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Pearson said it would merge Penguin Books with Bertelsmann's Random House to create the world's leading consumer publisher, a day after Rupert Murdoch's Sunday Times said his News Corp. group could bid for Penguin.
The education and media publisher Pearson said the newly created joint venture, which will bring together writers Ken Follet, Terry Pratchett, EL James and 2012 Nobel prize winner Mo Yan, would be named Penguin Random House.
Bertelsmann will own 53 percent of the venture and nominate five directors to the board, while Pearson would own the rest and nominate four. Both must retain their share in the venture for at least three years.
Analysts said on Monday they would have preferred a bid from a group such as News Corp, which would have brought cash into the company and enabled Pearson to quit a market that has been hit by the rapid growth of the ebook and fierce pricing pressures from supermarkets.
Pearson, however, focused on the benefits of scale and the savings available to the combined group.
"Together, the two publishers will be able to share a large part of their costs, to invest more for their author and reader constituencies and to be more adventurous in trying new models in this exciting, fast-moving world of digital books and digital readers," Pearson Chief Executive Marjorie Scardino said.
Analysts said the deal would also allow Pearson to retain a link between its education division and the world-renowned Penguin brand.
"We can see why Pearson has chosen this option, but there may be some disappointment there is no outright sale, and especially with the lock-in of the stake," Liberum said.
Shares in Pearson were down 0.8 percent at 1,211 pence at 1000 GMT, while the broader London market was down 0.6 percent.
October has been a busy month for Pearson. On the third day of the month Scardino said she would step down at the end of the year after 16 years, prompting analysts to question whether the group would sell off its last remaining media assets and focus wholly on its dominant education arm.
Most analysts, however, had focused on whether Pearson would sell FT Group, which prints the Financial Times newspaper.
Later in the month Pearson said it had bought educational services company Embanet Compass for $650 million in cash to bolster its position in the online market.
Bertelsmann, Europe's biggest media group and owner of European TV broadcaster RTL Group, is also in the middle of an overhaul to catch up with rapidly changing markets.
Random House has had spectacular publishing success with the record-breaking "Fifty Shades" trilogy by EL James, with its English-language imprints selling more than 30 million copies between March and June, with sales evenly divided between the trade paperback and e-book editions.
While Random House is strong in Britain and the United States, Penguin is the world's most famous publishing brand, with a strong presence in fast-growing developing markets.
Both groups have had to invest in the launch of ebooks. Random House says it has expanded its ebook programs to nearly 42,000 titles and substantially increased its digital-publishing offerings.
Penguin ebook revenues rose 33 percent in the first half, contributing almost 20 percent of its revenues.
Analysts say regulatory hurdles could be an issue for the tie-up, but with a joint market share of around 25 percent in the United States and Britain, they expect it will go through.
In 2011, Random House reported revenues of 1.5 billion pounds ($2.4 billion) and operating profit of 161 million pounds. Penguin reported revenues of 1 billion pounds and operating profit of 111 million pounds, with total assets of 1 billion pounds.
Penguin chairman and chief executive John Makinson will be chairman of Penguin Random House. Random House CEO Markus Dohle will take the same role at the new venture.
Showing the challenges facing Pearson, the British-based group also published a trading update, showing sales up 5 percent in the first nine months but operating profit down 5 percent, reflecting the sale of assets, acquisition costs and weakness in the British professional training market.
It reiterated its outlook of growth in sales and profits at constant exchange rates for the full year.