Bait 'n' Beer

Over the past six months or so, along with watching the publishing industry generally, I've looked at a couple dozen investment opportunities in or related to publishing. While there were one or two  that involved pretty traditional publishing models, most have been presented as new business models for digital publishing, technology plays, service providers for the new publishing environment, enhanced content development and/or updated versions of publicity and marketing businesses that incorporate social media and networks into the marketing mix for books.So far, I've passed on all of them.. The reason? In each case, even if the proposed business were as successful as its projections indicated, the return on investment would have been modest in relation to the risk of its  being attained. The kinds of risks involved (along with the inherent one in publishing...."Will anyone like this content enough to buy it?") include techology risks (as the platform, device and format wars continue to rage), serious competitive risks from free/cheap alternatives to books (print or digital) that continue to put downward pressure on prices,  and distribution risks, as consolidation continues in the channels, among many others. (As an aside, this raises the question about whether the meme "there has never been a better time to start a publishing compeny" holds water. If that's true, why are so few new ones being started/funded?)

In an unrelated story, on the surface anyway, Macmillan's (US) CEO John Sargent , in an interview with Michael Healy earlier this week pointed out that the publishing industry's condition was 'disastrous but stable' in describing the industry's collective and individual balance sheets. This was cited as a major reason why financial buyers, venture capitalists, and other investors are unlikely to disrupt the 'Big Six' publishers' positions by acquiring or consolidating them. (I would further point to the complete collapse of both Readers' Digest and Houghton Miflin Harcourt shortly after they sold to financial buyers in highly-leveraged transactions.) It shouldn't be a startling revelation that you can't put a lot of financial leverage (debt in relation to equity) on a business that has a great deal of operating leverage (relatively high fixed costs in relation to variable costs). Oh...the exception to that rule is if the business with high operating leverage generates consistent extraordinary returns to compensate for the additional risk deriving from the financial leverage.

About now (if you haven't given up on the financial jargon), you're saying, "So what?" and trying to figure out why you should care. Well, I think there is a serious question about whether capital flows to the publishing business generally will be adequate to fund the innovation that's required to move us from the current "disastrous but stable" mostly-print present to a more rational digital future. And the reason that capital flows are limited is not just because many publishers have weak balance sheets  but more importantly because the returns this business generates even when it's wildly successful are below-market returns, particularly when adjusted for the risks outlined above. While we don't have data for all the big six (let alone smaller publishers) broken out in ways that allow for close analysis, we know that the companies that are considered 'outperformers' (Harlequin, for example) are earning margins in the neighborhood of 15%. That's nothing to sneeze at but hardly the stuff that make venture capitalists drool (with the notable exceptions of Vook and Open Road Integrated Media, both of which have raised significant amounts of funding at big valuations. But in general,. when you combine modest margins with essentially flat unit sales for the past several years and it's hard to see why anyone would make a big publishing bet in the current environment.

Now, all of us are working on ways to improve returns on investment for our businesses. Some are re-jiggering business models; some refocusing into vertical markets, some are making investments in new workflow projects to make their content usable in more formats (more "agile") and some are trying a combination of these and other approaches. The problem is that the changes that need to happen, need to start happening now in order for publishers to be ready whenever the digital 'tipping point' occurs. The rapid eveolution of devices, tools and platforms suggests that this will happen sooner than we imagined (though not as quickly as some might hope). Along with that, the economic downturn of the past two years (coupled with a projected slower-than-normal recovery) means that publisher cash flows are probably not likely to be robust enough to accelerate R&D spending to keep up with this evolution. (And this is setting aside publishing's cultural difficulties with rapid change, a topic for another day.)
 
If you believe those things, and I do, then two big questions arise:

    1) Given weak balance sheets and low ROI's , where will the capital come from to finance the rapid innovation and change required? and

    2) If you don't have an answer to that question, isn't it likely that non-traditional players who have access to  plentiful,cheap capital and are historically more adept at rapid innovation and change (Google, Apple, Amazon, et al) will knock the Big Six from their 'stable' positions going forward?

Thinking about long term capital needs isn't as sexy as talking about technology and content, but capital markets are ruthlessly efficient in sorting out winners and losers, survivors and dinosaurs. Unless we can attract capital to this industry (and not only to the Big Six)  we will have very little control of our future. With the risk/reward relationship as far out of whack as it currently is, I'm not sure how that happens. Keep your eyes on the non-traditional players. They're the up and comers.