Until now, whenever positive or negative news or opinions have been flashed about Educomp, most of the limelight has been hogged by Educomp's SmartClass business. The last 2-3 years have been particularly bad for Educomp's stock because the SmartClass business has gone through two changes in business models & is now back to the original BOOT model. But most analysts or news-makers have ignored the developments of?Educomp's K-12 business, the business which comprises offering education right from Kindergarten to 12th Std, i.e. Junior College level. Educomp has smartly invested in building this K-12 business over the last 4-5 years & it is still a nascent business as there is a long way to go before it reaches it's true potential.
As investors we need to understand the operational limitations to analyse it's potential growth in the coming years. Whenever an organisation / trust / group / corporate opens a new school, as per regulations, it is permitted to start with only upto 5th Std in the first year and then add one higher Std in each following year. That means, if Educomp started a school in the year 2009 with classes from 1st to 5th Std, then added 6th Std in 2010, 7th Std in 2011, 8th Std in 2012 and so on, it will be only in the year 2016 that the school will be fully operational with all classes from 1st to 12th Std. Not just that. Whenever a new School starts, it does not get enough students to fill up 100% capacity of the available classes. The school starts with about 20% to 30% of average capacity utilisation in the available classes with maximum new admissions happening for the 1st Std & lower numbers for 2nd Std to 5th Std. With each passing year, it's average capacity utilisation goes up 10% to 20% as more & more students join the school in the existing classes. That means it will take atleast 5 years to reach capacity utilisation of between 70% to 100% in classes from 1st to 5th Std that the school originally started with. By the end of 5 years, the batch of students that had joined the school in 5th Std in the first year of operations, which must have been a very small batch of students, will have moved up to 9th Std. Hence, even at the end of 5 years of the school's operations, the capacity utilisation in classes from 6th Std and above will be well under 50%.?It will take another 4 to 5 years, i.e. a total of about 10 years from the year the school started operations. for the capacity utilisation of the entire school crossing the 70% mark & getting closer to 100% level of the total available seats in the entire school.
Most schools are planned with minimum capacity of 100 students per Std, comprising of 2 divisions of 50 students each for each Std. So, in the first year of operations, the school starts with just about 100 to 200 students, spread over the first 5 classes (i.e. an average batch size of just about 30 to 50 students) and adds about 100 to 150 new students with every passing year as a new batch of students is added and a few students join higher classes. In about 5 years of operations, the number of students in the school will have reached between 600 to 750 (i.e. an average batch size of 60 to 80), which will be about 50% of the total capacity of 1200 students (12 Stds x 100 students per Std).
With about 50% of the school's operating cost being Fixed Cost, i.e. it will remain more-or-less same irrespective of the number of students in the school, and the remaining 50% of the operating cost being dependent on the number of students in the different classes of the school, the school's profit margins are generally very low or maybe negative in the first couple of years of operations. But the margins improve rapidly as the student number builds up with every passing year. Educomp's management has indicated that a school earns an EBIT margin of just about 5% to 20% in the first couple of years of operations, but the EBIT margins improve rapidly to levels of over 50% by the time the school completes 5 years of operations. ( EBIT stands for Earnings Before Interest & Tax ).?Because of the Interest Cost, a new school will be in Net Loss in the first 2-3 years of operations, and start generating decent levels of Net Profit only from the 5th year onwards.?
At the end of FY'13, Educomp had 51 operational school with over 23000 students, i.e. an average of about 450 students per school, i.e. the average age must about 2 to 3 years. The management has already said that they will be adding atleast 6000 new students to these 51 schools plus a couple of new schools that could get operational for the new academic year, which will take the average to over 500 students per school. Apart from these, Educomp had over 8500 students in it's pre-school division, which operates under the brand name "Little Millenium". Most of the students completing the pre-school years will shift to one of Educomp's schools.?Educomp's K-12 division earned about Rs.190 crores revenue from the 32,000 students in total, translating into an average annual revenue of about Rs.50,000 per student.
So what is the potential of Educomp's K-12 business??Educomp has plans to have more than 90 schools operational by the end of FY'16 or 17. To be on the safer side, let's say they manage to get only 75 schools operational by the end of FY'16. Assuming that each school will have a minimum capacity of 1200 students (when fully operational), Educomp's 75 schools will have a total minimum capacity of 90,000 students. The average age of all 75 schools by then will be about 4 years. That means the overall capacity utilisation will be about 50%, i.e. a total student strength of about 45,000. This is nearly double of the current student number of little over 23,000 (excluding those from the pre-schools). The management has already mentioned that they will be adding over 6,000 students this academic year, i.e. Educomp will have over 29,000 students in their schools by the end of FY'14. With new schools opening during these 3 years, Educomp should be easily be able to add another 15,000 to 17,000 students in FY'15 & FY'16 together, which should take the total student number to 45,000 or more.?This near doubling of students in Educomp schools alone should help take the company's revenues from K-12 segment to between Rs.350 to 400 crores in FY'16, with an EBIT of close to Rs.200 crores and possibly a Net Profit of about Rs.30 crores.?By then debt levels of the K-12 business also would have started coming down at a good pace as the incremental CAPEX then will be low & the company can use the Cash Profit generated towards debt repayment, which will help bring down the annual interest cost & improvement in Net Profit margins.
Remember that the revenues received by a school in terms of course fee are recurring in nature as most of the students taking admission into a school generally remain with the school until they pass out all classes. So a student entering the school in the 1st Std will generally leave the school only after completing 12th Std, i.e. the school will receive fees from that student for 12 years. This recurring & predictability nature of the revenues of school deserve much higher valuations than in normal case.
Between FY'16 to FY'20 or FY'21, even if Educomp does not add any new school, the company's K-12 business can still double it's revenues on the back of increased capacity utilisation in existing schools. Even if Educomp has only about 75 schools operational in FY'20, it could be having close to 90,000 students, generating about Rs.700 crores in revenues, Rs.400 crores in EBIT and nearly Rs.250 crores in Net Profit.?Educomp's K-12 business alone could be commanding a valuation in excess of Rs.5000 crores by FY'20, i.e. a potential per share value of close to Rs.250/- (even after leaving a scope of 30% further equity dilution from now till FY'20).?
Point to Note: Educomp's K-12 business will still remain smaller than it's SMartClass business. By FY'20, i.e. 7 years from now, SmartClass could be active in over 2,50,000 classrooms, could be running via cloud-solutions, and generating well in excess of Rs.1500 crores in annual recurring revenues.
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