The Hindu Business Line : Educomp Solutions: Avoid

INVESTORS can refrain from subscribing to the book-built initial public offer by Educomp Solutions (Educomp). At the upper end of the price band of Rs 110-125 per share, the price-earnings multiple works out to 17 times its expected FY-2006 per share earnings on a fully diluted basis. Since the PEM already factors in an aggressive revenue and profit growth for FY-2006, it is a stiffly priced offer vis-a-vis other investment opportunities.

The company is one of the few players offering computer-aided learning solutions in the domestic education segment from Kindergarten to Class 12 (called K-12 initiative). For the year-ended March 31, 2005, it reported revenues of Rs 29.8 crore and post-tax earnings of Rs 6.3 crore. The operating profit margin worked out to 44.8 per cent in the latest year, up from 26 per cent for FY-2004.

Educomp has four business units — Smart Class, Education Infrastructure Projects awarded by the government, Professional Development for teachers, and retail services. The primary object of this offer is to part-finance the capital expenditure required for its Smart Class project in the domestic and American markets and education infrastructure under the BOOT (build-own-operate-transfer) model. It also plans to step up sales and marketing by its US-based subsidiary and explore acquisition opportunities.

In a Smart Class project, the company provides teacher-centric content mapped to the school syllabus, along with hardware infrastructure and connectivity.

According to the offer document, it expects 225 schools to sign up for this project over the next two years. On an average, it expects 10 classrooms to run Smart Class. Its also proposes to invest in developing content from its Bangalore facility for the American market.

Though Smart Class, along with Professional Development, is a market that has considerable growth potential, it is still at a nascent stage of development. In our view, the extensive deployment of computer learning aids in classrooms across the country will be slow to take-off. Since the barriers to enter this market are low, competition and pricing will put pressure on sustaining operating margins in the 40 per cent range. While the company plans to mitigate this risk through long-term annuity contracts with schools, the risks of execution (in terms of delivering customised content for schools) and scalability remain quite high. Since the US initiative is largely an unproven one, the risks associated with this venture will be fairly high.

As for the education infrastructure, contracts from various government/semi-government bodies are likely to get quite competitive in the coming years. The possibility of existing players engaging in a price war or new entrants creaming away market share is quite high.

Since the company has an established track record, clinching contracts may not pose a problem, but the margins are likely to witness a decline steadily.

Background: Educomp Solutions is offering 40 lakh shares, accounting for 25.06 per cent of the outstanding equity. The book-running lead managers are SBI Capital Markets and Karvy Investor Services. The offer opens on December 19 and closes on December 22.