Quercus Tfi Or Share Price (0Q44)

Despite indications to the contrary, overall UK book market growing The downturn in physical book sales in the UK in 2012 was, according to Nielsen BookScan numbers, limited to 3.4%, a considerable outperformance of other major markets such as the US, where sales contracted 9.3%. Much of this can be attributed to the continuing migration online. Best guesstimates suggest that around a quarter of the US market by value is now from eBooks, implying a slowdown to double-digit growth from triple-digit. While there has been some suggestion that sales of dedicated eReaders has now slowed, the substitution of mobiles/tablets should not be taken as proxy that sales of eBooks will fall, as eReading apps proliferate and the boundary between the two delivery channels becomes increasingly blurred. Figures put together by Future Publishing for the UK market, trawled from individual publishers’ releases, show sales of ‘traditional’ digital books are much higher than had been assumed; around 65 million in 2012, with a value of c £200m and more than double those in FY11. The clear implication is that UK book sales did grow in FY12, despite the headline drop.

Revisions to numbers The £4.8m reduction in the top line is clearly the main driver of change to the numbers, showing the extent of the operational gearing within the business. This is attributed to; lower levels of re-orders; eBook sales not moving ahead by as much as had been expected; and the non-appearance of a book that would have had a high profile over the key Christmas sales period, reportedly (not by Quercus) written by Suggs, which we now expect to be promoted in the current year. We are building a growing proportion of digital sales in the model, which has the twin benefit of the positive effect on the group’s cash profile, with no necessity to carry stock and the reduced risk of returns, traditionally a major risk after Christmas. We have also reduced our dividend number. The £1.1m cost of paying a maintained payout looks onerous in the light of the expansion opportunities available to the group. Our first foray into forecasting the current year bears the normal health warnings, but has been struck on what we regard as conservative assumptions on number of titles, etc. If the group’s intended autumn re-launch into the US market bears fruit, it could have a transformational effect on the numbers.

Doom overdone Quercus has still to demonstrate to the market that the investment made in its infrastructure – buildings, people, systems – will generate an acceptable return, but having a broad range of product and content across varying genres, in both physical and digital publishing, is a sensible strategy to leverage that infrastructure profitably. As a start-up, the group has been able to build a publishing house better suited to the digital age than many of its peers, with digital rights negotiated from the outset, a concentration on assembling attractive content that can be delivered across any of a wide variety of platforms, and a positive approach to ongoing engagement with readers and bloggers.

Valuation: Directors’ purchases should underpin Quercus, with its ISDX listing, limited liquidity and the volatile financial performance associated with an early-stage company having a disproportionate ‘hit’ product, is valued at a 21% discount to Bloomsbury, the larger of its independent peers (8.7x February 2014 P/E). The directors’ purchases demonstrate their confidence that this should be the low point, and the group remains comfortably cash positive, but the further disappointment over FY12 results may delay any major step-up in the rating.

Profits weighted to H2 The current publication programme contains a good spread of authors and genres, including The Chessmen by Peter May – currently number four in the original fiction chart, and the accompanying book to the Africa TV series; number three in the hardback non-fiction chart. The new imprints of Jo Fletcher Books (sci-fi, fantasy and horror) and Heron Books (fiction and non-fiction storytelling) are now offering a meaningful list, building scale and market positioning. The scale-up in corporate infrastructure spend took place mostly in H112. The US business launch is scheduled for autumn FY13 and we would expect this to reach break-even within months. With the ‘no-show’ book also now re-scheduled for Christmas 2013, we would expect profits to be more heavily H2 weighted than they would be naturally.