2023-06-20 00:46:00 ET
Summary
- PSO's shares have underperformed on both an absolute and relative basis in 2023 year-to-date, and this is largely attributable to the perceived threat of generative AI.
- AI represents both a risk and an opportunity for Pearson.
- I continue to have a Hold rating assigned to PSO; my view of Pearson is mixed, as it is too early to determine how AI could affect the company's prospects.
Elevator Pitch
My investment rating for Pearson plc ( PSO ) stock is a Hold. With my prior August 9, 2022 write-up , I touched on Pearson's post-COVID recovery progress and PSO's efforts to move more aggressively into digital learning.
In this latest article, my focus is on PSO's recent stock price underperformance and how this is linked to the rise of generative AI (Artificial Intelligence). My analysis leads me to the conclusion that there are both opportunities and threats for PSO relating to generative AI. In my view, it is premature to assess whether AI will be a boon or bane for Pearson, which explains my Hold rating for the stock.
PSO's Share Price Underperformance
Pearson's shares have declined by -6.2% year-to-date, which compares unfavorably with the S&P 500's +15.3% rise in 2023 thus far.
In particular, it is worth noting that PSO's share price dropped by -14.6% on May 2, 2023 before rebounding by +11.0% on the subsequent trading day, May 3, 2023. On May 2 this year, Chegg, Inc. ( CHGG ) saw its stock price fall by -48.4% . Seeking Alpha News reported on the same day that CHGG "warned that ChatGPT had a negative impact on new customer growth beginning in March with student interest spiking in the new AI tool." Chegg refers to itself as a "connected learning platform" in its media releases .
A May 6, 2023 Seeking Alpha News article cited comments from BofA ( BAC ) analysts noting that "the AI read-across (from CHGG) to Pearson was overly harsh." It is quite clear that PSO's shares have underperformed on May 2 this year and 2023 year-to-date due to concerns regarding disruption risks relating to the rise of generative AI.
Worries About The Threat Of AI
On May 9, 2023, Pearson issued a press release noting that the company has a "diverse business model" with "businesses outside of higher education" accounting for "the majority of profits (80%)." On the surface, it seems like PSO is much less exposed to the disruption threat than Chegg because of a reasonably low revenue contribution from higher education (20%).
But Pearson+, a key growth driver for PSO, could still be negatively affected by an increase in students utilizing AI chatbots and other tools associated with generative AI. In my earlier October 12, 2021 update for PSO, I have referred to Pearson+ as a "new digital college textbook platform" which could help the company "grab market share back from the secondhand textbook market" and "cross-sell its other digital products to students."
At the company's May 9, 2023 analyst meeting centered around generative AI, one of the attendees highlighted "the risk that students use piracy for content and ChatGPT for study services instead of subscribing to Pearson+." In response, PSO emphasized that "Pearson+ is about helping you learn and improve your knowledge and skills and practice", rather than "answering or helping you answer those particular questions" like AI chatbots.
Nevertheless, there is a real possibility of Pearson+ suffering from lower-than-expected subscription rates and revenue due to the growing popularity of AI chatbots among students. A smaller-than-expected subscriber base will also in turn weaken the cross-selling potential of Pearson+.
In broader terms, there is also a concern that Pearson won't be allocating sufficient capital to new initiatives to either mitigate the risk of disruption from AI or take advantage of related opportunities. PSO mentioned at its analyst event on May 9 that it won't offer "any specific numbers in terms of investment around AI", because AI has already been "embedded in what we do for a period of time." Furthermore, Pearson stressed that it has "the ability, skills, and the knowledge to manage this (the rise of generative AI) within the existing operating budget."
It is natural to be concerned that PSO might be too conservative and overly cautious when it comes to formulating its AI strategy. In my opinion, most investors might have preferred that Pearson guides for an increase in AI-related investment in specific quantitative terms to ease the market's fears.
AI Also Throws Up New Opportunities
In the previous section, I discussed about how AI could be a threat for Pearson. In this section, I focus on potential opportunities for PSO in the area of AI.
With respect to potential revenue upside, there are opportunities for Pearson to incorporate AI into its current products and services. In its May 9, 2023 press release, PSO disclosed that it has introduced "AI based open response assessments" and "proprietary predictive algorithms (to generate advice)" for the company's English Language Learning and Workforce Skills offerings, respectively. Assuming that these new AI-powered features gain resonance with Pearson's users, this might help to boost PSO's top line.
Separately, AI could have a positive impact on Pearson's future profitability. PSO shared at its May 9 analyst meeting that it is constantly "looking at ways to further increase efficiency and drive margin improvement", and acknowledged "the role of AI in terms of creating efficiency" in areas like "engineering" and "coding."
As an illustration of the positive financial impact of AI on companies in general, McKinsey published a research study titled "The Economic Potential Of Generative AI: The Next Productivity Frontier." Specifically, McKinsey found that there are a significant number of "generative AI use cases" which "could deliver total value in the range of $2.6 trillion to $4.4 trillion in economic benefits" every year.
Concluding Thoughts
It is in Pearson's hands to determine whether AI will have a positive or negative impact on its business operations in the future. If PSO can take an active role in leveraging AI to improve its top line and bottom line, the company should be able to thrive in the new age of generative AI. But assuming that Pearson is too conservative and takes a long time to adapt to changes brought about AI, there is a reasonably high risk of PSO being disrupted. I am staying on the sidelines with a Hold rating for Pearson, as I watch how PSO reacts and responds to new AI developments.
For further details see:
Pearson: AI In The Limelight