Educomp funding from banks under strain, says Espirito

Moneycontrol Bureau

The darling of fund managers and market operators alike during the heady days of the 2007 bull market, Educomp Solutions shares on Friday came close to breaking its 5-year low of Rs 168 seen in November last year. The stock has been under attack for the last two-and-a-half years from bears who have repeatedly questioned the company's corporate governance standards, accounting practices and business model.

A report by brokerage firm Espirito Santo on Friday raised all those issues afresh, and assigned a fair value of Rs 110 to the stock. The report comes barely less than two weeks after the resignation of the company's chief financial officer, Sangeetha Gulati.

The management has denied the Espirito report saying the brokerages's views were "sensational in nature" and there were nothing wrong with the company's financial practices.

Educomp shares on Friday closed at Rs 177, down 5% over the previous close, and down more than 60% over the last one year.

In November last year, the company had formed a special purpose entity (SPE) Edu Smart to raise money from banks by securitizing its receivables. What this means is that if a company is to receive Rs 100 from its debtors, it can raise money against that receivable, subject to a margin and for an interest charge. Educomp raised Rs 410 crore, with a margin of 20%, meaning it had securitized around Rs 510 crore of receivables.

According to Espirito Santo analysts Soumitra Chatterjee and Nitin Padmanabhan, bank funding for Educomp is getting difficult.

"At the start of the model, Edu Smart used to get Rs 60 for every Rs 79 securitized from banks meaning a cost of debt of 10%. This quickly declined to Rs 54 for every Rs 79 securitized resulting in cost of debt of 14% and zero cash balance for Edu Smart at the end of year 1. While we had expected in May 2011 that this funding would fall to Rs 50 due to rising securitization costs, it has actually declined to 45. Now either Educomp is paying securitization costs of 22.25% in return for Rs79 securitized or it is securitising only Rs 65 to keep the rate at 14%. The shortfall of Rs 14 implies that Edu Smart will find it incrementally difficult to pay Educomp, thus stretching its cash flows," the report says.

The SPE could now turn out to be cash drain on the company’s balance sheet in future, says the report.

"The SPE will be consolidated once India converges to IFRS from 2013 onwards which will lead to negative operating cash flow and free cash and debt to equity ratio of around 2:1. Management now has admitted this."

And the company’s much vaunted K-12 brand of schools is struggling, the report further says.

"Our channel checks of Educomp’s K-12 schools in 2012 suggest no major improvement over 2011, especially in schools which have been operational for more than 3-4 years. The only segment that could have helped Educomp in offsetting concerns of its core business is the K-12 segment, but things are not improving enough to make any meaningful impact."

But the most damaging of findings by the Chatterjee-Padmanabhan duo:

"In our research we notice that the statutory auditor of Edu Smart and registered address of Edu Smart is same. We believe this compromises independence, especially given any sense of excessive closeness between company and auditor will naturally concern investors given longstanding concerns about the structure of Edu Smart. Additionally, we are concerned about the cost allocation of resource coordinators which should have been booked by Edu Smart but is being booked by Educomp which is negative for minority shareholders of Educomp. Furthermore, the high turnover of company secretaries at Edu Smart also makes us uncomfortable on overall governance policies."

Below is the company's response:

"Educomp Management does not subscribe to the views expressed by Espirito Santo, which seem to be sensational in nature. Our business model and financial practices have been accessible to all our investors for far too long for such questions to be raised at this juncture. Educomp has pioneered many product categories and educational processes which have passed proof of concept stages a long time back. Its practices are a benchmark in many implementations across both private and government owned educational institutions in India. Compliance with the highest standards of Corporate Governance is our utmost priority and for any company it is a journey of continuous improvement. Any such analysis through the circulated report falls short of duties of a responsible research house and distracts energy of investors as well as management, which otherwise is completely focused and channelized on delivering on business outcomes."

Educomp shares are now trading at less than one-sixth of their peak value of Rs 1120 seen at the peak of the bull market in January 2008.