Premium on education?

IPO REVIEW

Online education provider Educomp Solutions' seems to have a good business model and its public issue looks fairly valued

While education is not a commodity, there is no disputing the fact that it has become good business. Given the government's increasing focus on bridging the digital divide, corporates are increasingly looking at the segment as a potential growth opportunity.

Delhi-based Educomp Solutions, one of the leading providers of technology-enabled education solutions and services for K12 (kindergarten to class 12) schools is entering the capital markets with a 100 per cent book building IPO of 40 lakh equity shares of Rs 10 each.

The price band for the issue has been fixed from Rs 110 to Rs 125 per equity share. On an FY05 EPS 0f Rs 5.29 (post issue of bonus shares and preferential allotment), the issue is valued at a P/E of 20-23x.

Given the size of the education market and the growth potential, the issue is fairly priced, say analysts. Educomp has registered a growth of over 25 per cent over the last few years.

The company plans to deploy the proceeds from the IPO for funding the capex required for its Smart_Class project, education infrastructure projects executed under the BOOT (build, operate, own and transfer) model, content development facility in Bangalore and the facility in New Delhi for online tutoring project.

Educomp also plans to invest in US subsidiary towards enhancement of sales and marketing and funding the proposed M&A activities.

Educomp Solutions, set up in 1994, is in the business of providing digital contents & IT education to schools, online tutoring, professional development, retailing of educational & games CD-ROMS, and providing ERP solutions to schools. Educomp employs 900 professionals and has presence in 27 locations across the country and has a fully-owned subsidiary in the US.

The company enters into a contract, usually for 3-4 years, with a school wherein it provides an end-to-end solution. It is also responsible for setting-up the infrastructure in the school required to run the Smart_Class.

The schools make payment for the whole package usually on a quarterly basis over the tenure of the contract. In India most of the schools do not have computers in classrooms and the schools do not have enough resources to make upfront investments in setting up such infrastructure.

Thus, Educomp's business model helps the schools to set-up infrastructure without having to invest upfront. The main risks to its business model is payment defaults by schools, apart from risk of piracy.

Analysts are bullish on the prospects of the education market in India. Also with the government pushing hard on the education policy front, companies like Educomp are expected to benefit in a big way. India is one of the largest education markets in the world in terms of the number of students.

Overall there are over 10,00,000 schools in India with over 202 million students enrolled. The number of privately run schools in India are over 30,000. The government spends more than 14 per cent of its total expenditure on education. Analysts also note that the thrust on technological literacy is a core objective of India's education policy.

Over the next year Educomp's major focus area will be expansion of its global business with a focus on the world's largest education market, the United States of America. According to estimates, the US market has a K12 content spend of over $10.2 billion (as of 2004), an online tutoring market spend of over $4 billion and an assessment market spend of $2 billion.

Though the potential sounds impressive, analysts have a different view on the US scenario. They note that the US market is highly competitive with the presence of large dominant players.

Thus the company may find it difficult to establish a foothold in US markets. The company failed to record any revenues from US in FY05. One advantage going for the company is the price advantage that it enjoys over its US competitors.

Educomp clocked revenues of Rs 29.18 crore in FY05 and Rs 5.35 crore in the second quarter of FY06. Net profit surged 332 per cent to Rs 6.32 crore in FY05, on the back of an expansion in operating margins from 24.8 per cent to 42.97 per cent.
 

FINANCIALS
(In Rs crore)	FY05	FY04	% Change	Q2FY06
Operational income	29.81	24.75	20.44	5.35
Other income	2.29	1.26	-	0.09
Operating profit	12.81	5.96	114.93	2.42
OPM (%)	42.97	24.08	-	45.23
Net profit	6.32	1.46	332.88	0.80
Net margin	21.2	5.90	-	14.95
EPS (Rs)	5.29	4.00	-	1.36
P/E@Rs 110		20.79
P/E@Rs 125		23.63

Total expenses went down 9.53 per cent during the year, mainly due to a 50 per cent reduction in cost of goods sold. ICT solutions segment accounted for 44 per cent of the company's FY05 revenues, while professional development segment accounted for nearly 35 per cent. Educomp is looking to increase total turnover to Rs 51 crore, in FY06.

At the lower end of the price band the stock commands a P/E of 20.79. Though there are no comparable peers as it has a unique business model, the leading player online education segment, NIIT is ruling at P/Es of 28x.

Issue closes: December 22, 2005