How Educomp misled investors with inflated profits

In FY10, ESL sold its Smart-Class business contracts to Edu Smart Services Pvt Ltd. (ESSPL), which was presented as an unrelated third-party company. ESSPL, established a few months prior to this transaction with a paid-up equity share capital of Rs 1 lakh, purchased the contracts for Rs 1,234 crore.

ESSPL then sold the product to schools and was supposed to collect payments through twenty quarterly installments over a period of five years or sixty months. These payments were for hardware, content licenses, and support services. As per Sebi investigators, ESL would bill ESSPL for 70 percent of the agreement value for hardware and content.

The issue arose when the schools did not make timely or regular payments, resulting in mounting trade receivables in ESSPL's books.

To address this, ESSPL converted these trade receivables into bank loans, with ESL allegedly providing a guarantee for these loans.

ESSPL then allegedly used these loans to pay ESL’s bills.

To simplify, Company A that wasn’t getting paid on time or at all by its clients found a way to hide that problem by putting a ‘third-party’ Company B (which was later declared a subsidiary) in the middle.

Educomp’s directors, Shantanu Prakash and Jagdish Prakash in their replies to Sebi said that all acts including transfer of business and execution of corporate guarantee for loans granted to ESSPL were undertaken in accordance with the law, in compliance with the provisions of the Companies Act then in force and after taking necessary approvals from shareholders.

Beginning of the end

Sebi investigators too point out that ESL’s arrangement began to fail after the amendment to Companies Act in 2013. Following the amendment, ESL had to declare ESSPL as a subsidiary and then ESSPL’s losses began to show in ESL’s books.

Net profit of ESL in 2010, 2011 and 2012 were Rs 282 crore, Rs 342 crore and Rs 137 crore. But from 2013, it started posting losses. In FY13, it posted a loss of Rs 143 crore and it kept rising; in FY17, it posted a net loss of Rs 782 crore.

ESL’s books also started showing a “steep rise in the provisions on trade receivable and write-offs” after FY23, according to the Sebi order.

Provisions as a percentage of sales was 2 percent in FY13, it went up to 19 percent in FY14 and a whopping 125 percent in FY15.

“The sharp rise in provisions can be attributed to ESL acknowledging that ESSPL was a subsidiary of ESL and disclosing it in its books consequent to the 2013 Act coming into effect (April 01, 2014), and also because of the fact that the lenders of ESL had taken ESL to CDR,” stated the Sebi order. CDR is for Corporate Debt Restructuring.

Also read: Sebi puts in place guidelines for Investor Protection Fund, Investor Services Fund

The company’s share price plunged in parallel.

The Sebi order noted, “ESL’s shares reached their peak price of Rs. 985.57 on NSE on October 01, 2009. However, the price of the scrip progressively declined and was trading at around Rs. 30 in April 2014, by which time ESSPL had been declared as a subsidiary of ESL. This downward trend continued in the subsequent years, and since June 2017 the share price of ESL has been in single digits. The scrip is currently trading at Rs. 2 (as on May 29, 2023 on NSE).”