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Nov 16, 2012, 12.56 PM IST | Source: Moneycontrol.com

India Ratings: Margin pressures surge for education sector

India Ratings says that intensifying competition in the Indian education sector will keep margins and cash flows of education companies under pressure. Although the long-term growth story is intact, challenges exist in terms of capex completion and funding growth while balancing capital structure.

India Ratings says that intensifying competition in the Indian education sector will keep margins and cash flows of education companies under pressure. Although the long-term growth story is intact, challenges exist in terms of capex completion and funding growth while balancing capital structure.

Multimedia education, K-12 (kindergarten to 12th grade), and instructional and computing technology (ICT) are front-loaded capex businesses, straining internal liquidity and leading to consistently negative free cash flow (FCF). The ICT business faces high receivable days due to extended sales cycles while K-12 and multimedia education (under BOOT-build, own, operate, transfer model) businesses achieve EBITDA breakeven only in three to five years.

India Ratings is of the view that the multimedia education space will rather become commoditised with increasing competition, with pricing becoming a key success factor. “As metros and Tier I cities achieve higher penetration, education companies will turn towards the Tier III and Tier IV cities for growth, which are highly price-sensitive markets. As the market has not yet matured for content to create differentiation, established companies could cut down their pricing according to the fee-paying capacity of end-users and to match quotes of upcoming competitors”, says Tanu Sharma, Associate Director in India Ratings’ Corporates Team.

Although aggressive funding models such as securitisation, currently being adopted by some education companies in their multimedia education business, will lead to an improvement in cash flows in the short-term, they also result in upfront booking of revenue and thus reduce revenue visibility. Also, higher refinancing risks stem from companies deploying surplus funds (generated through securitisation of future receivables) for meeting working-capital needs and financing capex. Growth is driven by continuous new additions, which can be slow as competition increases and the addressable market shrinks.

Risks of capex completion are high in the brick and mortar schools business, higher education or universities, which require heavy investment and a long payback period. Equity is the most apt funding source for such long gestation capex projects.

India Ratings believes the financial leverage of education companies will increase because of mostly debt-funded growth. Loss absorption of project costs in initial years and continuous investments into working capital could drag FCF and necessitate refinancing. While in the past, private equity had been forthcoming for education projects, it has been increasingly difficult for competitors to raise fresh equity in the current funding environment. High interest costs might also necessitate companies to go slow on new debt-funded projects.

Some of the India Ratings-rated education companies are: Educomp Solutions Limited (‘IND A’/Stable), NIIT Limited (‘IND AA-’/Stable), IL&FS Education and Technology Services Limited (‘IND A+’/Stable) and Extramarks Education Private Limited (‘IND BBB+’/Stable). 

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