Sell Side report on EDUCOMP Solution Ltd

Submitted by

Arun Marik &

Vismaya Agarwal

Indian Institute of

Management, Rohtak

Executive summery

We initiate coverage of Educomp with an accumulate rating and an end-of-the year target

price of INR379.9, that offers a 9.85 % upside from current stock price. Educomp is the

one of the largest company in the Indian educational sector and one of the leading players

in the Indian new age classroom and vocational training market.

After the successful turnaround of its business, and the recent downturn of the world

economies, Educomp’s main growth driver has become K-12 business and smart class

implementation in the Emerging Markets of India and South-Eastern Asia.

Educomp will grow revenues and expand margins on the wake of the

increasing exposure to Emerging Markets: Entry into new ASEAN countries and

launch of new products in India and USA will fuel more than 25% CAGR from 2010 to

2015. EBITDA margin will expand by almost same growth rate because of efficiency

improvements in online training and vocational training operations.

Valuation: Our valuation methods lead to a target price of INR 389 by the end of 2011.

We think Educomp may offer long term upside in case it succeeds in executing its 2010-15

business plan. This year will be crucial for Educomp to prove its ability to succeed in its

internationalization strategy. We evaluated Educomp applying techniques: FCFE and

multiple.

Main risks to our target price are:

Failure to expand into new markets due to unsuccessful product launches

The increase in the level of competition in current markets

Other risks come from lower than expected growth in Emerging Markets

volatility in exchange rates

An expected cap on fees in private institutions

Introduction

Educomp is the one of the largest education companies in India India taking care of the entire

education life-cycle of students. The company currently works with over 26,000 schools and

over 15 million learners and educators across the world. Educomp owns India’s largest K12

content library of rich 3D multimedia educational content modules. The company also operates

over 799 pre-schools, over 56 K12 schools, 7 Raffles Millennium International Design colleges

currently operational, Admissions started for Engineering & PGDM programs in AICTE

approved JRE campus in Greater Noida for August 2011 academic session, 339 vocational

training centres and has over 4.7 million users of its various online education portals: wiziq.com,

mathguru, Learninghour, Learnhub, Studyplaces and educomponline.com. As of July 2011, the

company employed over 15000 people and had 27 offices worldwide.

Educomp was founded in 1994 and is led by Shantanu Prakash.

Educomp mainly focuses on changing educational sector in the country. Mainly two sectors they

are focusing upon:

Mainstream teaching: Giving various technological solution to the teaching and learning

in the classrooms by the smart class or takshila schools they are trying to give a paradigm shift in

the new age educational sector in india. By havng JV with raffles or pearson geoup they are

trying to invent many new techniques and trying to import world class teaching techniques in

Indian classrooms.

Supplemental education solution: Edulgnit, mathguru, Gateforum, learning hours are

few names in the educational solution initiative by educomp. By these kind of forums they are

provoding various study materials, online portals for entrance exams or junior class preparation.

For example wiziq is a famous web platform where teachers and students can teach and learn lie,

online.

International Operations: Ask n Learn: Educomp acquired Singapore-based Ask n

Learn Pte. Ltd. in 2007. Formed in 2000, Ask ‘n’ Learn, is a premier Pan-Asian provider of

Education solutions and services. Ask n Learn currently provides internet-based e-learning

solutions, content and services to over 230 educational institutions across Singapore, China,

Thailand, Philippines, Japan, Brunei and Vietnam. Its customers include over 35% of all

Singapore schools, the National University of Singapore, Singapore Institute of Management,

Ministry of Defence, top regional universities, Ministry of Education (MOE) Singapore, MOE

Brunei as well as international schools. Ask n Learn products include: Learning Management

Systems, E-learning development tools, E-learning content, IT, Multimedia and Video training

services, Pre-school English enrichment franchise, E-learning portal for school-age children,

Professional IT services, Multimedia content development services and School administration

tools.

Learning.com: Educomp acquired US-based Learning.com in May 2008. Learning.com is the

premier provider of Web-delivered curriculum and assessment products as well as online Digital

Learning platform solutions to over 7700 schools, 1550 school districts and 3.2 million students

across the US. Learning.com products include: Sky, Learning.com's unique digital learning

environment, Curriculum products like EasyTeach, Aha!Math, Aha!Science as well as various

Assessment products.

CDEL: Educomp's subsidiary Ask n Learn signed an exclusive licensing agreement with China

Distance Education Holdings Limited, a leading provider of online education in China to

distribute Educomp’s smartclass products in China.

Indian Educational Sector:

Education in India is provided by the public sector as well as the private sector, with control

and funding coming from three levels: federal, state, and local. Child education is compulsory.

With around 26,478 institutions, India has the largest higher education system in the world In terms of

number of institutions.

0

5000

10000

15000

20000

25000

30000

Indian US China

26476

67064000

Currently estimated to be ~INR 46,200 crores(spends in India), and projected to grow at an average rate

of ~18% to over INR 232,500 crores in 10 years.

Main segments: The main four segments in Indian educational sector is getting attractive among

the Indian as well as foreign players. The ecosystem is given below.

Educomp Solutions, Everonn Systems and NIIT, are the largest players within the space. Educomp's

smart class segment constitutes the largest percentage share. In ICT segment, Everonn contributes

major share in terms of revenue growth. NIIT has tied up with various companies for providing training

and skill through e-learning.

46231

106582

232523

0

50000

100000

150000

200000

250000

2010 2015 2020

The report analyzes the Indian education industry with focus on formal and non-formal education

segments. The report also gives an insight into the scope of foreign collaborations in the sector apart

from discussing the key trends, drivers and issues in the market. It profiles the major players with focus

on key strategies adopted by them. Companies in different segment are given below:

The below diagram expresses various educational segments scaled on the basis of (A) Capital

Employment and (B) Competition. Listed companies like Educomp and Everonn have adopted

the strategy of first penetrating segments requiring lesser capital like ICT in Government schools

and multimedia in schools and then using cash flows from these segments to fund their

expansion into high capital employing segments like K 12 and higher education.

58%20%

15%

4% 3%

Educational Sector in IndiaK12

private & professional college

tutoring

vocational training

Key steps taken by Government:

Higher Education in india:

Increased government spending expected to further support the growth of this sector a lot. Some

major steps are: Central govt expenditure on higher education has increased CAGR of 30%

2008-09 to 2009-10 growth was 45%

State govt also increased expenditure significantly on this sector

However we believe, India’s public expenditure as percentage of DGDP is significantly

low in comparison with other countries. That makes a huge opportunity for high eduction

sector.

Educomp changing the scenario in educational business:

The business profile for Educomp is given below:

Smart class implementation: The smart class programme is the highest valuated sector for Educomp we will focus on the

reason behind this vast improvement:

The smart class program enables teachers to use digital content modules developed using

graphics and 3D animation in addition to the traditional chalk & talk methods. This result in

multi-sensory learning for students helped them improve their performance.

Educomp enters into a 5 year contract with the school and provides end-to-end solution which

includes the content library, projectors, digiboards, plasma screens and servers, thus e-enabling

the classroom by making digital content available on demand for teachers to use inside the

classroom. Further content usage in schools is going to be perpetual, hence the same schools will

come back to relicense the content after the initial contract period of 5 years, thus leading to long

term sustainable revenue.

Shift from BOOT model to that of Securitization

Educomp initially provided the smart class package on a BOOT model to schools in order to test

this completely new concept. However now with the concept of smart class planning out well

with private schools, Educomp has adopted a new model. The key highlights of this new model

are:

• Educomp will sell both hardware & content as a package to a third party vendor.

• The third party vendor will install the equipments in schools and also provide services of

installing, commissioning, maintenance and servicing the customer.

• The contract with the schools will be a tripartite agreement which lays down the responsibilities

of Educomp and the third party vendor.

• The third party vendor will securitize revenue streams and pay Educomp upfront for hardware

and content at a discounted rate (75%).

• Effectively Educomp transitions to be a pure content and sales organization with all

implementation and outsourcing now being outsourced.

• Debtors days in Smart Class have reduced from 150 days under the BOOT model to 90 days

under the Securitization model.

• The third party vendor will have to collect money from schools and repay bank loans. The

repayment of bank loans are guaranteed by Educomp (now at 20% from 100% at the start of this

new mechanism).

Financial implications of the Securitization model

• The third party vendor will pay Educomp 75% of the value of a contract upfront i.e. over a two

year period asagainst the earlier 5 year period. Educomp will receive 52.5% (30% hardware &

22.5% content) of contract value in year 1 and 22.5% (entire for content) of contract value in

year 2.

• The lender will have recourse to Educomp’s balance sheet and the securitized amount will

appear as an off balance sheet item on Educomp’s balance sheet. However recently Educomp has

moved to reduce the corporate guarantee to 20%.

• Reduced risk of equity dilution due to upfront receipt of payments.

• This improved cash flow will result in higher investments in the K–12 segment which is highly

capital intensive, but offers operating margins of about 50% once the schools are fully utilized.

ICT becoming stagnant: This is one of the most neglected segments among the educational sector. Most of the ICT

contracts require the vendor to make upfront investments which makes this segment unattractive.

Combined with this, the segmental margins are low at around 18% which seems far lower than

those enjoyed by other segments like smart class and K–12 schools. The company wise

distribution is shown below.

Though it consisted almost 15% of consolidated revenue of educomp, it is expected to go down as

educomp is much interested in lucrative segments like K-12.

School Learning Solutions

77%

Higher Learning Solutions

6%

k12 schools

9%

online, global & supplem

ental8%

Segmental revenue Q4FY11

Smart class, 62%

ICT, 15%

School learning solutions

Smart class

ICT

22%

23%

10%

12%

33%

ICT segment

Educomp

NIIT

Everonn

Compucom

Others

Upcoming K-12: K-12 is the most lucrative among all the segments. Most of the company got theier feet in this

segment.

Root to wings and Eurokids are the two main venture in preschool segment. Under Roots to

Wings, it has 220 franchisees and under EuroKids it has 575 franchisees along with 28 owned

pre-schools.

In high school segment also it is quite visible. Educomp through its subsidiary – Educomp Infra

provides the entire package of education infrastructure to independent trusts running schools.

This comprises of features like – land and building on a 30 year term lease, the Millennium

Learning system, teacher training programs, online content and the Smartclass. Educomp

currently has 50 schools operating under various brand names (Millennium, Takshila, Vidya

Prabhat) and will be adding another 31 schools by FY12.

But some main problems are the problems regarding regulations. Right now, no regulations on

fees are there for private schools. But a cap on the fees might affect the revenues of the company.

Higher learning solutions open new horizon: JV with raffles helped them made new scope in the higher education in india. There are more

than 10 colleges of rafles millennium group. Also with the approval of AICTE they have started

MBA college also.

Also JV with pearson group helped them to explore the vocational training section. The JV aims

at delivering a full span of world class training, assessment and accreditation across a variety of

skills and industries.

Though good visibility is there in the sector there is not much scope of rapid market capture

within 3-4 years. It is expected to be at the same level for the next few years.

Online and supplemental education still on nascent stage:

Learning.com Asknlearn are the two main ventures in the segment. They have almost 96% of the

whole market share. This segment is the main base by which the global exposure for the

company can be possible.

Learning.com is the premier provider of web delivered curriculum and assessment, and partners

with schools and districts throughout the United States of America. AsknLearn is Singapore’s

largest e-learning company which provides web based e-learning solutions, content and services

to over 130 institutions.

But this is still in the investment mode nad it is expected to have the same 8-9% market share

for the next few years.

Valuation

We have valued Educomp on FCFE basis as we feel that changes made in Educomp’s revenue

recognition due to the securitization model leads to frontloading of revenue which in subsequent

years won’t allow us to compare revenue on a year on year basis as the lower number of school

addition in a particular year than the previous year would result in a decline in revenue and

thereby will not allow us to rightly use the Price Earnings to Growth approach. Our price value

for Educomp is at INR 379.9/share. We have assumed a variable growth rate of 25-30% for the

period FY11-16E and . We calculated FCFE on the basis of cost of capital of 8%.

Assumptions:

We have taken the sales growth rate as 25% and 30% n different years. That gave us the

projected sales revenue.

We have taken EBITDA ,EBIT, accounts receivable turnover ratio, inventory turnover

ratio accounts payable on the basis of change in sales. They are projected as the

percentage of the sales.

The depreciation is also taken as the percentage of the sale revenue of the company.

We have taken the tax rate as 35% for the upcoming years.

As per the minority tax is concerned that is taken on the basis of the PBT. The percentage

of PBT is concerned.

We have taken that the number of shares will be the same. As we have seen that there

was a stock split in 2009 so we assumed that there will be no such affairs will be there in

upcoming two years.

Also it is assumed that the company will not take any more debt. So the debt value will

be same for the upcoming years.

The interest rate is taken as a percentage of the total debt.

We have projected important of balance sheet for the calculation part. They are shown below:

(Rs in Crs)

Year Mar

06

Mar

07

Mar

08

Mar

09

Mar

10

Mar 11 Mar 12 Mar 13 Mar 14 Mar 15

SOURCES

OF

FUNDS :

Share

Capital

15.96 15.99 17.25 17.29 19 19 19 19 19 19

Reserves

Total

73.59 98.8 262.9 388.57 1,613.

79

1,908.11 2,249.78 2,759.30 3,321.27 4,110.55

Total

Shareholde

rs Funds

89.55 114.7

9

280.1

5

405.86 1632.7

9

1927.11

07

2268.77

54

2778.29

65

3340.27

27

4129.55

43

Minority

Interest

0.17 12.84 19.36 80.43 191.48 191.48 191.48 191.48 191.48 191.48

Secured

Loans

10.93 18.35 62.23 468.89 692.78 692.78 692.78 692.78 692.78 692.78

Unsecured

Loans

0.04 107.2 315.1

1

420.62 355.05 355.05 355.05 355.05 355.05 355.05

Total

Debt

10.97 125.5

5

377.3

4

889.51 1,239.

31

1,239.31 1,239.31 1,239.31 1,239.31 1,239.31

Total

Liabilities

100.6

9

253.1

8

676.8

5

1390.2

6

2,872.

10

3,166.42 3,508.09 4,017.61 4,579.58 5,368.86

Current Liabilities and Provisions

Current Liabilities

7.56 18.51

60 199.5 229.34

337.83 439.18 439.18 548.98 823.47

Provisions 11.43

14.91

9.24 25.55 167.27

270.27 351.35 439.18 548.98 658.78

Total Current Liabilities

18.99

33.42

69.24

225.05

396.61

608.10165

790.53215

878.36905

1097.9613

1482.2478

(Rs in

Crs)

Year Mar

06(12

)

Mar

07(12

)

Mar

08(12

)

Mar

09(12

)

Mar

10(12)

March

11(12)

E

March

12(12) E

March

13(12) E

March

14(12) E

March

15(12) E

INCOM

E :

Sales

Revenue

55.52 110.0

8

286.0

8

637.0

6

1,039.

49

1351.3

4

1756.74 2195.92 2744.90 3293.88

EBITDA 28.49 57.44 146.0

1

329.1 613.25 810.80 1054.04 1317.55 1646.94 1976.33

Interest 0.81 2.1 6.47 30.18 58.98 61.9655

61.9655 61.9655 61.9655 61.9655

Depreciation

5.63 9.59 33.13 81.44 114.23 135.1337

175.67381

219.5922625

274.4903281

329.3883938

Profit Before Tax

22.05 45.75 106.41

217.48

440.04 540.5348

614.858335

878.36905

960.7161484

1317.553575

Total

Tax

7.73 16.64 34.51 75.59 158.42 189.187

18

215.200

4173

307.429

1675

336.250

652

461.143

7513

Net Profit

14.32 29.11 71.9 141.89 281.62 351.34762

399.6579178

570.9398825

624.4654965

856.4098238

Minority Interest(after tax)

0.09 0.12 0.3 6.85 5.75 7.0269524

7.993158355

11.41879765

12.48930993

17.12819648

Net Profit after Minority Interest

13.91 28.68 70.56 132.89 275.86 344.32 391.66 559.52 611.98 839.28

Extraordinary Items

0 0 -0.01 -0.02 49.05 50 50 50 50 50

Adjusted Net Profit

13.91 28.68 70.57 132.91 226.81 294.32 341.66 509.52 561.98 789.28

Number of shares (10 crs)

1.63647059

1.630471859

1.743083

1.73871516

9.66234676

9.66234676

9.66234676

9.66234676

9.66234676

9.66234676

EPS before Minority Interest (Unit Curr.)

8.56 17.66 40.9 80.84 29.15 36.36255547

41.36240684

59.08915263

64.62876069

88.63372895

EPS after Minority Interest (Unit Curr.)

8.5 17.59 40.48 76.43 28.55 35.63530436

40.53515871

57.90736958

63.33618548

86.86105437

Calculation of working capital is also shown here:

(Rs in

Crs)

Year Mar

06

Mar

07

Mar

08

Mar

09

Mar

10

Mar 11

E

Mar 12

E

Mar 13

E

Mar 14

E

Mar 15

E

Sales

Revenue

55.52 110.08 286.08 637.06 1,039.4

9

1351.3

4

1756.7

4

2195.9

2

2744.9

0

3293.8

8

Cash free

current

asset

Inventori

es

1.74 3.29 1.82 31.61 36.78 37.022

93

48.129

81

60.162

26

75.202

83

90.243

4

Sundry

Debtors

25.51 49.63 115.69 276.51 552.97 740.45

86

962.59

62

1203.2

45

1504.0

57

1804.8

68

27.25 52.92 117.51 308.12 589.75 777.48

16

1010.7

26

1263.4

08

1579.2

59

1895.1

11

Debt less

current

liabilities

Current

Liabilitie

s

7.56 18.51 60 199.5 229.34 337.83

43

439.18

45

439.18

45

548.98

07

823.47

1

Provisio

ns

11.43 14.91 9.24 25.55 167.27 270.26

74

351.34

76

439.18

45

548.98

07

658.77

68

18.99 33.42 69.24 225.05 396.61 608.10

17

790.53

21

878.36

91

1097.9

61

1482.2

48

Net

working

capital

8.26 19.5 48.27 83.07 193.14 169.37

99

220.19

39

385.03

85

481.29

81

412.86

35

Change

in

working

capital

-11.24 -28.77 -34.8 -110.07 23.760

09

-50.814 -

164.84

5

-

96.259

6

68.434

57

Ratios

Account

recievabl

e

167.70

8

164.56

17

147.60

5

158.42

49

194.16

64

200 200 200 200 200

turnover

days of

inventori

es

11.439

12

10.908

88

2.3220

78

18.110

77

12.914

7

10 10 10 10 10

Current

liabilities

% of

sales

13.62% 16.82% 20.97% 31.32% 22.06% 25.00% 25.00% 20.00% 20.00% 25.00%

provision

% of

sales

20.59% 13.54% 3.23% 4.01% 16.09% 20.00% 20.00% 20.00% 20.00% 20.00%

After the calculation we used the FCFE method to get the net present value which will help us to

get the share price.

Year Mar

06(12

)

Mar

07(12

)

Mar

08(12)

Mar

09(12

)

Mar

10(12)

Marc

h

11(12)

E

March

12(12) E

March

13(12) E

March

14(12) E

March

15(12) E

Net

income

13.91 28.68 70.57 132.9

1

226.81 294.32 341.66 509.52 561.98 789.28

Depreciat

ion

5.63 9.59 33.13 81.44 114.23 135.13

37

175.6738

1

219.5922

625

274.4903

281

329.3883

938

interst(1-

tax)

0.526

5

1.365 4.2055 19.61

7

38.337 40.277

58

40.27757

5

40.27757

5

40.27757

5

40.27757

5

incrase in

working

capital

-

11.24

-28.77 -34.8 -

110.07

23.760

09

-

50.81397

349

-

164.8446

025

-

96.25962

192

68.43457

496

Capex 80.67 241.52 536.8 841.65 -

1365.0

1

175.6738

1

219.5922

625

274.4903

281

329.3883

938

20.06

65

131.5

45

378.19

55

805.5

67

1331.0

97

-

919.03

4

784.1039

279

1153.827

787

1247.494

04

1419.901

415

NPV - $3,713.11

The value we got is 384.29 INR which is 11% higher than the market stock price. The P/E

calculated is almost 12. As the educational sector P/E is close to 30 so the company is

undervalued. In that respect value should be the multiple of P/E of industry and EPS. That value

is 12.08* 30= 362.4

Method

weight assigned Value(INR)

FCFE 80% 384.29

Multiple 20% 362.4

actual value 379.912

Conclusion

TP INR 379.9 with further upside potential in the medium term. We estimate a year-end

target price of €2.65 (table 13), that has been obtained from a weighted average of the prices

resulting from our FCFE and our Multiple Analysis. Weights are 80% and 20% respectively. We

assign a lower weight to the Multiple Analysis because of the inherent difficulties in finding a

group of close comparable to Educomp as we explained above. In our opinion Educomp offers

further upside potential in the medium term, as long as the growth strategy in emerging markets

proves to be successful. We believe that the market is still not fully discounting the growth

potential from online training, but we also understand that there is an elevated degreeof risk in

executing this strategy. 2011 results and business updates will be of particular importance to

show that Educomp is able to deliver on growth through product line expansion, especially with

regards to India.