Educomp Reiterate Buy

India

Educomp Solutions

IT, Education

CMP: Rs.2820

Reiterate: Buy Target: Rs.3800

With target price of Rs 3800 based on 35x FY10E EPS — We are initiating coverage on Educomp with Buy. At a price of 3800 company will be trading at 54.1x FY09 Earnings 35x FY10E EPS and 24x FY11E earnings. Company trades at trailing PEG to ratio of .5 for FY09, this ratio will decline further to .4 based on current prices.

Priced on 18th June, 2009 ±% potential

35%

Our last call on Educomp was in January, where we initiated a buy call on the stock at CMP 1715 with a target of 2750. Earlier in 2008 stock price fell by a huge percentage in 2008 due to rumors regarding company’s accounting policies.

Market Data Beta 52Wk hi/lo

1.2 4029/1342

Marketcap, INR Crore

5397

Shares in issue (mn.) Reuters

17.3mn EDSO.BO

Bloomberg

EDSL.IB

Share Holding Pattern (%) Promoters FII Domestic Inst. & Corp Body. Public & Others

Company has given detailed clarifications on these allegations and same can be found on the company website.

55% 40%

From the operations point Educomp has continued to deliver strong earnings and exponential growth, 40% CAGR in both revenues and Net income, is estimated for next four years.

Industry Potential India has emerged as one of the world’s largest consumer of education services with a target population of more than 445 millions, with public and private spending on educational services in India aggregating approximately $100 billion per annum. Spending on Education in private sector has grown by CAGR of 10.4% since 1994, double the 5.11% CAGR on total spending. Government spending on education has reached 4% of GDP and is expected to rise further as India focuses on reducing its literacy rates.

2% 3%

Company description Educomp Solutions Ltd, formerly Educomp Datamatics Limited, was incorporated in 1994 and is based in New Delhi, India. It is India's largest educational service provider mainly focused on the K-12 space. Educomp group serves over 19,000 schools and 9.4 million learners and educators across the world. Company operates private schools across various cities and also partners with various state governments. It has 27 offices worldwide. In addition, the Company operates through its various subsidiaries including author GEN, Three brix eServices, Learning.com, USA, AsknLearn Pte Ltd, Singapore and via its associates such as Savvica in Canada.

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Buy Educomp Solutions The company has three primary business segments: Meanwhile, the use of Smartclass has grown from 90 private schools in 2006 to 1,730 now,

1.

a bit below expectation of 1,800 by March 09.

2.

For FY09 segment revenue for Smart Class grew by 146% at Rs. 314 Crore contributing 63% of revenues, with margins at 59%, up 110bps and PBIT up 150% at Rs. 185 crores.

Revenue share from Smart Class business has been continuously increasing and has gone up to reach a level a 63%.Considering higher growth for the division compared to the entire company. Its share of revenues can increase further to 70%.

Smart Class business has contributes 76% of Company’s Operating Margins and going forward, on standalone basis, contribution of Smart Class will increase to 80%, excluding inorganic growth through acquisitions.

Figure 1:

Segmental Revenues Smart Class ICT Solutions Professional Development Retail and Consulting

FY07 44% 28%

FY08 49% 35%

FY09 63% 23%

17%

10%

6%

11%

6%

8%

3.

Licensing of tools that help existing education system to move to a higher standard of delivery. Direct Intervention – running schools, pre-schools and tutoring classes, online delivery etc. Post K-12 initiatives such as vocational and professional education.

Educomp's main business is developing and licensing digital lessons, which are uploaded onto servers and provided to schools. It also trains teachers (75,000 in the last quarter), provides vocational training to students with courses such as accounting and marketing, and offers online and in-person tutoring. It runs eight K-12 schools. It has joined up in January with New Delhi real estate developer Ansal Properties & Infrastructure to start 25 private schools in new townships. It aims to start 150 schools over the next three years. Educomp's big money-maker is Smartclass, a range of interactive digital lessons with animation and graphics that's marketed mainly to private schools as they have deeper pockets than public schools. The multimedia lessons-- 16,000 so far--are based on the different curricula in place across the country and use 12 of the country's languages.

Description

Segment

SmartTM Class

Highly animated Instructor-led content for schools delivered inside the classroom as a "teachers aid"

Private Schools

ICT Solutions

Educational Infrastructure and digital content to bridge the digital divide in government Schools

Government Schools

Professional Development

Technology aided learning Pedagogy & Cognitive learning workshops for teachers

Private and Government Schools

eTutoring TM Mathguru

Online portal for students of Mathematics

Learning Hour

Retail online eTutoring on all curricular subjects and test prep

Roots to TM Wings

Neighborhood schools for Kindergarten-aged children

Millennium TM Schools

Brick and Mortar Kindergarten to Grade 12 Schools

Product/ Service

Grades 6 to 12 (NCERT Books) US/ India / Middle East Kindergarten aged children K-12

Source: Company Reports

Fairwealth Securities

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Buy Educomp Solutions

this business more than 50%

Smart Class: This is the multimedia education business of Educomp catering to Private schools. Company charges upwards of 3000 Rs. Per student per month from each school. Company keeps infrastructure (multimedia content) on its books and transfers the content at the end of the contract.

On the school addition targets, Educomp

Company added 258 schools in Smart Class in 4Q09 taking cumulative number of schools to 1737. Cumulative number of students under smart class has increased to 1.98 million. Company doesn’t have any major competitors and we expect strong revenue growth of 50%+ for next three years and margins to stay above 55% for this business. This segment will continue to remain main driver of business for the Company. Company has projected that number of Schools will reach 2800-2900 by FY10E, resulting in 60% growth.

Smart Class: Company has covered 27 cities with total plan of 80 cities. EBIT margins for

closed the year with 12012 schools in ICT in line with the wide guidance of 12000 – 15000.

Margins for the ICT business settled at 20% for the quarter as against 31% in corresponding 4

th

last year. Margin deceleration was very

much expected however sharp fall has lead to downward revisions. We estimate margins for the business to settle at 15% post FY 2011 as against 20% anticipated earlier.

Educomp achieved growth rate of 700% on its education portal Mathguru.com on paying customers. Subsequently in last quarter Math Guru portal has been made free for all customers.

Margins for retail business improved from 41% to 71%.

ICT Solutions: This is computer literacy initiative funded by Union/ State Governments. Company manages and installs labs in public schools and bills to government. Highlight of this business is long term contracts (5-year). However, it results to high debtor days of around 180 days. Company added 2042 schools in 4Q09, revenue growth of 2% Y-o-Y, and taking cumulative number of schools to 12000. Margins have fallen sharply by 1000bps and will continue to fall to settle at around 15%. Number of states covered till now is 14. This business is likely to face major competition from several regional and national players forcing the margins down. This segment will witness high top line but lower bottom line growth as revenues are likely to grow at more than 35% for period FY09-FY11 but margins are expected to decline further to around 15% post FY11. Higher revenue share of this business would hinder company in reducing its working capital requirements down to below 120 days. When company attains steady state (post FY12) this business will constitute less than 15% EBITDA share of the company. Professional Development: Company trained 90000+ teachers in 4Q09 which is less than 7% of its total 1.4 million teachers. Revenues for the segment for 4Q09 increased by 12%( Y-o-Y). Margins for this business shall continue to remain high (above 60%). Revenue growth for this business will remain around 20%. Retail and Consulting: Company is putting a lot of stress on its retail business growth by focusing on both organic and inorganic channels. Company’s online education portal MathGuru has witnessed ~700% growth rate. Company is growing its Preschool portfolio (Root to Wings) by expanding through franchisee. Company bought 50% stake in Euro kids taking preschool number under its umbrella to 500. This business will continue to see lot of inorganic growth as company explores new ways to enter retail markets.

Key Developments during Q4 FY09

Fairwealth Securities

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Buy Educomp Solutions

Received financial closure for Rs 725cr of debt for its K-12 business.

Debtor days for company have come down from 179 days to 145 days.

K-12 Initiatives: Under this company will operate and manage entire schools and provide access to all its intellectual property. Total of 11 schools with 14000+ students have been established in 9 cities. Company targets 24 schools under K-12 initiatives this year. Company has already received financial closure for Rs 725 cr of debt including - Non-Convertible Debentures (Rs 100cr), out of which 250 crore has already been utilized. Company has planned 140 million of capital expenditure per school and expects EBIT of Rs. 45 million (at 60% margins) per year per school. This segment will see around 100% growth rate over FY09-FY12 and margins will remain above 60%. In steady state (FY14) this business will constitute more than 15% of the revenues and with negative debtor days of the company.

Results Analysis and Outlook Smart Class

Revenues

Smart Class ICT Solutions Professional Dev. Retail & Consulting Total PBIT Smart Class ICT Solutions Professional Dev. Retail & Consulting Total PBIT margins(%age)

Q4 FY 09

Q4 FY 08

Var. (%)

111

50

120

56

55

2

7

7

12

10

7

49

184

118

56

Q4 FY 09

Q4 FY 08

Var. (%)

Smart Class revenues grew by 120% contributing 60% of Net income with PBIT witnessing growth of 102 bps at 62.5 crores. Margins for the business stood at 57.2% down 420 bps. For full year revenues were 314 crores up 146% from FY08. Margins of 59.1 % improved 110 bps resulting in PBIT of 185.6 crores. ICT Business For FY09, the segment revenues grew 22% at Rs 113.42 Crore contributing 23% of the revenues with PBIT margins of 23.2% down 600bps and PBIT was down 4% at Rs 26.28 Crore. FY10E FY09 FY08 Var. (%) Sales

63

31

105

11

16

-34

OPM (%) OP Other income

5

4

-2

7

4

77

PL

55

Q4 FY 09

39 Q4 FY 08

PBIDT Interest

833

497

262

50

54

48

90

416

268

125

115

15

10

12

-17

431

278

137

103

25

12

4

175

PBDT

406

267

133

100

Depreciation

110

75

32

132

PBT before EO

296

191

101

90 208

Forex gain/Loss - FCCB

Smart Class

-

-7

-2

57

62

PBT after EO

ICT Solutions Professional Dev. Retail & Consulting Total

296

199

103

93

19

30

Tax Provision

97.

70

33

114

61

64

PAT

198

128

70

83

54

EPS (Rs)

109

70

38

26

39

73

-23 41.6

Fairwealth Securities

46.6

P/E

Page 4

Buy Educomp Solutions Analysis of Ratios: Company’s Debt Equity Ratio has increased significantly from 0.11 in 2006 to 1. 7 in 2009. Company has already made financial closure of secured debt for capital expenditure requirement for K-12 business up to the year 2011. Company’ Interest coverage ratio remains comfortable as most of the debt of the company is in the form of FCCB maturing in 2012. Company had high inventory turnover ratio as company has built up inventory of installing computers for its SmartClass and ICT business.

Ratios: Profitability Ratios % Operating Profit Margin

Mar-08

Mar-07

Mar-06

48.2

48.12

50.58

Gross Profit Margin

35.87

39.31

40.44

Net Profit Margin

25.51

25.54

25.89

Turnover Ratios Inventory Turnover Ratio Debtor Turnover Ratio

185.88

32.75

30.1

2.29

2.16

2.08

1.27

1.67

2.76

Current Ratio

5.41

4.5

5.33

Debt Equity Ratio Interest Covering Ratio

1.28

1.09

0 .11

21.69

25.81

37.13

Fixed Asset Turnover Ratio Solvency Ratio

Figure : Revenue & EBIDTA mar. Estimates

Future Outlook Company is poised to continue perform exceeding well with more than 70% revenue growth for the period FY09-FY11 and margins to stay above 45%. Net Profits are expected to rise 4 fold from Rs.700 million in 2008 to 2800 million in FY11 giving a CAGR of 58%.

Price Earning to Growth Rate Source: Fairwealth Securities Analyst Estimate PAT

High growth rate period is expected to continue to the middle of next decade, Educomp can well become blue chip Company of the future.

EPS P/E @ 2900 Profit Growth Rate(%age) PE/Growth ratio

FY07

FY08

FY09

28

70

128

FY10E 198

38 76 150%

70 41 71%

108 27 65%

0.51

0.50

0.41

Ideal Price Earning to Growth rate for a high growth company should be between 0.8 and 1, which easily justifies a 100% price appreciation form these levels.

Fairwealth Securities

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Buy Educomp Solutions

Growth Outlook Company is likely to post very high growth rate for a long time. Revenue figures are expected to show a CAGR of 70% for the period 2009-2011, 35% for the period 20112014 and 20% for the period 2014-2016. We forecast strong 50% CAGR in Net Profits over FY09-FY11E and see limited risks to the estimates given. Company has forward P/E of for FY-2011 on constant prices while growth rate is expected to be upwards of 30% for year FY11-FY14. Company will continue to shine even in downturn as spending on Education and price levels are highly resilient to economic downturns.

Segmental Revenues Smart Class ICT Solutions Professional Development Retail and Consulting K-12

FY09E 60% 23% 7%

FY10E 65% 17% 5%

FY11E 68% 12% 3%

10%

8%

10%

0%

5%

5%

Source: Fairwealth Securities Analyst Estimates Smart Class’s Contribution to Revenues and Profits will increase substantially while ICT business contribution will decrease.

Another positive for this company is its short payback period on its investment as significant business comes from long term contracts of 5 years.

Company understands its strengths and challenges ahead to deal with these challenges. Company has recognized four areas of opportunities/ strengths as under:

1. Large market opportunity(scale) 2. Create barriers of entry for other players through strong IP and product differentiation. 3. High operating margins (50%+) 4. Experience and ability to execute

Risks:  

  

Due to high margins and nature of business, company might face competition from new entrants. Company is in high growth phase; PEG (P/E to Growth) ratio will be an important consideration for the stock. Any disappointment on Earnings Growth numbers will see a sharp downward price movement. For FY09 margins for the sectors decreased substantially however strong revenue growth in Smart Class business, improved overall margins for Company, which will ot be the case going forward. Free cash flows to remain negative for a while; if credit market tightens or company fails to deliver on expectation, raising fresh funds will be a problem. If government reduces spending on education, earnings and growth potential are likely to taper down. Company faces huge execution risks in its Edu-Infra business. Also company has been very aggressive in its growth plans, both Organic and Inorganic, and it would be very difficult to manage such growth plans under unforeseen circumstances (E.g.-Key Man Risk, Death of MD/Promoter)

Fairwealth Securities

Page 6

Buy Educomp Solutions

Previous year Financials Statements (Balance Sheet, Income Statement and Cash Flow Statement) Figure Balance sheet(All figures in millions) Shareholders’ funds

FY06 160 736 895 2

FY07 160 988 1148 128

FY08 172 2629 2884 194

Secured loans Unsecured Loans Deferred Tax Liability Total source of funds Fixed assets

109 0 1021

183 1071 60 2590

622 3150 210 7061

Gross block Net Block Capital work in progress Total Investments Goodwill Current assets, loans and advances

375 185 67 252 21

949 723 108 831 102

2890 2342 372 2714 36

1

138

282

Inventories Sundry Debtors Cash Loans and Advances Total Current assets, loans and advances

17 260 609 49 935

Less current liabilities and provisions Net current assets Total Applications

187 748 1021

33 496 1106 110 1761 242 1519 2590

18 1157 2912 490 4639 610 4029 7061

Share capital Reserves and surplus Net worth Minority interests Loan funds

Company Debtor days are high, as both ICT and Smart class segment revenue collection starts post 90 days. It is around 120 days for Smart Class and more than 150 days for ICT. These will take time to reduce as K-12 and retail business are just beginning to pick up. Post FY15, we expect debtor days to come to around 100 days from 150 days presently.

For Q4 FY09 Debtor days are at 175 – 180 days up from 170 days in the sequential quarter.

Income Statement

Company’s debt equity ratio for FY09 stands at around 1.7, higher than 1.3 last year. Going forward Debt Equity ratio will decrease to around 1.2 as debt of USD 80 will get converted in to Equity which will also help company in raising cheaper debt in future.

Fairwealth Securities

Rs million Sales Other Income Total Cost of goods sold Personnel Expenses Admin & Other Expenses Total Expenditure EBITDA Depreciation EBIT Finance Charges PBT Total Taxes Profit after tax and before prior period items Balance bought from previous year Amount Available for App Balance Carried to Reserves EPS

FY06 555 14 569 95 91 100 286 269 57 212 6 220 79 141 115.2 254 220 11

FY07 1065 59 1124 304 105 155 564 501 93 408 14 453 170 283 229 512 455 18

FY08 2620 150 2770 798 338 238 1374 1246 322 924 42 1032 330 702 455 1157 1035 41

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Buy Educomp Solutions

Cash Flow Statement(All figures in millions)

On consolidated basis, Cash & Cash Equivalents at the end of the quarter of Rs 186.5 Crore and debt of Rs 907.4 Crore. Debtor days are at 175 – 180 days up from 170 days in the sequential quarter.

Key Cash Flow Statement Data

FY06

FY07

FY08

Net Income (Reported)

141

284

711

Depreciation & Amortization

56

96

331

Change in Working Capital

-60

(225)

(730)

Deferred Taxation Charge

The Company plans to sell both content and hardware together. The Company plans to approach financial institutions for securitization of receivables and finally outsource resource coordinators and logistics. The model would reduce the cash burden on the Company and lighten its working capital needs.

NA

NA

Other Adjustments, Net

0

10

193

Cash Flow from Operations

137

165

505

Purchase of Fixed Assets

-162

(675)

(2,224)

Purchase of investments

-50

-389

-16

Net Cash used in Investing activities

-212

-719

-2102

Shares Issue / (Repurchase) Proceeds/ repayment of borrowing

557

0

0

53

71

334

1094

3109

long

term

FCCB Raised Temporary Overdraft facility against fixed deposits

75

3

106

Net cash from financing activities

615

1088

3393

Source: Company reports

TECHNICAL OUTLOOK EDUCOMP

Source:IRIS Educomp is in a long term bullish trend .However the stock is in a short term correction & may touch 2800-2600 levels .this price should be used as a buying opportunity in the stock for a price Target of 3800-4000 in next 5-6 months.

Fairwealth Securities

Page 8

Buy Educomp Solutions

Why Buy: Valuations at 33x FY09, 22x FY2010E and 16x FY2011E. Growth rate from FY11-FY16 at 20%. EBITDA margins for 4QFY09 excluding extraordinary foreign exchange losses were around 60%. Although Company has only 180 crores of cash and a debt of 910 crores, we expect there could be a bonus issue as well as Split as Company has a very small share capital of only 18.3 Crore. With company’s extensive database and competitive edge in Global Education industry in the K-12 segment, there lies unlimited potential to expand geographically to emerging and undeveloped nations. Although we have not included any future growth into countries like, China, MENA (Middle East and North Africa) , we believe potential is immense and exponential growth period of this company might extend to next decade.

Disclaimer: This publication has been prepared solely for information purpose and does not constitute a solicitation to any person to buy or sell a security. While the information contained therein has been obtained from sources believed to be reliable, investors are advised to satisfy themselves before making Any investments. Fairwealth Sec Pvt Ltd., does not bear any responsibility for the authentication of the information contained in The reports and consequently, is not liable for any decisions taken based on the same. Further, Fairwealth Research Reports only provide information Updates and analysis. All opinion for buying and selling are available to investors when they are registered clients of Fairwealth Investment Advisory Services. As a matter of practice, Fairwealth refrains from publishing any individual names with its reports. As per SEBI requirements it is stated that, Fairwealth Sec Pvt Ltd., and/or individuals thereof may have positions in securities referred herein and may make purchases or sale Thereof while this report is in circulation.

Fairwealth Securities

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