Description

Scholastic is a compelling value in today’s market, with interesting catalysts on the horizon to crystalize value.  Long abandoned by investors because Richard (Dick) Robinson, Scholastic’s founder’s son, controlling shareholder, and Scholastic CEO from 1975 to 2021 was a capital allocation disaster.  Scholastic’s ample cash flow was ploughed into a wasted encyclopedia acquisition, failed e-reader development project, and most recently Manhattan real estate.  Scholastic is not covered by any wall street research firm.  Robinson’s death in July of 2021, co-incident with the end of an investment cycle at Scholastic, brings in new management and changes the paradigm.  It is morning at Scholastic.

Scholastic, at $31.50 per share, ($24.72 adjusted for the $6.78 of net cash on the balance sheet) trades for a 12% free cash flow yield.  This does not include the potential income from renting currently vacant retail space on the ground floor of their whole owned, unencumbered, corporate headquarters on Broadway in Soho nor the potential rent from excess office space in the same building.

With Richardson’s passing, control of the company passed to Richardson’s girlfriend, Iole Lucchese who is also an executive at Scholastic.  While Lucchese is the new Chair of the Board (while continuing in her operating role as Scholastic’s Chief Strategy Officer), Perter Warwick has been appointed CEO.  Warwick, is a veteran of Thomson Publishing where he ran the Legal Publishing division, among other businesses, before becoming the head of HR at Thompson.  My checks on Warwick-with managers that worked directly for him in Legal Publishing have come back stellar.  Warwick is a serious executive who understands budgets, incentives, and capital allocation, things Dick Richardson may have understood, but didn’t care about.

While Lucchese, obviously comes from Richardson’s camp and has promised to maintain Scholastic’s focus on its educational mission and to not to sell the company, she does strike us as ambitious.  With Dick out the way, she can focus on maximizing shareholder value.  And with Warwick in charge on a day to day basis, we expect that (eventually)  Scholastic’s recently renovated 327,842 sq headquarters on Broadway (between Prince & Spring) will be sold (and probably partially leased back), new projects will be subject to financial disciple, and the company’s ample cash hoard of $240m (plus >$50m in excess inventory investments due to supply chain issues) will be deployed to repurchase stock and/or accretive acquisitions.  Mgmt accedes that Scholastic should probably have leverage, not net cash and unencumbered real estate.

On both the FY2022Q4 earnings call in July and the FY2023Q1 earnings call in September Scholastic guided to 8-10% revenue growth for FY2023 and $195-$205m in FY2023 EBITDA.  Maintenance Cap ex is around $40-$45 per year according to Mgmt, resulting in $100m in free cash flow.  At current prices, Scholastic is trading at 4.5x EBITDA for a business where Trade has been showing steady growth, Book Fairs is rebounded strongly from a situational trough, Education is showing growth from new products and only starting to benefit from stimulus money hitting the education sector.  International should also show significant benefits from Australia and New Zealand which have only recently reopened post COVID.

We would not be surprised to see a Dutch Tender for stock in the high 30s to low 40s, or for Scholastic to maintain a steady bid for the stock in the open market.  SCHL stock’s precipitous drop from $42 to $29 post Q1 earnings is hard to explain on a seasonally weak quarter where annual guidance was reiterated.  Mgmt characterization of the business trends is that they are more confident now in guidance than when we originally gave it in July.

BUSINESS DESCRIPTION

Children’s Publishing and Distribution

Trade (think traditional children’s book publishing) (23.8% of FY2022 Revenue)

The core of the business, children’s publishing, is an IP rich growth business typically deserving of a high multiple.  Scholastics is the world’s largest publisher of and distributor of children’s books in print, digital .  Scholastic’s original publications include Harry Potter™, The Hunger Games®, The Bad Guys™, The Baby-Sitters Club® graphic novels, The Magic School Bus®, Captain Underpants®, Dog Man®, Wings of Fire™, Cat Kid Comic Club®, Goosebumps® and Clifford The Big Red Dog®, and licensed properties such as Peppa Pig® and Pokemon®.  The Trade

Book Fairs (26.2% of FY2022 Revenue)

Scholastic is the leading distributor of school-based book fairs in the United States.  Scholastic operates approximately 100,000 book fairs annually, with an 85% market share.  Book fairs is a low growth (although currently seeing a post-COVID rebound), capital intensive business.  Book Fairs is synergistic with Scholastic’s Trade division as the ability to offer wide distribution is a competitive advantage in signing and keeping authors.  Book Fairs were deeply impacted by COVID but are bouncing back strongly now.  At 85% of the book fairs, Scholastic is achieving higher revenues than pre-pandemic as same fair sales are up in the mid-teens and Scholastic has focused on larger more profitable fairs.

Book Clubs (7.7% of FY2022 Revenue)

Scholastic operates school-based book clubs consisting of reading clubs for pre-K through grade 8.  Classroom teachers promote the book clubs which allow students to purchase from curated selections at substantial discounts from list prices.  Teachers who participate in book clubs receive bonus points and other promotional incentives, which may be redeemed from the Company for additional books and other resource materials and items for their classrooms or the school.  Products are typically shipped to the classroom for distribution to the students.  Book Clubs have been in steady decline with $212m in revenues in FY2019 as opposed to $269m in revenues in FY2016 revenues.  Book Clubs were also impacted by COVID but are not bouncing back like Book Fairs.

Education Solutions (24% of FY2022 revenues)

The Education Solutions segment includes the publication and distribution to schools and libraries of children’s books, other print and on-line reference, non-fiction and fiction focused products, classroom magazines and classroom materials for core and supplemental literacy instruction. 

Recently, Scholastic’s Education division has invested in Scholastic Literacy, a comprehensive (digital and print) literacy program for students in K to 6^th grade.  Scholastic believes that the Scholastic Literacy core curriculum reading program contains a number of key differentiators, including the highest volume of authentic and culturally-relevant texts in the market and data to inform responsive, personalized instruction for students, which will help it continue to gain traction in the market.

In 2021 Scholastic launched PreK On My Way, an early childhood curriculum program designed to help children develop fundamental language, literacy, and math skills through literature and activities that explore content areas such as science, social studies, technology, fine arts, and physical development.  The Education segment is benefiting and should continue to benefit from significant stimulus dollars allotted for public education from COVID stimulus programs.

International. (18.4% of fiscal 2022 revenues)

The International segment includes the publication and distribution of its books and educational products outside the United States.  Scholastic’s primary markets include Canada, the United Kingdom, Ireland, Australia, and New Zealand, as well as in India, and Singapore.  Scholastic recently sold its US language business in China which supported tutoring in China which was impacted by recently Chinese government regulations

Real Estate

Scholastic owns 557 Broadway and 555 Broadway which it uses as its corporate headquarters.  Sephora rents most of the ground floor retail at 557 Broadway.  There is 7400 sq feet vacant at 557, and another 17,100 sq feet of vacant ground floor retail space at 555 Broadway. We have heard from conversations with brokers that activity for the 555 space has heated up.  There is also 22,627 sq feet of vacant retail or office space on the second floor of 555 Broadway as well as 6,650 vacant basement space.  We believe the going rate from ground for retail in Soho is still $400/sq ft, with the basement space likely thrown in for free.  17,100 sq feet at $300/ft and 8% cap rate would be worth $64m.  We believe there is additional vacant office space available for rent, but do not know how much.  Obviously, neither Manhattan office nor Retail real estate is particularly strong right now, but we expect mgmt to at least move ahead with the retail space if they get a decent offer.  Based on recent comps, we think the buildings are worth approximately $400-$500 million.

Post the sale of the buildings (if it ever happened), one might be paying only 2.0-2.5 EBITDA for Scholastic’s operating businesses depending on what you think pro forma rent expense would be.

RISKS

Lucchese proves to be just like Ricardson

Book Publishing suffers from a COVID Peleton effect

Competition in Book Fairs

Wasting cash on poor acquisitions

Catalyst

New Management imposes financial disciplne, returns focus. 

Share repurchases, Dutch Tender

Real Estated leased and/or sold