Educomp Solutions: Buy

Investors can buy the shares of Educomp Solutions, considering the bright growth prospects for its key verticals and the stock's sizeable valuation discount to its historic levels.

At Rs 2,088, the stock trades at 26 times its likely 2008-09 earnings. This is not cheap under current market conditions. But Educomp has locked into most if its contracts where it licenses digital teaching content on long-term basis, typically over a five-year period.

Continuing triple digit growth in high-margin segments such as Smart Class and retail & consulting, a healthy order pipeline for its services that cater to IT-enablement of government schools, support the valuations. Educomp's focus on the education sector also lends resilience against any broader slowdown as schools are unlikely to scale down investments in innovative teaching methods. With the Government's IT-enablement programme continuing on course, the company appears well placed to ride out the present slowdown in the economy.

Smart Class, where Educomp provides teaching content and education solutions across classes, boards and subjects, accounts for nearly 70 per cent of its revenues and enjoys a an EBIT (earnings before interest and tax) margin of 60 per cent. This segment continues to add hundreds of schools under its fold, with a current roster of 1,267 schools and 1.43 million students using this service. For the past six quarters this segment has managed triple digit growth, over same periods in the preceding years.

The retail segment, a tutorial service led by the math Web site mathguru.com is growing at over 600 per cent, and from insignificant contribution a couple of years ago now contributes 11 per cent of its revenues. The business enjoys a 70 per cent margin and would contribute to higher margins as it adds users.

Educomp's Information Communication Technology (ICT) business continues to win a string of Rs 50-100 crore orders and works with as many as 14 State governments. These projects are for a five-year duration and are mainly volume driven as they involve IT-enablement of Government schools. Given the present economic crisis and Government thrust on public spending, Educomp may continue to be well placed to tap into increased budgetary allocations on education. But Government deals may mean longer receivable cycles and expanding working capital requirement.

Most of Educomp's projects involve upfront capex for which additional debt may be required. But the company has tied up loans for its capex requirements over the next few years. An increase in its debt-equity ratio, at 1.22 for 2007-08, would mean increasing interest costs