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Educomp Solutions
Scarcity Value No More
Whilst Educomp is taking the right steps towards high quality long
term opportunities such as brick & mortar schools and colleges, the
sustainability of its core Smart_Class business is threatened by
saturation in the premium end of the market and eroding
competitiveness in the mass market. We remain sceptical of the
indicated like-for-like numbers and are worried by falling profitability
until clean numbers emerge.
Educomp has underperformed the BSE500 index by 40% since January 2010
driven by its lack of clarity on clean like-for-like financials and emerging
competitive and regulatory issues. With the business now trading below
historical averages, are all the concerns in the price? We think not.
Key Investment Drivers
Weakening Smart_Class franchise hidden by EduSmart: Educomp’s
Smart_Class business continues to face rising competition and deteriorating
economics due to the saturation of demand in the premium end of the market.
We expect revenues to start declining from FY12 due to these trends. This
business faces a key litmus test when ~300 legacy customers come up for
renewal in FY12 and when clean like-for-like numbers for 3Q and 4QFY11
are published.
EduSmart will continue to need equity infusion from Educomp: Our
analysis (see our Education thematic dated 15 December 2010) highlights
questions around whether EduSmart can be run as a standalone business. Our
estimates point to further equity infusion by Educomp into EduSmart as
EduSmart is likely to be substantially FCF negative (by ~10-13% of the
contract values) in years 2/3/4 of operation. We estimate that EduSmart will
need a further ~Rs1bn equity infusion as its repayments accelerate combined
with the need to pay Educomp. We also note that as per our model
EduSmart’s NPV is negligible, making it unattractive for genuine third party
players to sign such an agreement with Educomp.
Slow ramp-up in K-12 business: Educomp’s K-12 business is running
substantially behind management’s earlier aspiration with just 43 schools
implemented by FY10 compared to 150 earlier indicated. We also find that
some of the schools have less than ideal ramp-ups and substantial revenues
are driven by acquisitions and JVs rather than by organically set up schools.
Valuation, Recommendation and Outlook
Although, Educomp appears superficially attractive at 15x FY11 P/E, its
weakening core businesses, scaling challenges in K-12 and its deteriorating
balance sheet (rising leverage and contingent liabilities) worries us. Our DCFbased
valuation points to a valuation of Rs372, a 31% downside. This implies
an FY12 earnings multiple of 12x.
Educomp is a provider of technology-based education
products and services for kindergarten to twelfth grade
(K-12) education. Educomp provides technology
enabled products and services to both public and
private schools, including Smart_Class, instructional and
computing technology solutions (ICT solutions) and runs
a network of brick and mortar K-12 schools. It has also
diversified into online initiatives (like Mathguru and
Learning Hour), running pre-schools (Eurokids, Roots to
Wings), colleges (Raffles Millenium International) and
vocational training (IndiaCan). However, Smart_Class
remains the core revenue and profit contributor to the
business.
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