Educomp Solutions - Views post Q3-FY'15 result

First lets discuss Educomp's upfront Q3 numbers, then we will go to finer details. Educomp's Q3 results are mixed upfront. Sales revenue is down from Rs.130 crores to Rs.124 crores Q-o-Q, but Total Income has increased from Rs.151 crores to Rs.154 crores, mainly because of higher Other Income at Rs.30 crores compared to Rs.21 crores in Q2. The Sales revenue is lower mainly because of School Learning segment's contribution dropping from Rs.56 crores to Rs.42 crores, partially compensated by higher contribution from Online Supplemental segment where revenues increased from Rs.54 crores to Rs.62 crores, despite absence of Gateforum from Educomp's fold. That means Online Supplemental business has pleasantly surprised me, while School Learning segment has disappointed.

My guess is that Educomp has started billing most of it's SmartClass customers only for the Content, while the hardware is being paid for by the Schools upfront. What makes my guess stronger is the sharp drop in Educomp's Total Expenses (excluding Interest & Depreciation) from Rs.161 crores to Rs.128 crores. This is fabulous and I hope going forward Educomp moves towards 100% additions on this model of billing only for Content and Schools pay for hardware upfront, possibly through a third-party vendor. This will boost profitability going forward. Earlier Educomp used to charge around Rs.5000-5500 per classroom per month under a 5-year contract for Hardware+Content deal. I am estimating that under Only Content contract, Educomp could be charging about Rs.3000-3500 per classroom per month for a Contract of same duration, valuing each contract at about Rs. 2 lakhs per classroom over a 5-year term. That means an addition of every 1000 classrooms adds about Rs.20 crores to Educomp's Topline, but it is currently recognised in 20 quarterly installments.

Coming to the Other Income part, it generally comprises of Income from investments or Profit from sale of assets, etc. But incase of Educomp, some portion of the Other Income is possibly coming from recoveries of receivables which the company had previously written-off. This will get confirmed if the trend of healthy Other Income figure continues in the coming quarters. Educomp has written-off around Rs.1200 crores worth of receivables or assets in the last 3 quarters. Even if Educomp manages to recover 20% to 30% of this amount over the next 2 years will be very good for the company's results in future quarters. As at March'2014, Educomp's Capital Reserves figure stood at around Rs.2200 crores. In the first 3 quarters of this fiscal, Educomp's Total Net Loss is close to Rs.1500 crores. If we see another good chunck of write-offs in Q4 as well (hopefully the last one), then Educomp will end this fiscal with negligible Capital Reserves figure. So as and when the write-offs are over and the company starts moving towards Net Profit, the various analytical ratios like RoCE will start looking very very strong. Watch out for this sometime in the second half of next fiscal.

Coming to the most important part of my analysis. I have been studying the Capital Employed figure, which the company declares in the Segmentwise data every quarter, and co-relating it with the Write-offs that the company is doing every quarter. In the chart above I have compared Educomp's Cash Loss against the change in Educomp's Consolidated Capital Employed figure. Cash Loss comprises of company's Net Loss reduced to the extent of Depreciation, but including the Write-off amounts. This Analysis clearly shows that Educomp has got Net Cash Inflow over the last 7 quarters. The Cash Inflow amount are not very big, but positive nevertheless. The inflows clearly suggest that Educomp is managing to cover all it's Operating and Other expenses & Interest payments. Some credit for the Net Cash Inflow goes to the company's efforts in aggressively going after receivables. There has been consistent positive development on this front. Hopefully it will continue in the coming quarters. 

Educomp Solutions - Quick turnaround underway!!

Most people following Educomp Solutions Ltd had considered the company to going for History Books after seeing the Q2-FY'14 results, which were very very disappointing to say the least. Educomp posted the lowest quarterly revenues in more than 3 years and posted a Net Loss which was close to 50% of the company's Total Income for the quarter. Things were going from bad to worse. It seemed like Educomp did not even have enough cash to take care of it's everyday existing operations, forget about going for more business. There were reports that the company had not paid salaries to thousands of employees and even their Provident Fund payments were delayed for more than 4-5 months. From Q2 results, it was obvious that 3 out of Educomp's 4 business segments were struggling. The SmartClass business, which was the company's main contributor had virtually come to a standstill with revenues collapsing over 70% Y-o-Y. The Higher Learning Solutions business' contribution too had dropped nearly 75%, but it was small in any case. The K-12 Schools business, which was expected to give Educomp long term stability with steady moderate growth, too posted nearly 25-30% Y-o-Y drop for Q1 & Q2. The only business which managed to post decent 2-digit growth was the Online Supplemental segment, whose contribution increased to nearly 47% of Educomp's Total Income.

TTM Total Income Progress (Segmentwise)

As you can see from the charts above, Educomp's School Learning Solutions (SLS) business, which was contributing over Rs.1000 crores on a 12-months basis until about June'12, has seen it's revenues slide rapidly over the last 6 quarters and now stands at about Rs.350 crores. In these 6 quarters, the contribution of SLS to Educomp's consolidated Income has dropped from a whopping 69% to still reasonable 40%. But going by the last couple of quarters performance, it is expected to further drop to about 25%, before it starts picking up again on the currently underway restructuring. The business segment which has shown the biggest increase in contribution is the Online Supplemental business. It's contribution on 12-months basis has increased from 15% to 37% from June'12 to December'13 and will soon overtake SLS to become the biggest contributor to Educomp's Income, atleast temporarily.

The most important business for Educomp in terms of the biggest Capital Employment is the K-12 Schools business. The Total Capital Employed (TCE) in this business is over Rs.2000 crores, more than 50% of Educomp's TCE in all it's business segments. I have written about Educomp's K-12 business & it's ultimate importance to the company's long term future, in my report a few months back. (Click here for that report) The K-12 business, which is run via one of Educomp's subsidiary, too was struggling to meet it's debt repayment obligations & needed some restructuring in repayment terms. It's CDR proposal was approved and implemented during Q3-FY'14. Total loans worth about Rs.750 crores have been rescheduled for repayment over a 12 year duration. Plus the consortium of Banks even approved some working capital to the company to help it continue investing in it's existing operations. The revenues from K-12 business bounced back in Q3 with an 8% Y-o-Y growth after reporting a drop of between 25 to 30% in the previous 2 quarters. The revenues from this business are expected to get back to the 20%+ growth trajectory in the next fiscal, especially from the new Academic year.

TTM EBITDA progress

The EBITDA performance of Educomp's all 4 business segments will give you the true idea of the company's state of affairs. On one hand, the K-12 business' profitability has increased rapidly and is expected to remain high, thanks to the reasons I have already explained in my report. The Online Supplemental business too is rapidly getting into the black at the EBITDA level. Infact this business could get to posting small Net Profit as well in FY'15. The TCE involved in the Online Supplemental business is very small at less than Rs.100 crores and hence there is not much Debt or CAPEX associated with this business. Hence it could very easily start posting a Net Profit in the coming few quarters. The Higher Learning Solutions business, which is very insignificant for Educomp, is also trying to get into the black.

The biggest dampener to Educomp's fortunes in the last 18 months has been the SmartClass business, which is part of the SLS business. It's profitability has just collapsed since Sept'11, when the company tried to super-charge it's business growth by putting immense pressure on the company's balance-sheet and things did not go as smooth as expected. Between June'11 and June'13, the TCE in Educomp's SLS business doubled from Rs.735 crores to Rs.1460 crores, that means nearly Rs.700 crores of revenues during this period that the company had booked, did not translate into actual Cash Flows. As per my estimates, most of this money is still locked with the Banks, which were part of the tri-partite agreement during the days when Educomp was doing SmartCLass implementation via it's vendor EduSmart. I have no idea if the Banks are ever going to release those funds or else the company will atleast get the annuity revenues which are being paid by the Schools to EduSmart. There has been some beginning of recovery of Cash stuck in this business, which is reflected in the drop in Rs.83 crores of TCE from Rs.1460 crores to Rs.1377 crores. Hopefully this will continue in the coming quarters as well, which will help improve Educomp's Cash position and also help it restart it's SmartClass implementations, which are currently at a virtual standstill. Hopefully the Banks which are also looking into a CDR proposal for Educomp Solutions Ltd, will be encouraged with this development.

Finally, I have a feeling that all the CDR related stuff should get sorted out latest by March'2014 and Educomp should be able to restart it's growth engine, though at a much more moderate pace, from Q1 or Q2 of FY'15. Whatever be it, I am sure that Educomp's management will look at bringing down the TCE of the company from the current level of close to Rs.4000 crores to something like Rs.2000 crores over the next 3-4 years. For that to happen, Educomp's growth should be less Capital intensive and more Cash Flow generating. I think that is very much possible. Until the point I see signs of those things happenning, my fingers are crossed with lots of optimism in my mind.