead analyst for the issuer. "This view reflects Pearson's tough trading conditions, particularly in North America and the UK; the greater-than-originally-anticipated spending on restructuring; and certain start-up costs for new contracts in higher education and increased provisions for returns."

"Pearson's trading conditions are also likely to remain challenging for the next year and as a result we don't expect its credit metrics for 2014 to improve compared to 2013", adds Ms Dixit.

RATINGS RATIONALE

Today's outlook change reflects the announcement of Pearson's second profit warning for 2013, under which it expects to report an 'adjusted' operating profit of GBP865 million in fiscal year 2013. This figure compares unfavourably with the 'adjusted' operating profit of GBP932 million under IAS19 revised reported by Pearson in fiscal year 2012. Just under half of the difference relates to associate accounting for Penguin Random House. The GBP865 million amount is before restructuring charges, but includes the equity income from the Penguin/Random House joint venture, which Pearson will report as an associate from 2013 onwards.

The company has indicated that it has incurred GBP170 million in restructuring charges in 2013 compared to its original guidance of GBP150 million. The GBP40 million of cost savings realized during 2013 are also lower than Pearson's guidance of over GBP50 million. While the company expects to realise benefits from its 2013 restructuring programme in 2014 and beyond, it still anticipates that it will expense another GBP50 million in net restructuring charges in 2014. Moody's further notes that Pearson has made certain additional investments during 2013, including launch costs related to certain multi-year service-based contracts in higher education, which are negatively affecting profits.

Operationally, 2012 and 2013 have been the toughest years in Pearson's recent history. After achieving a retained cash flow (RCF)/net debt ratio (as adjusted by Moody's) of 22.9% (compared to 34.8% in 2011) in 2012, Moody's expects a marked deterioration in the ratio in 2013. The ratio deterioration is not only due to difficult trading conditions but also a visible increase in net debt due to acquisitions (although Moody's notes positively that the Mergermarket Group disposal will bring in proceeds of GBP382 million in Q1 2014). In Moody's opinion, Pearson could find it challenging to achieve an RCF/net debt ratio (as adjusted by Moody's) in the high teens in both 2013 and 2014. In this regard, the rating agency recognises that this ratio will also carry the impact of exceptional restructuring related outflows in 2013 and 2014.

Moody's currently expects Pearson's growth prospects to improve from 2015 onwards driven by better trading conditions in its core markets supported by growth opportunities (such as Common Core in the US). In Moody's opinion, Pearson seems to be taking the right steps from a strategic perspective by executing the restructuring and necessary investments targeted to meaningfully strengthen the company's position in digital education services. In line with its growth strategy, the company also continues to increase its exposure to emerging markets via add-on acquisitions. In December 2013, for example, Pearson announced its acquisition of Brazilian company, Grupo Multi, for GBP440 million in cash (in addition Pearson will assume GBP65 million of debt from Grupo Multi).

Pearson's Baa1 rating remains underpinned by the strong international industry positions that its activities occupy, as well as its strategic focus on: (i) long-term investment in content; (ii) the development of digital products and services; and (iii) international expansion coupled with (iv) a focus on increased operational efficiency. Pearson is in a better position than its immediate competitors, particularly in terms of its education activities, as demand for (complex) digital products and services continues to grow. The rating also considers Pearson's track record and its ongoing commitment to managing leverage, so that it can retain its Baa1 rating.

Key challenges for Pearson include its (1) exposure to the fiscal health of US states and international government funding bodies, in its schools and higher education businesses; (2) the current difficult market conditions in the US education market; and, to some extent, (3) vulnerability to (i) the advertising cycle in the Financial Times group, as well as (ii) the management of the accelerating transition of trade book publishing to electronic formats (in this regard, Moody's notes positively the Penguin and Random House joint venture created in 2013). Pearson has well-defined and tested acquisition criteria. However, the company's ongoing acquisition activity, which is aimed at further developing Pearson's emerging market position and broadening its educational offerings, still entails a degree of execution risk.

RATING OUTLOOK

The negative rating outlook reflects the deterioration in Pearson's credit metrics expected in 2013 and the difficult operating environment which is likely to continue in 2014.

WHAT COULD CHANGE THE RATING - DOWN

The Baa1 rating could come under pressure if Pearson cannot sustain an RCF/net debt ratio (as adjusted by Moody's) in at least the high teens (in percentage terms) and maintain a debt/EBITDA ratio of below or around 3x.

WHAT COULD CHANGE THE RATING - UP

Given Pearson's declared intention to use financial flexibility for add-on acquisitions, Moody's does not see a near-term catalyst for an upgrade. Should Pearson sustain an RCF/net debt ratio above the mid-twenties (in percentage terms), free cash flow (FCF)/net debt above the mid-teens (in percentage terms) and debt/EBITDA well below 2.5x, upgrade pressure could ensue over time.

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was the Large Global Diversified Media Industry published in December 2010. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Headquartered in UK, Pearson is an international media company with a strong focus on education. The group recorded GBP6.1 billion in sales and GBP936 million in reported adjusted operating profit in 2012.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Gunjan Dixit
Asst Vice President - Analyst
Corporate Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Paloma San Valentin
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's changes outlook on Pearson's Baa1 ratings to negative from stable; affirms ratings
No Related Data.

 

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