Forget Pearson plc — I’d buy this small-cap peer instead

Following recent results, Pearson plc (LON:PSON) could be a falling knife. Here’s a far more enticing opportunity to this Fool.

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In theory, those companies that feature in the market’s top tier should offer less capital risk than those lower down the market spectrum. However, try telling that to investors of international media and education company, Pearson (LSE: PSON). A little over two years ago, shares in the £5.4bn cap were changing hands for 1465p. Following a questionable change in strategy and several profit warnings, they now trade at just 660p.

In addition to reporting the biggest pre-tax loss in its history (£2.56bn) last Friday — most of which was attributable to an impairment of goodwill after awful trading in its North American operation — the FTSE 100 constituent also reported an 8% fall in underlying sales. 

It wasn’t all bad. Although net debt levels almost doubled to £1.09bn thanks to restructuring costs and the strong US dollar against the pound, this was considerably less than feared. Pearson’s CEO John Fallon also did his best to reassure the market, stating that the company would continue its digital transformation and efforts at simplifying the business, controlling costs and focusing investment on new growth opportunities in education. While I’m not totally convinced on the merits of selling the company’s 48% stake in Penguin Random House, this will go some way to reducing the aforementioned debt pile.

The fact that Pearson’s shares now trade on a price-to-earnings (P/E) ratio of 13 for the new financial year suggests they might offer reasonable value. Given that the outlook is so unclear and a dividend cut appears nailed on, however, I think there’s a better opportunity further down the market.

A magical alternative

Most of us will recognise Bloomsbury (LSE; BMY) as a publisher of adult and children’s books (including the Harry Potter series) but the £127m cap actually has a second, non-consumer division focusing on academic, professional, special interest and content services. It’s this part of the business that excites me the most.

Back in October’s interim results, Bloomsbury reported that its consumer revenues had increased 36% to £37.3 million, with revenues for children’s trade rocketing 63%. Although total revenues for the aforementioned non-consumer division £25.4 million were almost identical to the same period in 2015, the company did report that academic and professional digital resources revenues had doubled year on year to £2.0 million. 

While the stock trades nowhere near the price it once used to (375p back in June 2005), I think the company’s growing focus on generating digital revenues through the implementation of its Bloomsbury 2020 plan will see the shares push higher over the medium term. With the first services on the new platform — the Arcadian Library Online and Bloomsbury Popular Music — already launched, the business now intends to provide sales, marketing and distribution services to make these available to universities, institutions, libraries and individuals around the world. By 2021/22, it hopes to achieve revenues of £15 million and profits of £5m from digital resource publishing alone.

In the meantime, Bloomsbury remains a solid dividend payer.While the rate of growth isn’t explosive (around 5% per year), a 4.2% yield expected in the next financial year is four times better than the interest you’d receive from the current best-paying instant-access cash ISA. It’s also more than many FTSE 100 businesses are prepared to distribute to their owners.

For those who like their companies in sound financial health, Bloomsbury’s net cash position and decent free cash flow should also appeal. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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