CL Educate is entering the primary market on Monday, 20^th March 2017 with a fresh issue of 21.80 lakh equity shares of Rs.10 each and an offer for sale (OFS) of upto 26.59 lakh equity shares by promoters, PE investors and other shareholders, both in the price band of Rs.500 to Rs.502 per share. Representing 33.61% of the post issue paid-up share capital, issue will raise Rs. 239 crore at the upper end, of which OFS portion is Rs.130 crore. Issue closes on Wednesday, 22^nd March and is likely to list on NSE and BSE on 31^st March. 

CL Educate offers test preparation services, mainly for MBA, banking and law entrances, under the ‘Career Launcher’ brand, across 151 centers in 87 Indian cities. It also offers enterprise solutions such as integrated business, marketing and sales service to corporates and advisory and research incubation services to educational institutions / universities, with broad revenue split of 60:40 between test preparation and enterprise services. 

On FY16 consolidated revenue of Rs. 297 crore, PAT of Rs. 21.7 crore was earned, translating into net margin of 7.3% and return on net worth of just 9.0%. During H1FY17, revenue and PAT stood at Rs. 161 crore and Rs. 12.9 crore respectively (net margin at 8.0%). On equity of Rs. 11.94 crore, EPS for first half of FY17 was at Rs. 10.74.

Despite slow yet steady growth (revenue and PAT CAGR of ~13% during FY13-16), company and its business model have certain drawbacks. For one, it is a small company but doing too many things – test preparation, publishing, integrated corporate support, vocational training under Govt. schemes, research incubation and K-12 schools. While the opportunities in each segment may be large, lack of management band width is not helping it succeed in all. Take for example - K12 vertical under Indus World Schools has nearly 60% of company’s capital deployed, causing strain on profitability and return ratios, as performance is unsatisfactory.

Secondly, fate of vocational training under Govt. schemes is out in the public too, as huge working capital gets locked with mounting receivables and delayed collection cycles. Everonn Education, Educomp Solutions and Core Education are classic examples from the listed space, which have lead these companies to near liquidation.

Similar to peers, CL Educate also has huge outstanding trade receivables (despite major chunk of test preparation fees being received up-front). Outstanding debtors of Rs. 127 crore, as of 30-9-16, represent 5 months of sales, of which, Rs.94 crore is outstanding for over 6 months, which is quite alarming. In addition, Rs.6.42 crore is outstanding for over 6 months from 2 group entities (Nalanda Foundation and Career Launcher Education Foundation). Such financials do not project a good picture, especially before one is about to get public!

Thirdly, company’s related party dealing show that receivables and interest of Nalanda Foundation (running Indus World Schools) to the tune of Rs. 27 crore have been converted to unsecured loan by the company, over the past few years. When company itself is in need of funds, blocking sizeable amounts in a group entity does not help. 

Lastly, company is highly sensitive to changing assessment patterns, like in May 2015, when civil entrance exams underwent policy change, company’s revenue for that vertical contracted to Rs.2 crore from Rs.18 crore, practically shutting down one opportunity which had been established over the years! Thus, the business is quite on precarious grounds.  

Coming back to IPO details, of the fresh issue proceeds, about Rs. 53 crore is earmarked for working capital funding, Rs. 19 crore for debt repayment and Rs. 20 crore for strategic initiatives. Total debt, which stood at Rs. 65 crore (30-9-16) will decline to Rs. 47 crore post IPO, while cash and equivalents are at Rs. 12 crore. Current net worth is Rs. 256 crore (30-9-16) and promoters own 64.72% stake, PE fund Gaja 15.04%, HDFC 4.96%, leaving balance 15.28% among a host of shareholders such as Edelweiss, India Infoline, S P Family Trust etc. Promoters and PE investor Gaja are making a part exit, while few like S P Family, Edelweiss, India Info and other shareholders are exiting completely.

At Rs. 502 per share, company will have market cap of Rs. 709 crore and EV of Rs. 743 crore, which leads to EV/EBITDA and PE multiple of 13x and 23x respectively, on H1FY17 annualised earnings. On one year forward numbers (FY18E), these multiples are 12x and 22x respectively, which are quite stretched.

Listed peer MT Educare, which became public 5 years ago, is currently ruling 17% below its IPO price. On annual topline of Rs. 300 crore and similar margins, its market cap is Rs. 337 crore vis-à-vis CL Educate’s asking market cap of over Rs. 700 crore. Despite double the centers at 293, MT’s valuation multiples are much lower – EV/EBITDA 6x and PE 17x.

Another coaching peer Career Point, which went public 7 years ago, is currently ruling 64% below its IPO price. On annual topline of Rs. 85 crore and much higher margins, its market cap is about Rs. 200 crore and is trading at EV/EBITDA multiple of 5x and PE multiple of 11x. Thus, on peer comparison, issue is grossly over-valued.

Another point to be highlighted here is that companies from the education sector have rarely rewarded investors. Both MT Educare and Career Point drew a lot of investor fancy for their respective issues, but their fate is out in the open. Failure of closely-tracked and much- discussed education duo like Everonn and Educomp will also weigh on this issue.

To conclude, the issue is weak on fundamentals - working capital intensive business, mid-single digit margins, single digit RoE coupled with expensive valuations and education sector being a non-performer (empirically) make this issue an avoid. 

Disclosure: No Interest.