Tuesday, February 02, 2010

Educomp Results Analysis

Educomp Solutions' consolidated revenues, EBITDA and PAT rose 37%, 86% and 92% YoY to Rs2.6bn, Rs1.33bn and Rs612mn respectively.

Educomp, as indicated in Q2FY10, initiated the process of securitizing its Smart_Class revenue through selling contracts to Edusmart (which borrowed from banks against receivables from schools and corporate guarantee of Educomp) where Edusmart is a non-Educomp company apparently owned by ex employees of Educomp and is independently run (Yeah right!!)

In Q3FY10, the company transferred 518 schools with contracts worth Rs980mn (on top of 300 schools in Q2FY10 with contracts worth Rs630mn). Educomp has received sanctions worth Rs4.15bn for securitisation of Smart_Class revenues from many leading banks and has received Rs2.45bn disbursement. Besides, securitisation proposal worth Rs2-3bn is under consideration.

The transfer of existing Smart Class contracts to Edusmart would be done in tranches over the next few quarters.

The apparent reasons given are

• The new Smart Class model would improve cashflow for the company
• Would address the issue of frequent equity dilution,
• Some convoluted tax saving logic (I have no idea how this is possible)

Here is my analysis of the situation

1. This is a more expensive form of debt structure except that ‘Financing cash flows’ appear as ‘Operating cash flows’ in Educomp’s books

2. People say it increases lumpiness; Incorrect. It gives them a perfect tool to smoothen earnings and show growth, as there is absolutely no logic to how many contracts are securitized in a quarter.

3. Of course this can last for a short while only. Once they have securitized all their contracts, they would have to rely on new additions every quarter(growth in which is slowing down due to increased competition and lower realizations as Educomp is forced to cut prices because it no longer has the best product in the market). After that, the growth at least if not revenues, are likely to fall off the cliff

4. Once there are no annuity revenues from smart class, they have to keep adding a large number of schools every quarter to remain at the same level. You are already seeing that in their Government Schools business (predictably, they have started to hide their Gov’t business numbers by clubbing it with the smart class segment)

5. However, I hope you would agree with me that value cannot be created (or destroyed) through accounting changes. Stripped of the accounting treatment, the organic growth in their smart class seems to be slowing

6. The fact is, that with high stakes on their stock price, Educomp simply must keep showing growth to survive. In securitization, it has found a legal way of doing so.

7. Promoter holding is already down to 50 percent and may not want to dilute more. Debt is already at 1000+ Cr (excl unconverted FCCB of another 400 Cr and not counting off balance sheet guarantees for smart class securitization) despite diluting additional 35% post the IPO.

8. Of course, the hope is that some of their new initiatives (Own K-12 schools, online learning, and hundreds of other options that Educomp is buying with its overpriced currency …read stock) would by that time (when there are no more contracts to be securitized) begin to contribute materially.

9. For now, at least one will see their numbers grow at 100% over the next year or two, with a much smaller actual growth.

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