Educomp Solutions

Shareholders in Educomp Solutions, an education solutions provider, can stay invested with a one-two year horizon considering the company’s strong growth prospects in digital content and product licensing to private schools and strong government order-book for IT enablement of schools.

At Rs 3,591 the stock discounts its likely 2008-09 earnings by about 60 times. This is explained by triple-digit growth rates in its revenues and net profits over the past couple of years and superior margins that Educomp enjoys.

The earnings before tax, interest, tax, depreciation and amortisation (EBITDA) margin of the company for 2007-08 was 47.6 per cent while the net profit margin stood at 26.7 per cent, well above peers. The stock’s valuation is also at a premium to peers such as Everonn Systems and NIIT.

The prospects for Educomp’s key revenue-generating divisions of Smart Class — a high-margin business — and information communication and technology (ICT) — a volumes play — are very promising.

The private schools looking at innovative and effective methods of pedagogical delivery and the government initiative in its schools for increasing ICT infrastructure are key drivers for growth. A recent CLSA report suggests that there are 75,000 private schools accounting for 90 million students. The training and education market size is estimated to be $40 billion currently and is expected to grow at 16 percent annually over the next five years.

Further, wired classrooms are estimated to have a potential of $800 million over the next few years. The union budget has allocated Rs 650 crore towards establishing 6000 model schools in 2008-09.

Together, these statistics indicate that the Smart Class segment and the ICT segment have considerable addressable market and even if a part of it were tapped, would enable Educomp to grow at high rates over the next few years. The professional development division and retail foray that delivers online content to students in India, the US and select countries in the Asia-Pacific region, also hold potential over the medium term.
Smart Class, a key segment

This segment contributes 49 per cent of its revenues (2007-08) and enjoys a whopping 58 per cent PBIT margin. More impressive is the 174 per cent growth in revenues in 2007-08 over the previous year.

This is on the back of triple digit growth in 2006-07. This segment envisages the company building the entire IT infrastructure for its private school clients and design of the digital software content based on curriculum requirements of these schools.

The software content is licensed to the school, which is charged on a per student basis periodically. With content spanning kindergarten to Class 12 across subjects and boards of education, the digital content developed by Educomp caters to a wider category of students, thus keeping more schools interested . So far, the company has managed to win 1,093 schools covering 1.1 million students. This represents a 182 per cent growth in the number of schools over the past year. Most of the deals, which span a five-year period, are based on the BOOT (build-operate-own-transfer) model.

A digital content library has also been developed and, along with IP licences given out to these schools, a sustainable revenue stream is generated, over and above pure IT hardware sales.

With private schools trying to make pedagogy student-friendly and effective, the potential for Educomp’s solutions in this segment continues to be promising over the next few years.
ICT, a volume play

The ICT segment caters to government-run schools and works towards IT-enablement. This segment contributed 36 per cent of its annual revenues last fiscal and has grown 209 per cent over 2006-07.

What drives this segment are the State and Central Government initiatives towards IT infrastructure establishment in schools.

Educomp works with 13 State governments, covering 1,285 schools. The deals are more of the nature of IT-enablement rather than complete solutions. This makes the business more of a volume play for Educomp. With the Budget indicating increased spends on computerising government schools, Educomp, with its existing relationship, may be well-placed to tap into opportunities.
Other forays and inorganic growth

The company also delivers content online to several countries abroad. Here again, the content is tailored to a vast set of students across classes. The online content seeks to simplify content for students. Online tutoring for competitive exams such as the IIT-JEE and PMT has also been started.

The company has formed JVs and acquired majority stakes in several online curriculum and content developers in the US, Singapore and other APAC countries such as Indonesia, Vietnam and Brunei.

JVs have been formed with reputed organisations such as Raffles in Singapore to start model schools in India. The company has acquired a 51 per cent stake in learning.com, to provide e-learning services to students in the US.

The company has also acquired a 50 per cent (to be raised to 74 per cent later) stake in Eurokids, a preschool chain. All these divisions are in the nascent stage and it may be a few years before they significantly contribute to revenues and margins.
Risks

Educomp is required to build the entire IT infrastructure upfront, which requires considerable capital. In a high interest environment, the borrowing costs may increase substantially. With a substantial government clientele, the payment cycles may be longer, expanding working-capital requirements.