Educomp Solutions Ltd's stock price movement post the company's announcement of Q4 & FY'2013 results suggests that the ship is sinking rapidly & everyone needs to get out. But I am of the opinion that the worst period in Educomp's history ended at the end of Q3-FY'13. Almost all the troubles for Educomp Solutions are connected to it's SmartClass business. As I have mentioned in my previous reports on Educomp, the troubles started when the company changed the business model for SMartClass. During the Q3-FY'13 result concall, the company's management announced that they are returning back to the BOOT model for SmartClass and this I think is the end of the troubles for the company. This shift back to the BOOT model will lead to increased transparency, improved & consistant Cash-flows and will be liked by most of Educomp's Institutional Investors.
But there are a few Very Important points that Investors need to keep in mind while evaluating Educomp's result post Q3-FY'13. (1) Eventhough Educomp is selling SmartClass Equipment+Content at a price of around Rs.3.70 lakhs per classroom, the Cash-flows will be spread over the term of the Contract with the school. i.e. When Educomp signs up with a school to equip 10 of it's classrooms with SmartClass at a price of Rs.3.70 lakhs per classroom for a period of 5 years, the contract value of Rs.37 lakhs is received by Educomp in 60 Monthly installments of about Rs.62,000 each or 20 Quarterly installments of Rs.1.85 lakhs each. (2) Educomp needs to Invest it's Capital upfront in purchasing Equipment that needs to be installed in those 10 classrooms. The Equipment cost is somewhere around Rs.1 lakh per classroom. That means, Educomp needs to Invest atleast Rs.10 lakhs at the start of the contract and it will take about 6 quarters of payments to recover it's Investments in Hardware. From the 7th Quarter onwards, the money it receives can be considered as towards it's Multimedia Content, i.e. Intellectual Property. (3) Each new classroom addition under SMartClass adds Rs.18,500 to Educomp's quarterly Cash-flows. Until the Q3-FY'2013, Educomp had almost ZERO classrooms under BOOT model, hence there was not recurring Cash-flows from SmartClass until then. Most of the 6500 classrooms that Educomp has added in Q3 & Q4 can be assumed to be added under the BOOT model. In just 2 quarters,
Educomp's recurring quarterly cash-flow from SmartClass BOOT has crossed the Rs.12 crores mark. I know this figure is very small currently compared to the SmartClass revenue Educomp was reporting on a quarterly basis. Remember, SmartClass is already active in over 1 lakh classrooms as of now, out of which 85,000 classrooms were added in the last 3 years alone. We can expect Educomp to add about 20,000 new classrooms to SmartClass BOOT every year from FY'14 onwards. This will add Rs.37 crores to Educomp's Quarterly Cash-flows every year. Apart from that, there will be renewal of contracts coming up for classrooms where SMartClass was implemented 5 years ago. So we can expect Educomp's SMartClass BOOT revenues to cross the Rs.100 crores quarterly rate in the next 2 years. For the 85000 classrooms that Educomp has added in the last 3 years, Educomp is earning a small trail revenue of about Rs.5,200 per classroom per quarter. This amounts to about Rs.45 crores per quarter for 2 more years after which it will taper off. This revenue will help keep the SmartClass revenue to a respectable figure until the BOOT revenues themselves reach the levels of it's past.
As per my estimates, SmartClass revenues are expected to be low at less than Rs.350 crores for FY'14, but will keep improving substantially with every passing quarter & should be closer to Rs.500 crores for FY'15 and over Rs.650 crores for FY'16. But the biggest positive part is that the EBITDA margins are expected to be much stronger right from FY'14 onwards at levels of over 35%. To arrive at these estimates, I have assumed an addition of 17500 classrooms in FY'14 and a 10% Y-o-Y growth in further years, with pricing remaining around the Rs.3.80 lakhs per classroom mark.
The expected drop in SmartClass revenue for FY'14 by over Rs.100 crores seems to have spiked the market, which has pushed the stock to a series of Lower-Circuits. But there are so many positives that are being ignored at the same time. SmartClass is no more a solo product that Educomp will be offering the thousands of schools it already has tie-ups with. Educomp has launched the SmartClass tablet solution as well as the English Mentor language Lab. Both these products have the potential to become part of hundreds of schools in the very first year. Both the products can offer subscription-type recurring revenues to Educomp. We will get more details on the pricing of these products at the end of the current quarter. On the conservative side, I am expecting these 2 products to add between 20 to 30% incremental revenues to SmartClass revenues in FY'14, i.e. in the range of Rs.60 crores to 100 crores. This could bridge most of the expected drop in SmartClass revenues in FY'14 compared to FY'13.
The other big positives are: Educomp's other three business segments are growing at a good pace. (1) There are over 23,000 students in Educomp's 51 operational schools and another 8000+ students in nearly 225 pre-schools. In it's ConCall, the management has said that they will be adding atleast another 6000 students to it's Schools & is confident of posting a 25% growth in K-12 revenues in FY'14. I think this should be easy. The bigger positive in this is that as more & more schools mature in terms of period of operations, the profits margins are expected to improve. For FY'14 the K-12 division should be reporting a revenue figure of over Rs.240 crores & EBIT of about Rs.120 crores. This 25% growth can continue for the next 4-5 years as the number of students in each school fills up the capacity in stages. The students number in Educomp's schools will cross the 50,000 mark in the next 3 years. (2) The business segment of Educomp to report the strongest growth in FY'13 was the Online & Supplemental, which reported a growth of 56% Y-o-Y & now contributes nearly 25% of Educomp's Total revenues. Since the company is still investing in expanding it's reach & capacity, this business reported an EBIT Loss. But some of the divisions in this business have posted a break-even by the end of FY'13 and the company has shut-down a couple of loss-making slow-growth divisions. So even this segment is expected to post a turnaround with a small EBIT profit in FY'14. On the conservative side we can expect the revenues from this segment to grow by atleast 30% to touch the Rs.400 crores mark from Rs.305 crores in FY'13. Even if this segment manages to bring it's EBIT Loss down to Zero, it will boost Educomp's consolidated profitability by 2 to 3%. (3) Educomp's Higher Learning division, which comprises of 7 Colleges which conduct Undergrad courses in Design as well as Engineering, posted a decent growth of 25% in it's revenues for FY'13. This growth is expected to repeat in FY'14 as well because all these 7 colleges will induct a new batch of students for the new academic year as the existing students continue into the next year of the course. This division's EBIT loss reduced by 20% in FY'13 and is expected to drop another 40% in FY'14 as the incremental revenues will not be accompanied with proportionate increase in operating costs.
Summary: Following are my expectations for FY'14:
The School Learning Solutions division, which includes SmartClass, ICT & the 2 new product launches: SmartClass tablet & English Mentor, is expected to post a Total revenue of about Rs.525 crores with an EBIT of about Rs.150 crores.
The K-12 Division, which includes Schools & the pre-schools, is expected to report a total revenue of about Rs.240 crores & an EBIT of Rs.120 crores.
The Online & Supplemental division, which includes units like Vidyamandir, Gate Forum, WizIQ, Learning.com, etc., is expected to post a revenue of close to Rs.400 crores and Zero EBIT.
The Higher Learning division, which includes the 7 colleges, is expected to post a revenue of close to Rs.100 crores and an EBIT Loss of about Rs.18 crores.
Educomp Solutions Total Income for FY'14 is expected to be in the region of Rs.1300 to 1350 crores on the conservative side, with an EBIT of about Rs.250 crores. Educomp's Net Profit or Loss will then depend on the company's Interest Cost. For FY'13, Educomp's total Interest cost was Rs.249 crores. With Improving Cash-flows from most of Educomp's Business divisions, coupled with lower CAPEX in FY'14, Educomp should be able to contain it's Net Debt to current levels of about Rs.1950 crores or maybe bring it down by Rs.100 crores by the end of FY'14. In any case I am not expecting Educomp's annual Interest cost to be any much lower than Rs.250 crores. Hence there will hardly be any Net Profit for FY'14. But FY'15 will be a far better year, when I am expecting Educomp to post it's highest ever annual Total Income figure of well over Rs.1600 crores and an EBIT of around Rs.400 crores and a Net Profit of over Rs.100 crores. By then Educomp's Net Debt is expected to be down to around Rs.1500 crores, which will bring down it's Interest burden leading to boost in Net Profit margin.
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