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In a transition phase
Educomp Solutions (Educomp), a diversified education
solutions provider, is an established player in an
attractive space. We like its strategy of seeking
leadership in its space, its presence through the entire
education value chain and strong partnerships.
However, going forward, we see challenges in
maintaining the growth momentum in the school
learning solutions (SLS) segment (76% of revenue). We
believe the company is entering a transition phase
where growth in the SLS segment is set to slow down
and its higher education business is expected to take
time to scale-up, impacting overall financial
performance. We initiate coverage with a Sell rating and
a target price of Rs425.
SLS segment witnessing slower growth: Growth has
slowed in the SLS segment, which accounts for 76% of
Educomp’s revenue, pulling down the company’s overall
growth rate. The smart class segment (part of SLS) faces
increased competition that could restrict realization per
classroom. Also, in the case of the Information and
Communication Technology (ICT) business, the
management plans to adopt selective bidding to improve
profitability. Though many contracts are coming up for
renewal in these two businesses the company may not
secure all the orders due to stiff competition.
K-12 and higher education to take time to scale-up:
While the K-12 segment is capital intensive and has a longer
gestation period, it ensures recurring revenue to the
company. We like the formal education space considering
the shortage of quality institutions in the country. However,
it will take time to scale-up this business.
Upside potential limited: We believe concerns over lower
growth, subsidiaries in investment phase and contingent
liability from the new smart class model are priced in the
current stock price. However, as most of the revenue is from
non-recurring businesses, the company would have to
better its performance every year to grow. The higher
education business will take time to scale-up. Hence, we
believe the company is entering a transition phase. We
initiate coverage with a Sell rating and target price of Rs425.
Our net profit for FY12E/FY13E is 6%/8% lower than
consensus mainly due to lower EBITDA margin assumption.
Key Risks: Key upside risks to our earnings would be
higher-than-expected growth in the smart class segment,
faster ramp-up in higher education business and reduction
in contingent liabilities due to the new smart class model.
Valuation Analysis
Limited upside potential
We initiate coverage on Educomp with a Sell rating and target price of Rs425, implying 12.3x
FY12E and 10.0x FY13E earnings estimates. Our main premise for the Sell rating is companyspecific
and not relating to macro issues. We are very optimistic on the Indian education space
and Educomp’s diversified presence in each sub-segment and strong partnership/tie-ups.
However, there are certain business model related challenges which are making us skeptical on
growth prospects of the company for a couple of years and the creation of contingent liability as
Educomp provides bank guarantee for smart class sales. From a clarity standpoint, we need more
insights on Edusmart model and its profitability, and the status on consolidation with Educomp
once IFRS practice is adopted by the company. Our net profit estimates for FY12E and FY13E are
lower than consensus by 6% and 8% respectively mainly due to our lower EBITDA margin
assumptions. Our lower margin assumption stems from the fact that higher education business
and online, supplemental business are in investment mode and would take time to expand
margin.
P/E and EV/EBITDA based valuation is not the right parameter as the stock has witnessed serious
de-rating on account of broader market correction and corporate governance-related issues
which cropped up in 2008 and later from 2009 onwards due to changes in business model of
smart class which is not understood in toto by market participants. The changes in the model
happened in the segment which had the highest weightage on overall revenues. Hence, we have
used DCF as the methodology as we feel that this would capture profitability as well as value
emerging from businesses such as K-12 which is recurring in nature.
Exhibit 12: DCF Assumptions
WACC 12.3%
Cost of Equity (Ke) 8.6%
Risk free rate 8.0%
Market Return 15.0%
Beta 1.15
Cost of Debt 12%
Weighted Cost of Debt (Kd) 3.7%
Terminal Growth Rate 3%
PV of Cash Flow till FY21E (Rsmn) 8,337
Terminal Value (Rsmn) 92,220
PV of Terminal Value (Rsmn) 28,878
Firm Value (Rsmn) 59,006
Less: Net Debt (Rsmn) 5,307
Less: Contingent liability (Rsmn) 8,200
Equity Value (Rsmn) 42,871
Price/Share (Rs) 425
Source: Centrum Research Estimates
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
In a transition phase
Educomp Solutions (Educomp), a diversified education
solutions provider, is an established player in an
attractive space. We like its strategy of seeking
leadership in its space, its presence through the entire
education value chain and strong partnerships.
However, going forward, we see challenges in
maintaining the growth momentum in the school
learning solutions (SLS) segment (76% of revenue). We
believe the company is entering a transition phase
where growth in the SLS segment is set to slow down
and its higher education business is expected to take
time to scale-up, impacting overall financial
performance. We initiate coverage with a Sell rating and
a target price of Rs425.
SLS segment witnessing slower growth: Growth has
slowed in the SLS segment, which accounts for 76% of
Educomp’s revenue, pulling down the company’s overall
growth rate. The smart class segment (part of SLS) faces
increased competition that could restrict realization per
classroom. Also, in the case of the Information and
Communication Technology (ICT) business, the
management plans to adopt selective bidding to improve
profitability. Though many contracts are coming up for
renewal in these two businesses the company may not
secure all the orders due to stiff competition.
K-12 and higher education to take time to scale-up:
While the K-12 segment is capital intensive and has a longer
gestation period, it ensures recurring revenue to the
company. We like the formal education space considering
the shortage of quality institutions in the country. However,
it will take time to scale-up this business.
Upside potential limited: We believe concerns over lower
growth, subsidiaries in investment phase and contingent
liability from the new smart class model are priced in the
current stock price. However, as most of the revenue is from
non-recurring businesses, the company would have to
better its performance every year to grow. The higher
education business will take time to scale-up. Hence, we
believe the company is entering a transition phase. We
initiate coverage with a Sell rating and target price of Rs425.
Our net profit for FY12E/FY13E is 6%/8% lower than
consensus mainly due to lower EBITDA margin assumption.
Key Risks: Key upside risks to our earnings would be
higher-than-expected growth in the smart class segment,
faster ramp-up in higher education business and reduction
in contingent liabilities due to the new smart class model.
Valuation Analysis
Limited upside potential
We initiate coverage on Educomp with a Sell rating and target price of Rs425, implying 12.3x
FY12E and 10.0x FY13E earnings estimates. Our main premise for the Sell rating is companyspecific
and not relating to macro issues. We are very optimistic on the Indian education space
and Educomp’s diversified presence in each sub-segment and strong partnership/tie-ups.
However, there are certain business model related challenges which are making us skeptical on
growth prospects of the company for a couple of years and the creation of contingent liability as
Educomp provides bank guarantee for smart class sales. From a clarity standpoint, we need more
insights on Edusmart model and its profitability, and the status on consolidation with Educomp
once IFRS practice is adopted by the company. Our net profit estimates for FY12E and FY13E are
lower than consensus by 6% and 8% respectively mainly due to our lower EBITDA margin
assumptions. Our lower margin assumption stems from the fact that higher education business
and online, supplemental business are in investment mode and would take time to expand
margin.
P/E and EV/EBITDA based valuation is not the right parameter as the stock has witnessed serious
de-rating on account of broader market correction and corporate governance-related issues
which cropped up in 2008 and later from 2009 onwards due to changes in business model of
smart class which is not understood in toto by market participants. The changes in the model
happened in the segment which had the highest weightage on overall revenues. Hence, we have
used DCF as the methodology as we feel that this would capture profitability as well as value
emerging from businesses such as K-12 which is recurring in nature.
Exhibit 12: DCF Assumptions
WACC 12.3%
Cost of Equity (Ke) 8.6%
Risk free rate 8.0%
Market Return 15.0%
Beta 1.15
Cost of Debt 12%
Weighted Cost of Debt (Kd) 3.7%
Terminal Growth Rate 3%
PV of Cash Flow till FY21E (Rsmn) 8,337
Terminal Value (Rsmn) 92,220
PV of Terminal Value (Rsmn) 28,878
Firm Value (Rsmn) 59,006
Less: Net Debt (Rsmn) 5,307
Less: Contingent liability (Rsmn) 8,200
Equity Value (Rsmn) 42,871
Price/Share (Rs) 425
Source: Centrum Research Estimates
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