Random House of the Living Dead
Welcome to the 160th edition of SHuSH, the official newsletter of The Sutherland House Inc. If you’re new here, hit the button:
The Department of Justice (DOJ) is suing to block Penguin Random House’s acquisition of Simon & Schuster. Our coverage of the trial’s first week is here. Week two has been relatively slow so I’m going to step back and look at the biggest story to emerge from the trial thus far: the revelation that Penguin Random House is a vampire corporation.
At the beginning of the millennium, Random House (pre-Penguin) had revenues of $2.3 billion (all US figures) and a profit margin of 9 per cent. At the end of the aughts, it had revenues of 2.3 billion and a profit margin of 9 per cent. It was the biggest publishing company on the planet but it had ceased to grow.
Growth matters, especially to Random House’s parent company, Bertelsmann SE, a public company. People buy shares in publicly listed companies because they believe the entity will grow and produce larger profits in the future, making the share price rise and the investor happy. That is the whole game for public companies.
When an asset at a public company does not contribute to growth it is dead weight. It needs to be fixed or jettisoned.
Bertelsmann decided to fix Random House. In 2012, it struck the richest deal in book publishing history, acquiring 53 per cent of Penguin Books, which it then merged with Random House to make the biggest publisher even bigger.
It was said at the time that the two publishers, with combined revenues of $3.9 billion, would be able to share costs, attract better talent, take more risks, offer new products, develop new markets, and otherwise innovate. Together they would have the scale to stand up to bookselling chains like Barnes & Noble and the massive digital players, Amazon and Apple.
It was a lot of hype, of course. Random House had its pick of talent, all the size it needed to negotiate with Barnes & Noble, and it would never be in the same league as Amazon. Markus Dohle, CEO of Penguin Random House, is lucky to get a mid-level account manager on the phone at Amazon.
But the deal went ahead and expectations for the new Penguin Random House were sky high. They had to be. Bertelsmann’s purchase price valued Penguin at $3.5 billion, or more than twenty times its annual profits of $171 million. Penguin Random House would have to be far more than the sum of its parts to justify that price.
Over the next several years, Bertelsmann doubled down on its bet, scooping up the remaining 47 per cent of Penguin in two separate transactions to eventually own it outright.
Did any of the anticipated magic happen?
The first full year of a combined Penguin Random House was 2014. Revenues were about $4 billion, and that’s where they’ve been ever since (leaving aside a nice bump in 2019, the year of Michelle Obama). Profits are up, which might be considered a good sign. But they didn’t grow as a result of the combined firm’s increased scale, new competitive muscle, better talent, new markets, new products, or innovations. As far as I can tell, the improved profitability was achieved the old-fashioned way: the payroll shrunk from a high of 12,800 to 10,800. Also, e-books and audiobooks improved the profitability of all publishers. And the Obamas each knocked one out of the park.
The point is that seven years down the road, Penguin Random House remained exactly the sum of its parts, minus 2000 workers. The acquisition was a big-time bust. Most of the $3.5 billion purchase price was wasted.
Yet in 2020, Penguin Random House decided to repeat the whole process, striking a deal to buy Simon & Schuster, once again at a ridiculously high valuation, once again promising that magic would result from the increased scale, improved access to talent, innovation, etc. The new firm, said Markus Dohle, the same man who failed to find synergies between Penguin and Random House, would “create the future of books.”
Dohle was called to the witness stand last week to answer questions about his Simon & Schuster bid. Along the way, he had some interesting things to say about the Penguin debacle. He showed that its failure was far more monumental than it appeared, at least to me. Dohle pointed out that while Penguin Random House was failing to grow after the merger, the rest of the book trade expanded handsomely—from $9 billion to $11 billion between 2013 and 2019. As a result, Penguin Random House lost a huge chunk of market share, from 25 per cent to 21 per cent, according to a chart displayed by PRH lawyers. “We lost market share almost the size of Simon & Schuster since the merger,” said Dohle, who for some reason is still CEO of Penguin Random House.
If you’re doing the math, Bertelsmann paid $3.5 billion for Penguin only to lose market share the size of Simon & Schuster, for which it is now trying to pay $2.2 billion to recover the lost share. Dohle is shelling out $5.7 billion to stand still.
(I will say this for Dohle, he must be a talented operator. There is always competition for capital at big companies. No division ever has enough. Yet Dohle convinced his board to fund an S&S acquisition despite what happened to his last one. I bet that went over well with the leaders of Bertelsmann’s investment-hungry digital and streaming operations.)
Why did the Penguin merger fail so badly? A DOJ lawyer read one of Dohle’s texts to the court: “We really screwed it on the product side post-merger.”
Pressed on that point, Dohle testified that Penguin Random House was unable “to acquire and publish enough of the books that our readers want to buy.” His firm has “market-leading sales and distribution service,” but without the right books, it’s not much of an advantage.
“I take full responsibility for everything that happens in the company,” he said before blaming his editors. “I think we could have been more aggressive, nimble, agile, faster on the content side.” He particularly noted that there were too many layers of management involved in signing new books.
Other facts that slipped out in court underscored Dohle’s point about his firm’s problems in acquiring new titles.
Last week we mentioned that the head of Hachette, Michael Pietsch, said a third of his income is derived from his backlist, titles published in previous years that still sell reliably. Backlists are the ballast in a publisher’s ship, providing a stable financial base from which big bets can be made on forthcoming books. Hachette’s backlist produces a third of the company’s revenues.
Dohle testified that his company has been spending on new book acquisitions at a record pace, including $650 million in author advances in the US. Nevertheless, 58 per cent of his company’s revenue in 2020 came from its backlist.
That’s mindboggling. While a healthy backlist is essential for publishing success, beyond a certain point, a high ratio of backlist to frontlist sales indicates a serious underperformance by the frontlist. I’m not sure what that point is—40 per cent maybe? 45? 50? But there’s no doubt that 58 per cent is a problem, especially when you’ve been out-spending all your competitors and winning the lion’s share of auctions for anticipated best-sellers.
It may be that Penguin Random House is now so large as to be unmanageable. It has 275 imprints, according to its website. That number will climb to well over 300 if it swallows S&S. Having that much scale can be great if everything is running smoothly and the market is growing. But things are not running smoothly and the market is flat. It’s hard enough to turn around one underperforming business in a flat market. Turning around 300 of them, or even the most important thirty, needs John D. Rockefeller, or Sakichi Toyoda, or Jack Donaghy.
Having failed to produce organic growth since the last century, the only competitive advantage remaining to Penguin Random House is scale, which explains why it is desperate enough to overpay for Simon & Schuster. If S&S were to wind up with HarperCollins or Hachette, producing a second gigantic publisher, PRH would have to compete on an even playing field and there’s scarce evidence it can. So in the classic manner of living-dead companies, PRH swans from acquisition to acquisition, sucking the life out of each expensive prize to maintain the illusion that it is still a vital force.
If the S&S deal goes ahead, PRH will drain it like it drained Penguin. Dohle promised at the time of purchase to preserve Penguin’s special character but it is now just another ashen imprint, indistinguishable from all the others in the crowded PRH stable.
That’s the irony of the DOJ’s suit to block Penguin Random House’s purchase of Simon & Schuster. Probably the best way to ensure Penguin Random House doesn’t become an unfairly dominant force in book publishing is to let it overpay for Simon & Schuster and spend the next decade failing to absorb the acquisition properly, pissing away the asset’s value, and losing ground to competitors.
I remain skeptical of the DOJ’s case but would be happy to see it win. S&S deserves a better fate. Plus, who cheers for the zombie?
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