E-Textbooks and the Textual Revolution

The market for e-textbooks is small but growing quickly: It's up 44.3% from last year, according to publishing industry research firm Simba Information. That's just a drop in the bucket, when you consider that e-textbooks still account for less than 5% of total U.S. textbook sales.

In my previous article, "A Textbook Case of Digital Disruption," we looked at the state of play in the e-textbook space. Now let's cover where to look for investment potential going forward.

Right now, the major publishers -- Pearson (NYS: PSO) , McGraw-Hill (NYS: MHP) , John Wiley & Sons (NYS: JW.A) , and Cengage -- have their fingers in almost every pie to one degree or another. These companies don't break out their revenues to the granularity I'd like, but here are some indicators:

  • Pearson derives 14% of its global book sales from e-books (of which e-textbooks are a subset). E-book revenues doubled in 2011 compared to the previous year.
  • McGraw-Hill noted in its fourth quarter 2011 earnings that "McGraw-Hill Education is benefiting from the rapid growth of digital products and sales that is transforming the education market." Keep in mind that McGraw-Hill intends to split into two companies -- McGraw-Hill Education and McGraw Hill Financial -- so if you wish to keep following this theme, stick with the former.
  • Wiley reported that for 2011, digital book revenue increased 74% and now accounts for 16% of the relevant business unit's book sales.

The one place where the big publishers have not invested is in those companies generating their own content: Flat World Knowledge and Nature Publishing Group. I don't imagine that Nature will necessarily steal market share from the publishing majors; it's more likely that they could exist in tandem. So far, Nature has published exactly one e-textbook. Scientific American recognizes that e-textbook to be the Cadillac of digital, but Nature still operates in a premium, niche market. The bigger question is whether Flat World Knowledge's open-source approach could be a game changer. While this is an appealing notion, open source has hardly made a dent in other markets.

Pearson and McGraw-Hill seem to be making more of a splash in e-textbooks than Wiley, which is probably more a reflection of Wiley's size than its innovative tendencies. Broadly, the publishers don't yet seem to have committed to a particular vision of the future in this space. McGraw-Hill and Pearson have both said that creating interactive books is a critical part of their strategies, and Wiley sees the huge opportunity before it. Other than that, they're all keeping their cards close to their chests.

One certainty is that Apple (NAS: AAPL) comes out ahead, both as the impetus for and beneficiary of the e-textbook market. Most of the companies in the table above recognize the tablet as a critical development in this space. Barnes & Noble has seen a major increase in digital sales, but this may not be enough to save the company. B&N is still too focused on linking digital books to the Nook, and Apple seems decisively to have pulled that rug out from under B&N's feet. Meanwhile, Amazon's recent Kindle launch just for college students was the only real Kindle flop. Still, Amazon remains an important player, particularly with its offering of rental e-textbooks.

What to look for going forward:

  • Any of the private companies in my previous article are acquisition targets. I would look at any such acquisition as a firm bet on the technology and platform that company offers.
  • There are strong rumors that Chegg -- the textbook renter with increasing digital focus -- is headed for an IPO. This could be an attractive offering and warrants consideration if the rumors prove true.
  • Look out for the publishing majors abandoning platforms in which they are currently invested. Those companies are likely to be the king makers in this transition.

Calling the odds
Ultimately, I think this game is still too close to call, but I expect it to heat up quickly. Keep watching, pay attention to the issues above, and you'll be ready to strike when the time is right. In the meantime, you can read my esteemed colleagues' writing on Pearson, McGraw-Hill, and Wiley.

If you want to read about another company that is changing the rules of the game in its industry, have a look at our free report: "Discover the Next Rule-Breaking Multibagger."

At the time this article was published Fool contributor Sara E. Wright owns no shares in any of the companies mentioned above, but she sure did dump a ton of cash into textbooks in college. The Motley Fool owns shares of Apple and Amazon.com. Motley Fool newsletter services have recommended buying shares of Apple and Amazon.com, and have recommended creating a bull call spread position in Apple.The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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