A major source of pressure on Elsevier is the decline in university library budgets. The global recession caused widespread reductions in the spending of both public and private universities, and there is little indication that library budgets will resume rates of increase seen in recent decades. Additionally, the political climate in the United States is becoming more hostile to public research and education: Republican state legislatures have made aggressive moves in recent years to slash public university budgets, resulting in the closing of entire departments and university presses and increased pressure on library budgets. It has even become de rigueur to ridicule public spending on research and medicine, with anecdotes appearing in GOP presidential campaign speeches in the last two cycles. The climate of fiscal austerity, in short, is unfavorable for any company that depends on well-funded public academic institutions.

Industry analysts are also already highlighting better value in other publishing companies. A February note from Macquarie identified better value in peers like Thomson Reuters, UBM, and Informa, while an April 2012 report from GlobalData flagged the possibility of the Elsevier division losing market share to Thomson, Wolters Kluwer, and in other businesses to Pearson, Dow Jones, and McGraw-Hill. Standard & Poor's recently reaffirmed a sell rating on the company.

Elsevier's upside potential looks capped, since there is no room for top-line expansion given tight university library budgets, and no room for cost-cutting in an industry where the labor of academic researchers, editors, and peer reviewers is provided, literally, for free. Critics note that even the functions provided by Elsevier - journal layout and reviewer coordination - are often outsourced or poorly performed. For some journals, even layout is handled gratis by academics, who submit their articles pre-formatted according to provided LaTeX templates.

We regard the common stock as an implicit naked short put option because, while the upside potential from the publishing division is limited, the downside risk from any revolt by its customers (libraries), laborers (academics), or funders (governments) is not. Elsevier's substantial profit margin has persisted for as long as it has partly because of the lack of awareness and the apathy among stakeholders; those factors are changing.

Open Access, Radicalized

The old publishing model made some sense in a world where expensive print distribution was needed. As the internet made electronic distribution the norm, journal publishers fought to keep prices high even as their costs declined. The open access movement advocated, instead, for passing the savings and simplicity of online distribution on to the academic community. Over the last decade, public opposition to the old model was periodic and sparse, usually limited to a few outspoken professors, librarians, or journal editors.

Social media and improving technology have allowed opposition to rent-seeking by publishers to become more coordinated and widespread. The public relations disaster and boycott triggered by the Research Works Act (RWA) provides an excellent example. In 2005, the U.S. National Institutes of Health (NIH) introduced a widely-praised policy ensuring that the public could access any published research that had been made possible by NIH funding. In December 2011, Representatives Darrell Issa (R-CA) and Carolyn Maloney (D-NY) introduced a bill, the RWA, designed to ban open-access mandates for publicly funded research. The Research Works Act would have prohibited the NIH policy and any others like it from being instituted by any federal agency.

Alarm regarding the Research Works Act quickly spread among the online academic community, and in early 2012 more than ten thousand academics signed a boycott of Reed Elsevier ( "The Cost of Knowledge"), promising not to edit, referee, or publish in Elsevier journals until "radical changes" were made to the publisher's business model. The boycott garnered attention from many major media outlets. When Elsevier promptly pulled its support from the RWA, its representatives in Congress -- Issa and Maloney -- announced hours later that they would not push for action on the legislation. It was later learned that Elsevier had made numerous donations totaling $29,000 to the 2012 campaigns of friendly politicians including especially Issa and Maloney ( The Guardian). Instead of being content to fight a rear-guard action, open access advocates went on the offensive by pushing for the Federal Research Public Access Act ( FRPAA), a bill that would extend the NIH access mandate to every federal agency. In addition to the FRPAA legislation, a campaign sprang up to seek the help of the White House. access2research was founded by Michael Carroll, a law professor at American University and a founding member of Creative Commons, John Wilbanks, a senior fellow at the Kauffman Foundation for entrepreneurship, Heather Josef, Executive Director of the Scholarly Publishing and Academic Resources Coalition (SPARC), and Mike Rossner, Executive Director of the Rockefeller University Press. The four open access advocates met recently with John Holdren, Director of the White House Office of Science and Technology Policy. The meeting was less than The campaign asks open access supporters to sign a White House "We the People" petition---petitions garnering 25,000 signatures are promised a response from the administration.

Opposition is not limited to individual researchers and online coalitions. There is mounting evidence that university libraries and faculties are also finding their voices. In April, 2012, the Harvard University faculty advisory council instructed the faculty and graduate students of the university to pursue several steps to shift university funds and focus away from for-profit scholarly publishers, including shifting their own submissions to open access journals, resigning from the editorial boards of journals that would not permit open access or low-cost subscriptions, "moving prestige" toward open access journals, and several other steps. ( Harvard University) A few weeks later, the mathematics department of the Technical University of Munich announced that it had cancelled subscriptions to all Elsevier journals, citing unsustainable subscription prices. In May, Winston Hide, an editor of a top Elsevier-published biomedical research journal, stepped down from his post, citing the publisher's unwillingness to grant access to researchers in developing countries. ( Times Higher Education) Inspired by the move, another editor of an Elsevier journal, Bart Knols, resigned from his position days later to embrace the open access movement. The Wellcome Trust, a major charitable organization in the U.K., recently announced an open access policy for the research it funds, and the British government asked Wikipedia founder Jimmy Wales to help develop an open access policy for all taxpayer-funded research. Finally, the Horizon 2020 framework, an ¿80 billion research funding framework for the European Union, will apparently feature significant new policies mandating open access for publicly-funded research. Elsevier denied reports that it had made concerted lobbying efforts to strike open access language from the policy proposals.

Beyond the concrete policy proposals, the fight to make taxpayer-funded research available to taxpayers is radicalizing young academics who were previously content to ignore the issue. One activist, a principal investigator at a research lab at a major university who manages the Twitter account @fakeelsevier and writes at http://fakeelsevier.wordpress.com/, described himself as previously apathetic about access issues. But the effort to stop the RWA radicalized him and many of his peers, he said: it coincided with the campaign to stop SOPA and PIPA legislation, tying the open access movement into the already well-established net neutrality campaign online. The proposal of the Research Works Act was not just a public relations misstep, he said, but a watershed moment that granted new life to the open access movement. The researcher offered a succinct choice to Elsevier and similar publishers in a recent post: "Adapt, or be disintermediated."

Open Access, Sustained

The best argument that the company has put forward to defend their business model is that, in exchange for all of the free labor that makes the business so profitable, Elsevier provides academics with the "high-impact" journal brands that committees want to see on the CVs of tenure applicants. Until recently, the only response from the open access movement was to point out that rentier capitalism is unjust. Today, the best response is that high-impact open access journals exist as a viable alternative to the old model.

Open access publishing is typically divided into two methods. "Green" open access consists of databases and websites where authors archive their papers for free access by the public. Examples include arXiv in the physical sciences, SSRN for social sciences, philpapers for philosophy, and RePEc for economics. Archived articles are usually either reprints of work already published in traditional journals or final drafts completed just prior to publication. "Gold" open access publishing involves full access to the public, right on a traditional publisher's website, often paid for by the article authors. The Public Library of Science (PLoS), founded in 2000, has become an influential gold open access provider. Article publishing costs are typically paid by the institutions or foundations sponsoring the research, and those costs range from $1350-$2900 per article; PLoS offers a fee waiver for authors who do not have the funds to cover publication fees. PLoS attained profitability in 2010. "Public Library of Science is a non-profit organization," says Wilbanks, "but they are making revenues hand over fist. PLoS One went from nothing to become the largest journal by volume in the world three years." Another gold open access model has been successfully demonstrated by the Rockefeller University Press, which voluntarily opens access to its journals after a 6-month embargo (half the time of the NIH access mandate) and yet remains profitable. Executive Director Mike Rossner, one of the access2research founders, notes that institutional libraries are still willing to pay for current research and that switching to a rolling 6-month current access package has not reduced Rockefeller's revenues.

BioMed Central, another open access startup founded in 2000, had established annual revenues in the range of $15-20M when it was purchased in 2008 by Springer Science+Business Media, the second-largest scientific, technical, and medical publisher and Elsevier's closest competitor. Other open access publishers like Frontiers Media and Nature Publishing Group have followed the gold OA model. Wilbanks takes the success of PLoS and the profitable exit of BioMed Central to be signs that the first wave of open access startup models is complete, such that "now we are seeing real experimental business models, competition between open access publishers, and the big guys laying their bets." But where Springer and other major traditional publishers are either buying up open access publishers or developing their own models in-house, Elsevier seems trapped within its current configuration. "Elsevier reminds me of Microsoft during the antitrust lawsuits over the integration of Internet Explorer into Windows...they knew they would have to unbundle Internet Explorer from the operating system, but it was not in their interest to give up a day early." Wilbanks describes the research and development capabilities that Elsevier has by virtue of its size, its user data, and its profitability as unique in the world, but acknowledges that, given its profit margins, it is understandable why the company would not pursue R&D that might undermine its own position.

Elsevier's position, however, is giving an advantage to Nature and to Springer. Brand is still important in the online space, and the reason the Cost of Knowledge boycott is only targeted against Elsevier is that it alone has taken an oppositional approach - its competitors have all embraced alternative and evolutionary business models. Where Elsevier lobbies regulators and attempts to buy favorable legislation, publishers like BioMed actually urge support for the open access petition.

The financial community is taking notice. In March of this year, ING downgraded Reed Elsevier from a buy rating to a hold, citing increased expected capital expenditures, decreasing market share in the legal division, and the success of the open access movement: "Some open source titles have been achieving impressive citation share. For example, PloS Biology now achieves the highest citation share in its subject....Open source is likely to act as a negative pressure on pricing, or at least on price inflation, in the journal market. As a result, we have nudged down our organic growth estimate for Elsevier between 2014 and 2016 to 3% from 4%." Macquarie analysts noted in February that the boycott was indicative of a larger, more threatening trend: " L ooking forward for Reed Elsevier, we believe this petition raises the specter again of what technology tends to do to pricing: it makes business models more transparent, and it reduces pricing overall." They pointed in particular to downward trends in both revenue growth and operating margins for the Elsevier and legal divisions. Claudio Aspesi, the senior analyst for European media at Sanford Bernstein, has said that there is no open access model that would allow Elsevier to maintain its current profit margins, and has actually called for the company to break itself up.
Source: Macquarie Capital
Organic Revenue Growth and Operating Margins are Declining

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