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Everonn IPO : Expect Huge Listing gains

Everonn Systems: Capitalizing on the Government’s initiative in IT education

Amount to be raised: Rs.50 crore

Price band : Rs.125-140

Post Issue Equity : Rs.13.85 crore

Oversubscription : 130 times

Major Competitors : Educomp Solutions, NIIT Ltd and Aptech Ltd.

Objects of the issue

Particulars	Amount (Rs in crore)
Institutional Education and IT Infrastructure Service	30.00
Virtual & Tech Enabled Learning Solutions including content development setting up 3 new studios in India, 1 in studio in Singapore and 2 overseas offices in Dubai and Singapore	17.25
Working Capital	5.00
Mergers & Acquisitions	8.00
Investment in Subsidiary	1.00
Bland Building	1.00
Issue Expenses	3.81
Total	66.06

About the company:

Everonn Systems incorporated in 2001, is a Chennai based company engaged in institutional education IT infrastructure and Virtual technology enabled learning solutions. The company is a fully integrated knowledge management, education and training company offering a range of services across the education spectrum as follows:

Ø Creating educational and training content that is globally relevant

Ø Designing and executing large learning initiatives

Ø Setting up the needed infrastructure for learning and training

Ø Partnering with various state governments to bridge the digital divide

The company currently has a point of presence in 1900 schools across 8 states in the country. The company has more than 2000 people on its roll as on date.

The company has two strategic business units (SBU) namely

SBU I: Institutional Education and Infrastructure Services enabled learning

· Setting up IT education infrastructure in schools and colleges

· Delivering IT education in schools and colleges

through the BOOT (Build, Own, Operate and Transfer) Model.

The list of responsibilities to be fulfilled under the BOOT model involves offering turnkey solutions with a complete range of services that include

ü Setting up state of the art computer labs

ü Designing the course curriculum and study material

ü Providing teacher services

ü Automation of the school administration system

The Company works closely with schools to implement innovative models to create and deliver content to enhance student learning and bridge the digital divide.

SBU II: Virtual and technology enabled learning solutions (VITELS)

VITELS focuses on providing specialized content through an interactive remote delivery mechanism:

• Offers turnkey education and software solutions to Schools and colleges, working professionals, corporates and the retail segment
• Management Education from Premier Institutes on Direcway Platform.
• Virtual learning through Zebra Kross and Direcway extended to 197 colleges, schools and Retail Centres

Education Sector in India:

The Indian education sector is the one of the largest markets for school education in the world. India has around 12 Lakh schools both in the government and private segment put together providing education from KG – 12 (K-12) to over 20crore students. Of this around 80% are government funded and the balance 20% are private sector funded. There are over 5 million teachers across the country who need training in IT and other subjects. The IT training market is growing at 14% p.a compared to 4.4 % global growth. The education in this country is funded through a 2% education cess charged on direct and indirect tax collections and through other budgetary allocations under various “Shiksha” schemes. The government has allocated Rs.30000 crore through the 10^th plan for Elementary education and Rs.13825 crore for secondary and higher education which can still be termed as “pittances” given the need of the hour. Around 40% of the country’s population is in the age group of 6-24 yrs, which is the target population for formal education and out of which less than 60% have enrolled for formal education as per Ministry of HRD reports. Public expenditure as a % of GDP is still at a poor 4% and has scope to improve by leaps and bounds in a knowledge economy. Though the country has been having a vast network of academic infrastructure right from the days of the British colonization and their legacy resulting in a vast English speaking population which is being leveraged currently by companies in the IT and ITES sector, concerns do exist over the availability of a strong employable talent pool. The country’s demographic profile is an inherent advantage and associations like Nasscom are addressing such issues through certification tests on skill assessments to and increased industry institution interface to produce employable candidates. After all education is the most potent force that can bring about a social change and if such education is provided with innovative use of technology, it shall turn out to be a paradigm shift in the learning curve of the current generation and adds value to the pedagogy by making education simpler and better for one and all. All these factors put together showcase the immense potential and opportunities waiting to be tapped by companies operating in the education sector. The outlook for these companies over the next decade appears to be quite robust.

Strengths:

Ý The promoters have a strong track record in providing IT education services and have more than 19 years of experience in the education industry.

Ý The company is lead partner of Hughes Communications for providing management courses from reputed national institutions through remote learning facility.

Ý The company’s foray into areas like online web tutoring, animation, graphic design and multimedia will be revenue accretive in future

Ý The company has a presence in 13 states and has MOU’s wit more than 2000 schools/ institutions to provide IT education and infrastructure services. These contracts are generally for a five to six year period and hence offers earnings visibility in the long run

Ý Major contracts secured from West Bengal and Karnataka governments during the year to automate more than 800 schools across the states. The company has also secured a Rs.30 crore contract from the Gujarat government for providing IT infrastructure services across 1256 schools in the state. The present order book position of the company stands at Rs.110 crore to be exceuted over a two to three years period.

Ý Aggressive expansion plans to add around 1000 schools per annum under the BOOT model.

Ý Is targeting the overseas markets like Dubai and Singapore which should bring in sizeable export earnings from 2008 onwards.

Ý The Virtual learning model given its increased geographical penetration will lend greater brand visibility and recall to the Everonn and Zebra kross brands.

Ý Education testing services for GRE, TOEFEL to be offered through virtual class rooms

Ý The company is also setting up a unique teacher’s recruitment portal called http://www.teachersofindia.com/ which will be an exclusive placement forum for teachers and other potential candidates looking for career opportunities in the field of education. The revenue model for this website will be through yearly subscriptions from educational institutions and ads from service providers. The domain name has already been registered and the company expects this new initiative to be a significant revenue driver.

Ý The company is in the process of setting up a subsidiary for its retail venture whereby the company plans to set up retail outlets across its network of schools, colleges and institutions to sell educational content.

Ý The business is closely linked to the education sector and the maximum growth is registered in the second and fourth quarter of the financial year. To deseasonalise/negate the impact on the financial performance during the balance quarters , the company is entering into corporate and professional development programs as well as summer coaching assignments during its off-peak seasons

Weakness:

ß The company derives almost 95% of its revenues from State governments for its school/institutional education services. The payments from Government projects are exposed to systemic delays and results in tight working capital position for the company. The receivable days for the year ended FY 07 alone amount to 7.8 months and amount to 65% of total sales. An age wise analysis of debtors reveals that almost 20% of the dues are pending for greater than 6 months. Most of the receivables represent dues from the Karnataka and West Bengal governments. Even much larger companies with similar business models like Educomp Solutions and NIIT have their debtor days at 4-5 months. The company would do well to reduce its dependence on government projects in future as huge amount of capital is getting locked up in receivables, whose cost of financing will bear its brunt on the margins of the company.

ß Direct competition from Educomp Solutions and NIIT Ltd. (in certain verticals) though the latter is a much larger and diversified player with international presence in IT training and development. Quality, competitive pricing and efficiency will be the key to sustenance in future against such bigger players as Educomp has an established presence in most of the business verticals of this company.

ß The company had diversified into an unrelated business of tourism in 2001 and after some minor losses over the years has decided to wind up the activities of the subsidiary.

ß The company has been utilizing its internal accruals for meeting working capital requirements rather than for its expansion plans. Even a pre IPO placement for Rs.5 crore to India China pre IPO (Mauritius) fund has been utilized for funding the ballooning working capital requirements of the entity. The company will have to resort to more short term borrowings in future to meet its working needs if it doesn’t improve its collection mechanism in the days ahead. As a result of high receivables the company is also facing an Asset liability mismatch (ALM).Its debtor days are at a near 8 months whereas its payables days are at 5 months, reflecting the increased liquidity crunch the company continues to face.

ß Delays in statutory remittances of ESI and PF albeit no defaults till date

ß The business model is exposed to the risk of piracy and misuse of content developed by the company. The content is distributed through VSAT (Very Small Aperture Terminals) and has the risk of being exposed to piracy if customers resort to infringement of copyrights. The brands of the company “Zebra Cross” and “Everonn” have not yet been registered with the trademark registry.

ß Cash Flows negative at the investment and financing levels, though positive at the operational level.

ß Upfront investments in School projects are quite high. The company had to amortize its entire infrastructure costs incurred upfront on its educational initiatives in Karnataka government aided schools, which had resulted in a negative impact on the operating margins by atleast 500 basis points for FY 07.

ß The Virtual class room concept is still at a nascent stage in the country. Many students still prefer the campus education mode. The company derives only 3% of its annual revenue from VITELS in the absence of major tie ups in the private sectors at the moment. Educomp’s Virtual class room initiative “Smart Class” is a major competitor given the significant strides it has made through its long running tie ups with a number of premier educational institutions in the private sector like DPS, PSBB, Caramel, St.Johns etc... to name a few.

ß All the products of the company are closely related to the education curriculum in force at the moment. Any changes in the curriculum may make the products of the company obsolete.

ß Highly dependant on government policies on education and the budget allocation to the sector as a whole.

Comparative table between Educomp and Everonn systems:

	Educomp Solutions	Everonn Systems
No. of educational institutions covered	Over 5000 institutions in 30 states	Over 2000 institutions in 13 states
Geographical Presence	International Presence with projects in US, India and Singapore	Major presence in India alone at the moment, setting up operations in Singapore and Dubai post IPO
Virtual Class Rooms	Smart Class	Zebra Kross
Scope of operations	Larger and diversified	Smaller player when compared to Educomp
Dependence on Government	Has a diversified revenue stream with increased shift in product mix towards private institutions and reducing the dependence on state governments	Highly dependant on government allocations, policies and government aided schools for revenues
Debtor days	Varies between 4 to 5 months	Varies between 7- 8 months
Content Library	Has more than 12000 modules of educational content that are globally relevant	The company is in the process of developing a content library and is looking for an acquisition in this space with a planned budget of Rs.8 crore
Financial comparison	The company has superior margins both at the operating level as well as the profitability level and has a huge war chest for Rs.110 crore to meet future expansion plans	The company's margins have come down during the current financial year due to increased IT infrastructure costs, education and training expenses. The company is plagued by liquidity constraints due to a strained working capital position

Financials

Financial Summary -Everonn Systems Limited
		31-Mar-07	31-Mar-06	31-Mar-05
Net Sales	Rs. Million	430.4	309.3	194.3
Operating Income	Rs. Million	430.4	309.3	194.3
OPBDIT	Rs. Million	176.3	143.7	99.6
PAT	Rs. Million	48.6	49.1	15.1
Net Cash Accruals	Rs. Million	132.9	95.6	73.5
Equity Share Capital	Rs. Million	138.5	17.1	17.1
Cash Flow from Operations	Rs. Million	36.3	65.6	34.5
Tangible Networth	Rs. Million	401.7	178.1	128.1
Total Debt	Rs. Million	235.4	268.9	104.6
OPBDIT Margins	%	41.0	46.5	51.3
Net Profit Margins	%	11.3	15.9	7.8
ROCE	%	15.9	26.4	17.5
PBDIT / Int. & Finance Charges	Times	7.54	9.24	6.92
Net Cash Accruals / Total Debt	Times	0.56	0.36	0.70
Total Debt / Tangible Networth	Times	0.59	1.51	0.82
Total Debt / PBDIT	Times	1.34	1.87	1.05
Current Ratio	Times	2.32	1.71	3.84

Notes to financials:

· The sales have grown at a CAGR of 30.35% over a three year period from FY 05 to FY 07 and the bottomline has grown at a CAGR of 47.65% over the same period.

· The drop in operating margins over the last two years has been on account of increased infrastructure costs, education, training expenses and increased manpower costs.

· The interest expenses are expected to move up over the next few years on account of increased borrowings for expansion and working capital related funding arrangements. The impact of the increased debt levels will be felt acutely in the next couple of years on the bottomline unless certain high cost debt is retired out of the IPO proceeds.

· The company has had a substantial equity dilution during the current year and no dividends have been declared for FY 07. The company will have to meet the increased return expectations of shareholders from the current year onwards, given the wider base it has to address. The internal accruals have been used in the past to meet working capital needs. The company must ameliorate its operating cycle and utilize the accruals for strategic purposes.

Inter Firm Comparison -FY 07
		Everonn	Educomp	NIIT
Net Sales	Rs. Million	430.4	1065.7	3902.7
Operating Income	Rs. Million	430.4	1121.7	4051.5
OPBDIT	Rs. Million	176.3	556.3	717.6
PAT	Rs. Million	48.6	285.8	316.2
Net Cash Accruals	Rs. Million	132.9	379.8	630.0
Equity Share Capital	Rs. Million	138.5	159.9	197.6
Cash Flow from Operations	Rs. Million	36.3	165.1	680.3
Tangible Networth	Rs. Million	401.7	1088.9	3094.0
Total Debt	Rs. Million	235.4	1383.8	1390.0
OPBDIT Margins	%	41.0	52.2	18.4
Net Profit Margins	%	11.3	26.8	8.1
ROCE	%	15.9	23.7	16.0
PBDIT / Int. & Finance Charges	Times	7.54	38.63	14.35
Net Cash Accruals / Total Debt	Times	0.56	0.27	0.45
Total Debt / Tangible Networth	Times	0.59	1.27	0.45
Total Debt / PBDIT	Times	1.34	2.49	1.94
Current Ratio	Times	2.32	7.27	2.11

Note:

· The financial summary of Everonn Systems and Educomp Solutions cannot be strictly compared with NIIT Ltd. given the scale of operations in the form of diversified business and geographical segments of the latter.

· Educomp Solutions hold sizeable cash reserves at 110 crore and hence the higher current ratio.

· The financials of Educomp hold the edge over Everonn systems on most parameters and have witnessed triple digit growth rates and hence the latter can be expected to trade at a substantial discount to Educomp Solutions in the secondary market.

Valuation

Particulars		Educomp	NIIT	Everonn
Market Cap	Rs.Crore	3,708.2	2,618.1	193.9
Market Price	Rs.per share	2,265.3	1,193.3	140.0
Sales	Rs.Crore	106.6	390.3	43.0
Operating Margins	%	52.2	18.4	41.0
Net Profit	Rs.Crore	28.6	31.6	4.9
Net Profit Margins	%	26.8	8.1	11.3
Market Cap/ Sales	Times	34.8	6.7	4.5
EPS	Times	17.7	16.7	3.5
Book Value		75.4	163.1	62.5
Price to Book Value	Times	30.0	7.3	2.2
Equity Capital	Rs.Crore	16.4	21.9	13.9
No. of Equity Shares	Quantity in crore	1.6	2.2	1.4
Enterprise Value	Rs.Crore	3,710.2	2,752.0	220.6
EV/EBITDA	Times	66.7	38.4	12.5
Face Value per share	Rs.per share	10	10	10
PE ratio	Times	129	71.45	40

EV represents Enterprise Value which represents Market capitalization + Debt

Notes:

· It has been assumed that the pricing of the issue will be done at the upper band of the issue at Rs.140 per share, as the issue has received an overwhelming response in the primary market by getting oversubscribed 130 times.

· Educomp and NIIT trade at expensive valuations due to the high growth rates prevailing in the sector and the premium the investors are willing to accord for the promise the sector as a whole displays going forward. The growth rates in India have outperformed the global growth rates for technology led education given our favorable demographic profile and the increased awareness on Information technology

Therefore the following factors make the stock an attractive investment opportunity upon listing:

ü Everonn’s reasonable growth trajectory in the past

ü The fast growth rates in the education sector

ü The fancy valuations for Educomp Solutions trading at a huge PE of 129 times its trailing FY 07 earnings.

ü The huge untapped market in the IT/ IT-aided education segment and increased government thrust on education through budgetary allocations.

Listing forecast: For companies with unique business models like Everonn Systems, the listing will definitely result in huge gains for the investors who have subscribed to the issue. The best method for valuing such companies would be on the basis of EV/EBIDTA basis whereby the EV/EBIDTA of similar/comparable companies will be taken into account. In the above case, Educomp is the only peer company with exactly the same business models. Educomp’s current Enterprise Value quotes at 66.7 times its EBIDTA. This figure cannot be taken as a benchmark prima facie for valuing Everonn systems as the latter is a much smaller and evolving player with less attractive financials when compared to its bigger competitor. So the best option under such circumstances will be to accord certain discounts to Educomp’s EV to arrive at a fair valuation for Everonn Systems.

EV/EBIDTA ratio for Educomp: 66.7 times

Less: Discount for Operating margins @ 11% 7.34

(Representing the difference between Educomp and Everonn’s Operating Margins)

Less: Discount for Net Profit Margins@15% 10

Adjusted EV/EBIDTA for Everonn Systems 49.36 times

EBIDTA for Everonn for FY 07 Rs.17.63 Crore

Adjusted Enterprise Value for Everonn Rs.857 Crore (49.36 *17.63)

Debt on the books of Everonn System Rs.23.5 crore

Adjusted Market capitalization Rs. 833.5 crore

No. of equity shares Post issue 1.385 crore

Expected Market Price upon listing Rs. 602 (833.5/1.385)

The target listing price of Rs.602 represents a premium of 330% over the issue price of Rs.140. The scrip should scale this level comfortably given the positive scenario surrounding this issue.

Safe Harbor: All Equity investments are subject to market risks. This analytical review should be construed as an opinion and not as a recommendation. Investors are advised to exercise adequate caution and make informed decisions on their personal investments.