treehouse - hbj capital

8/10/2019 TreeHouse - HBJ Capital

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Tree House Education & Accessories Ltd (THEAL)- Scalable Business Model in high potential Education sector


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Content Index

Treehouse Education & Accessories Ltd (THEAL)Snapshot :- Slide #3

THEALsInvestment Highlights :- Slide #4

Our Research Desksviews on THEAL :- Slide #5

Pre-School EducationIndustry Overview :- Slide #14

THEALBusiness Overview :- Slide #22

THEALInvestment Rationale :- Slide #32

THEALFinancials:- Slide #41

Concerns & Reasoning :- Slide #43

Conclusion :- Slide #45

Specialists in discovering Multibagger stocks


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THEALInvestment Snapshot(as on Feb 17, 2014)

Recommendation :- BUY

Maximum Portfolio Allocation :- 6%

Investment Phases & Buying Strategy

1stPhase (Now) of Accumulation :- 80%

Current Accumulation Range :-210-240 Rs

THEAL is a classic Peter Lynch type stock. It is operating in an

easy to understand business in which everyone can see the huge

growth opportunity. THEAL has shown great execution track

record to out beat competition and emerge as ndias largest

Self operated Pre School chain.

Core Investment Thesis :

We believe THEALs inherently strong Earnings profile and

Returns profile is being masked by Long gestation assets in the K-

12 business segment. With the company announcing a

divestment of these Assets, our Analysis makes case for a healthy

re-rating of the stock. Valuation Re-rating of the stock would

anyways be only a bonus as Earnings growth itself can deliver

healthy profits for Investors.

Current Market PriceRs. 219.95

Current Dividend Yield0.55%

Bloomberg / Reuters CodeTHEAL. IN/

THEA.BO

BSE / NSE Code533540/ TREEHOUSE

Market Cap (INR BN / USD Mn) 90.75

/147.32 [1 USDRs. 61.6]

Total Equity Shares [Mn]35.96

Face ValueRs. 10

52 Week High / Low Rs. 217.3 / Rs.302

Promoters Holding 30.87%

FII - 1.16%

DII - 10.22%

Other Holdings - 57.75%



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Investment Highlights


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Thanks ! For helping us grow from a 4member startup to a 250

Member company..Looking forward to continuously serving you with

the best Research Ideas in Small Cap and Mid Cap stocks.


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Dear Members,

We are happy to present Treehouse Education & Accessories (THEAL)as our Multibagger Idea for the monthof February. While we have been recommending 12 Ideas every year to our Members who are looking at us as a

good source of Idea generation for their Portfolios, we have only a handful of stocks in our Fund & Portfolios.Although we are positive about all our Stock Recommendations, only the High conviction ideas amongst them makethe cut to our Portfolios. I certainly believe that THEAL has a high probability of entering our Core portfolio soon.THEAL with its Low earnings risk and Quality business model can certainly be a good complementary addition to ourhigh growth Multibagger Ideas.

All of us know that India is a Young country with a large population of school going kids. Indian Education sectoroffers tremendous opportunities with increasing spending of Indians towards education and increasing social bias of

sending Kids to Private schools. This huge opportunity is easily visible to everyone and in fact Education stocks hadbeen a darling of Stock Markets a few years ago. But Markets backed the wrong business models and badpromoters and this resulted in huge wealth loss for Investors. We have always focused on companies that havegreat Business models and that have a quality Management to capitalize on huge opportunities profitably. This hashelped us to stay away from the wrong stocks in the Education sector. The only two stocks which we have tracked inthis sector for the past several years has been THEAL and Navneet Education. This is our first recommendation fromthe Education sector and we have enough reasons to believe that we are backing the right company.

- Pre-School per Center Return ratios - Hugely Profitable (ROIC of >40%).- Strong Delta in overall Return ratios with the announced Asset divestments. (250 Cr of Investments).- Long Term advantages of a Self-Operated Pre-School chain Vs Franchisee model. (Moats for Treehouse).- Strong Growth Opportunity planned. (No: of Pre-Schools to more than double over the next 3 Years ).- Earnings Quality and Operational Leverage in the business. (Low Volatility, Low Variable costs).- Strong Financials (Negative Working Capital, Strong Balance Sheet, Investors Support, Promoters Buying).- Reasonable Valuations for a Quality business run by a Credible & Competent Management.


Our Research Desks views on the Stock Idea


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1.) Pre-School per Center Returns RatiosHighly Profitable (ROICs> 40%):

* The Overall returns ratios of its Pre-School business is masked by its Long Gestation K-12 Assets (43% ofBalance Sheet Assets delivering only 0.04X Asset Turnover). The blended Asset Turnover ratio of the companysPre-School business is around 0.45X. With an Operating Profit Margin of around 50%, the company generates

unleveraged ROEsof > 22%. (Slide37 for more details).

*While even this ROE may look ordinary, the real high ROE nature of the business gets hidden in the Blendednumbers. The company has been on a rapid expansion spree adding large number of Pre-Schools over the last fewyears. In fact, out of the 440+ Pre-Schools almost 300 schools were added over the last 3 years. These Pre-Schools will deliver far higher Utilization Ratios and eventually higher Margins going forward.

* Most of these new Pre-Schools have reported strong Performance, with a majority of them breaking even

within a 2 year period. In fact, all the schools which are over 3 years old are extremely profitable with strongutilization ratios and consistently delivering significantly higher Asset Turnovers of over 1.2Xand thus higher ROEs.

* In order to show the real ROCE picture of the companys Pre-Schools, we have analyzed the Per-Centerprofitability along with Return metrics (Slide -34). The companys old Pre-School centers earn between 30-120%returns on their Capital Investment. This shows the high quality returns profile of the companysbusiness modeland current trends indicate similar returns from the companysnew Pre-Schools.

*CompanysMargins continue to be higher than Industry Average, reflecting the strong Brand equity. Itsability

to attract students in a short time frame can be seen from the shorter Break Even periods and the relatively higherFranchisee fee compared with competitors. Company continues to keep costs under control and expand Margins.

* Since majority of the companys Pre-Schools are self-operated, it has more negotiating power andkeeps costs under check. It has also resorted to modes such as Day Care centers, Teacher training, Increasedbatches etc to sweat its Assets better and reduce Rental costs as % of revenue. Its strong execution trackrecord in this regard can be seen from its profitability even in a high cost market like Mumbai.




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2.) Strong Delta in the overall Return Ratios with the announced Asset divestments :

*Currently Treehouse Education has almost 250 Cr of its Balance Sheet assets tied up for its K-12 business in theform of Lands, Buildings, Security Deposits etc. The company had announcement a Divestment plan on these Assetsand we believe that the company would net in around 150 Cr Rs through its Asset divestments. (Slide36).

*These Assets are not inherently bad Capital Allocation decisions. In fact the companysK-12 Assets can be soldat a premium of 1.25-1.5X its Book Value. It is just that the K-12 business is a far more long gestation businesscompared to the companysPre-School business and hence itspresence dampens the Return Ratios in the short tomedium term and limits aggressive CAPEX needs of THEALsPre-Schools.

* K-12 business has far bigger potential than Pre-Schools considering the opportunity size involved and therelatively lower competition. Scaling up this business requires a lot of capital. We believe that once the regulatory

hurdles decrease and the company perfects its K-12 business, THEAL can definitely scale up K-12 business quickly.

* K-12 Schools have high student stickiness and assures strong revenue streams over a 12 year period. Henceonce a K-12 school matures, it can delivers strong Free Cash Flows. With the Asset sales, even the ROCE of theremaining capital locked in the K-12 schools can deliver healthy returns (Slide 38). Company can continue toexpand its K-12 business on an asset light model and use its Pre-School network as Feeder input and thus achievingquick break even compared with other K-12 schools.

* Companys Revenues would continue to be dominated by its Pre-School business as it embarks on anaggressive expansion plan and the planned asset sales can be used to fund that growth. Considering the companysincreasing reach, financial position, brand valueTHEAL has the potential to replicate a similar success story in K-12 segment over the next 10 years using an Asset light business model.

* We believe that the companys increasing Balance sheet allocation towards Pre-School assets for the next 3-5years can significantly improve its Returns Ratios and help it capitalize on the huge opportunity for Pre-Schools inTier- 2 and 3 towns. This can certainly trigger much higher Valuation for the stock going forward.




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3.) Long Term Advantages of Self-Operated Pre Schools Vs Franchisee model (Competitive Moats) :

*THEALsbiggest difference with that of other Pre-School chains is that majority of its Pre-Schools are companyoperated compared to Franchisee based expansion of others. The companysSelf Operated : Franchisee mix of 75:25 is starkly in difference with peers such as Euro Kids or Kidzee. The company has perfected its model of scaling up

self operated schools and is now the largest self operated Pre-School in India.*After analyzing both models from every perspective, we believe there is enough evidence to believe that Self-

Operated model makes far more Financial sense for shareholders (Slide 26). In a relatively asset light businesssuch as Pre-Schools in which everything is centralized and the local Franchisee just contributes to location and basicadministration, there is very little advantage in going for Franchisee model. In addition to Financials, Quality ofeducation is higher and thus self-operated schools command higher Brand equity.

* Companysbetter Brand Equity is visible in its shorter Break even, higher utilization, better Margins etc. StrongWord-of-Mouth publicity has helped the company to attracts students compared with peers. The company is in factthe Market leader in 9 out of the Top-20 cities in India. Company is geographically stronger in Western India. WithTHEAL entering several new markets, it expects to increase its Market share across different geographies.

*Companysself-operated model helps it to negotiate better and keep costs low and also allows it to competemuch more effectively in the Market place. Self operated structure also allows it to provide better opportunities forits HR resources (Teachers) and creates a solid base for future expansions.

* Companys aggressive and profitable expansion in a self operated model speaks volumes about theManagementsexecution capability. They have been the only ones to consistently emphasis on the importance ofhaving a self operated pre-school chain and have delivered on the tough task of execution.

*We expect THEAL to have 1,00,000 (1 Lakh) students in its Pre-Schools by 2018. This large scale can easily beused to leverage into several new opportunities such as K-12 Schools, Day Care, Accessories etc. If the company isable to deliver a strong user experience it definitely has a long way to go in building several alternate profit streams.




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4.) Strong Growth Opportunity planned (Pre-School centers to more than double over next 3 years) :

*THEALsstrong track record of opening new pre-schools in the last 5 years gives us confidence of the companyachieving its target of operating 1000 pre-schools over the next 2-3 years. This along with student growth in

existing centers can help the companysrevenues to compound at 30%+ over the next few years (Slide39).

*THEAL has also been open to acquisitions at fair price to drive inorganic growth in its Pre-School business. Ithad acquired Brainworks and Global Champs over the last 2 years. Companysplans to tap its Global Champs brandfor expanding its Budget Pre-Schools and Brainworks brand to expand on a Franchisee mode to low cost locations.

*With an increasing Social desire for Pre-School education driven by working parents, increased affordability,urbanization and higher awareness of benefits of education - the opportunity for growth of Pre-Schools is

humongous in India. With Organized players not even cornering 30% of the overall Marketwhich itself is growingfast, well established players such as THEAL can continue their strong growth for many more years.

*The next set of growth is expected to come from Tier-2 and 3 towns which are under-penetrated by most ofthe organized chains. THEAL will use Franchisee models in areas where it does not have any execution capability.The company is able to charge a higher Franchisee fee compared with its competitors.

* The company continues to increase its Teacher training capacity as it would help it to scale up withoutcompromising on quality. It also helps the company to have control over costs and have lower attrition. Itsconsistent focus on improving quality of user experience has given it a better brand image.

*Company increases the number of Batches in its Top performing centers (Morning batch, Afternoon batchetc)and hence it can increase the overall capacities without any significant investments. This makes the companyscapacity expansion relatively easy and highly profitable.




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5.) Earnings Quality & Operational Leverage in the Business (Low Volatility & Low Variable Costs) :

* THEAL is one of the few businesses which can be safely called as a Recession Proof & Inflation Proofbusiness. Companysearnings doesntalter materially due to an Economic downturn. It is one of the few big ticket

spending of an household which falls under the non-discretionarypart.

*Despite Intense competition, quality Education providers can continue to have decent Pricing power derivedfrom a superior student experience. Demand is relatively in-elastic and just because some other Peer undercuts,the Pre-School cannot drive away students from THEAL.

*We believe that THEALsearnings is of very high Quality considering its stability and very low Earnings risksinvolved. Once a Pre-School centre get established, it continues to produce consistent earnings and has very little

risk of lower Revenues or enrollments unless there is significant damage to the companysBrand.

*Pre-Schools have a lot of Fixed costs and very little variable costs (Slide35). Hence, the Operational leveragein the business is extremely high. With increasing Utilization ratios, the Operating profit margins can vary from 30%to 70%depending on the maturing of the center. Hence, the companysdelta in overall Margins and Return Ratioscan be significant as volumes build up.

* Additional Revenues from a center come not only at higher Margins but also without any new additionalInvestment. Thus Incremental ROCEsare very high in this business. With the Non-Volatile nature of the business,the reverse negative operational leverage cant occur in established centers and is possible only in case of arecklessly aggressive expansion.

* Once a center gets established, the utilization ratios increase and with increased No: of branches - all well runPre School centers turns into cash cows. They start generating significant Free Cash Flow enabling the company touse internal accruals for expansion.




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6.) Financials - Negative Working Capital, Strong Balance Sheet, Investors Support, Promoters Buying :

* THEAL continues to stay Lean and Efficient and the companys efficiency ratios are definitely above itspeers. Company continues to improve on its Revenue/ Student, EBIDTA/ Center metrics, etc (Slide 31).

* If we strip out the Security deposits which are essentially a CAPEX element, THEAL works on a healthyNegative Working capital cycle aided by strong Fee advances from students.

* Big Private Equity investors such as Matrix partners have continued to show faith in the Management teamand are investing in the business consistently (Slide 40). We believe companyshas access to strong Equity capitaland hence funding aggressive growth should not be an issue.

* With a low debt Balance sheet combined with Cash inflows from asset divestments and Internal accruals, webelieve that the company does not require to substantially leverage its Balance sheet or dilute its Equity to achieveits current expansion targets.

* Promoters have been consistently increasing their stake in the company and they have in fact subscribed toshares at a premium to the current share price, which indicates their confidence in their business. With strongInvestor and promoter backing, the share does have a decent floor to its price.

7.) Reasonable Valuations for a Quality business run by a Credible & Competent Management :

* One of the most comforting factors in THEAL has been the Management quality of Mr. Rajesh Bhatia. Therehas been a lot of passion and discipline with which he has continued to build THEAL. We are convinced that thecompany has a long way to go and it has the right set of people at the top to drive this growth.




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*THEAL has been the first Pre-School chain to give ESOPsto teachers and make them enjoy the benefits of thevalue creation that has happened. Our analysis also shows company follows clean accounting policies.

*Despite several positives - inherently superior business model, high growth rates, good management etc, the

stock is reasonably priced with a forward Price/ Earnings multiple of 14X, EV/ EBIDTA multiple of 6.5X and CashFlow from Operations multiple of 11X (Slide42).

In a country that is starved of quality education and that has seen demand for education booming, we believethat THEAL has a great future. As the company continues to execute well, the company would start getting noticedby Institutional investors and would recieve higher valuations. We believe that THEALs earnings quality can becompared with hospital stocks such as Apollo, Fortis etc and this combined with lower gestation and higher ROCEnature of Pre-School business should make the stock more attractive to investors.

At the current Market Capitalization of 800 CrTHEAL is one of the few bets where a good Management teamis chasing a large opportunity with a share holder friendly business model. We would advise Investors to starttaking positions in the stock at the current price and increase their Allocation % s going forward. The stockdefinitely has the potential to become a Long Term Portfolio stock and deliver Multibagger returns overtime.



Regards,

[ Gokul Raj . P, HeadInvestment Research ]


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Pre-School EducationIndustry Overview


B i Ed ti O t it


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Booming Education Opportunity


Indias overall spend on Education to GDP has grown from just 1% to 5% which has been the major growth

driver and revenue source for private sector education providers.

Urban households account for 26% of the population but account for 57% of the overall private spend on

education. Technical Education caters to just 2.6% of the overall students but account for 20% of the overall

household on education.

On a percapita basis, the richest 10% of the urban population spends 90 times more on education than the

poorest 10% of the rural population.

d d


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Indian Education System


Indian Education system continues to be highly

regulated and fragmented. Most of the Market is

unorganized with very few national players.

Indian companies have been able to scale up in

relatively less regulated spaces such as Pre-Schoolsand IT training.

Over the past few years, Corporates have also

started entering the highly regulated K-12 segment

through proxy structuring to take advantage of the

huge demandSupply mismatch.

I di K 12 Ed ti


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Indian K-12 Education


The Indian K-12 segment can be

divided into two types i.e by

Management and by Level of

Education as shown.

K-12 admissions have seen huge

shift from Government schools to

Private schools over the past few

years driven by Increasing

Aspirations and decreased quality

of public school education.projects.

The enrolment in K-12 is

expected to grow to about 351

mn in 2018 which will lead to

additional capacity requirement of

about 34 million.

The K-12 share in the total

enrolments is poised to increase

to about 48% in 2016-17 from

42% in 2011-12 .

Bi t it i T iti F


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Big opportunity in Tuition Fees


Tuition fee is the single largest

component of private

expenditure on education and

accounts for 34% of overall

expenditure.

Of the total private expenditure

on technical education, 58% is on

tuition fees . Of the total private

spend on tuition fee, 62% goes to

private institutions.

Tuition fees go up progressively

in general education as the level

of education rises. The maximum

jump happens between higher

secondary and above higher

secondary level.

Comparing similar levels of

education, tuition fees are always

higher in urban areas compared

to rural areas.

P h l O t it f O i d Pl


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Preschool Opportunity for Organized Players


The Indian Preschool GER penetration is among

the lowest in the world at 54% as against a global

average of about 80-90% which offers enormous

potential for the industry.

The Indian preschool market is estimated at

about USD1.3Bn and is growing at about 38%. Thenumber of preschools in India is about 31,000 and

is expected to grow by about 26% per annum. The

total number of students enrolled in preschool

stands at about 2.6 mn with a preschool

penetration of 2.7%.

Preschool Market Growth


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Preschool Market Growth


CRISIL Research projects the

overall preschool market will

grow at a CAGR of 20% over

2013-18 from the current market

size of INR 66bn to INR 165bn,driven by increasing penetration

levels in the industry.

The organized preschool market

is expected to grow at a CAGR of

26% over FY13-18E to INR 42.8bnfrom INR 13.2bn.

Assuming an addition of about

80 students per preschool the

organized sector would need to

add about 8400 preschools.

Indias total students catered by

the organized preschool are set

to reach 1.02 mn from the

current levels of 0.35 mn.

Preschool Competitive Scenario


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Preschool Competitive Scenario


Preschools are predominantly neighbourhood institutions which address a micro market and are driven by

local conditions. Individual pre-schools, therefore, require low capital as compared to other educational

institutes.

There are no education board to regulate these schools. However, branding and an internal set of teaching

structures are increasingly becoming mandatory due to the increasing demands of parents.

There are many models of operations in the pre-school segment. The key models of preschool are self-

operated model and franchisee model.

Most key players in the preschool segment go for franchisee model as it helps them to expand faster and

there is no major capital investment.


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THEALBusiness Overview


Tree House A Snapshot


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Tree House-A Snapshot


THEAL is the largest self operated preschool chain in India and is known for qualified and experienced

teachers, standardized curriculum and quality education.

THEAL has about 379 preschool centers as on 31stMarch,2013 and proposes to open another 90 in FY14

taking the total to about 469 preschool centers.

THEAL is also present in the K-12 school segment, especially at locations where it has a strong pre-school

presence. It also provides School Management services to 24 operational K-12 schools.

THEAL offers a wide range of courses for different age group of children from play group, nursery, junior

KG, senior KG, mother toddler, activity classes, teacher training and summer camps.

Pre School Service Offerings


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Pre School - Service Offerings


THEAL vs Peers


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THEAL vs Peers


The biggest difference of THEAL

compared to its peers is its focus on Self

operated Pre-Schools compared with its

peers focus on Franchisee expansion.

In the case of a franchisee model the

profitability margins and overall returns

are much lower but franchisee model

provides greater flexibility in terms of

scalability but has lesser quality control .

projects.

The franchisor enjoys a EBITDA marginsof anywhere between 70-85% on all

franchisee centers excluding one time

license fee received from the franchisee.

In the case of a franchisee he has to incur

higher capital expenditure apart from

paying license fee and royalty to franchisor.

While the Margins may be higher, the

overall quantum of Profits and ROCs are

higher in Self-Operated mode (with higher

Operational Leverage).

Preschool Matrix Own Outlets vs Franchisee


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Preschool MatrixOwn Outlets vs Franchisee


THEALs Geographic Presence


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THEAL s Geographic Presence


THEAL manages about 300

preschools while the

franchisees manage about 79

preschools across geographies.

THEALs current operations

are centered around Western

India with nearly 50% of the

300 self operated schools

situated in Mumbai region.

THEAL plans to tap other

regions like Bangalore in South

India and Kolkata in East India

in the Tier I areas as well as

Pune, Udaipur and

Bhubaneswar in the Tier II

regions going forward.

THEAL plans to open 45

centers in Tier-II and Tier-III

cities in FY14 and FY15 apart

from its Tier-1 openings.

Self Operated Model


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Self Operated Model


The self operated model helps the company to maintain standardization and quality across its branches

apart from allowing it to capture the entire revenue opportunity instead of sharing with the franchisee

partner. Self Operated model is more difficult to execute compared with a Franchisee model.

Tree House has the largest self operated model with 75% of its overall centers compared to peers whohave only about 25% on self operated model.

The company intends to maintain its ratio of 75: 25 in case of Self Operated : Franchisee. The company

opens Franchisee modes only in locations where it doesnt have any execution experience and where it is

necessary to have a local partner who runs the show.

Franchisee Model


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Franchisee Model


In this model, the company expands its operations and extends its brand name through a franchise, in lieu

of which, it is paid a one-time franchise and a royalty fee.

The royalty fee, which is based on total fees generated by the preschool, is in the range of 10- 20%. THEALcharges a royalty of 15%. In the franchise model, most preschools have a minimum built-up area

requirement of 1,000-2,000 sq ft with a one-time franchise fee, depending on the location.

THEAL charges a differentiated franchisee fee as per the tier of the cities, which is far above the peers. This

is due to the higher Brand equity and the difference in THEALs and its peers strategy for expansion.

Highly profitable Centers


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Highly profitable Centers


THEALs profitable centers are quite high. Most of the centers become profitable as they mature. This can

be seen from the improvement in FY13 over FY12. In FY 12 the number of profitable centers was about 153

out of 184 centers which translates into a success rate of about 83.15%.

In FY13 the number of profitable centers was about 229 as against 262 total centers which translates into a

success rate of 87.40%. The number of successful centers in Jaipur, Hyderabad and Kolkata showed

significant improvement which demonstrates the potential to expand in varied geographies.

Strong Revenues & EBITDA Margins


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Strong Revenues & EBITDA Margins


THEALs revenues have grown from about Rs.39.24 Cr in FY11 to about Rs.216.09 Cr in FY15 ie, a growth of

about 53.19% CAGR. The growth in revenues was driven by increase in number of centers and increase in

student per school which stood at a healthy 60-75 per school during the past 5 years.

The EBITDA margin grew from 15-18% in FY08-09 to 54.1% over the past four years. This growth was led by

Improving operating leverage. With fixed selling and admin costs, any increase in enrollments has led to

strong improvements in profitability.

The preschool EBITDA margin are likely to exceed expectations, with key levers being improving average

student per preschool growth, lower SG&A expenses and better realizations vs cost inflation.


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THEALInvestment Rationale


Robust Track Record


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Robust Track Record


THEAL has grown rapidly from FY08 with the support of PE funding. The company has perfected its Pre-

School business and scaled it up rapidly during the last 5 years.

THEAL has grown its revenues from Rs.5.42 Cr in FY08 to about Rs.114.28 Cr in FY13 growing at a CAGR ofabout 83.9%. While the base is now higher, the company can still aim for a 30%+ CAGR.

THEALs EBITDA margins has grown from about 15.87% in FY08 to about 55% in FY13 as several of its Pre-

School centers started generating profits.

THEAL had posted a loss of Rs.0.19 Cr in FY08 as a result of several new openings in the previous year.

High ROC Business


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High ROC Business


THEAL is one of the

few businesses that

has a potential to

generate ROC of

more than 100% in aoptimistic scenario

and a 25% ROC in a

bad scenario.

The inherent

Returns potential of

its business model isextremely high. The

companys best Pre-

School centers have

been earnings ROCs

upwards of 100% for

several years now.

Even in case of a

Margin dip, the

company will

continue to maintain

higher ROEs.

Improving Operational Leverage


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Improving Operational Leverage


THEALs student population is expected to increase rapidly from about 7182 students in FY11 to about

53288 students in FY15 indicating strong cash flows.

The student per center which was around 40 in 2011 has scaled upto 78 in 2013 and is expected to remain

around 74-78 levels till 2015. This is what has led to strong Margin improvements.

The center per student ratio is calculated including the new centers. The total number of centers added by

the company has grown from 178 in FY11 to 379 in FY13 which is an increase of about 112% in two years.

The increase in student ratio has led to better student teacher ratio which is likely to improve from about

18 to 15 in FY2015.

K-12 Asset Sales to unlock capital


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K 12 Asset Sales to unlock capital


Of the roughly 500 Cr balance sheet assets currently - 200 Cr Rs is locked in Pre-School business, 230 Cr in

K-12 business and 70 Cr as Cash and Equivalents.

THEAL is on the process of offloading its K-12 Assets which will help it to become asset light and raise

capital to fund its future growth.

THEAL has plans to sell 5 K-12 Properties. It hopes to sell these assets over the next 2-3 years and that

would help it to raise cash of about Rs.1200 Mn as against a book value of Rs.962 Mn. THEAL will be able to

accumulate net cash of about Rs.800 Mn by FY16E which is about 8% of its current Market cap.

THEAL expects the asset sale to be about 1.25-1.5X its book value which is reasonable considering the

quality of its K-12 assets.

Improvement in Return Ratios


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Improvement in Return Ratios


Pre-School

Overall Financials

K-12 ROCs to improve


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K 12 ROC s to improve


In 2010 THEAL has ventured into the K-12 segment. It operates 24 schools, with an overall investment of

more than INR 2.4bn i.e. about 50% of the asset base. The company also acquired business commercial

rights for INR 250mn to operate 12 schools for the next 30 years.

THEAL has invested INR 960mn in land & building and provided security deposit of INR 1.1bn to the trusts

to operate schools. This has made significant capital unutilized.

Once the asset reduction process is completed, THEAL will operate 24 schools with just INR 312mn in

investment. The K-12 school operations are a steady cash cow business with virtually zero earnings risk, it

should have the potential to exceed return on investments.

THEAL has guided ROC of about 20% from FY16 and has the potential to generate ROC of 56% in FY19.

Aggressive Center Expansion


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Aggressive Center Expansion


THEALs management has been

aggressive and has been adding about

80 preschools over the last four years at

a CAGR of about 60%.

THEAL plans to add about 350

preschools over the next three years

from the current 300 self operated

preschools and thus more thandoubling the center count.

THEAL has also planned to increase its

franchisee base from the current 79 to

about 260 as it moves to newer

locations in Tier-2 and 3 towns.

Given that the new centers take a

turnaround time of 2 years time, we

believe there is enough earnings

visibility in the stock.

Strong PE Interest & Good Management


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Strong PE Interest & Good Management


THEAL has started its business in 2003 and is run by first generation entrepreneurs Rajesh & Geeta Bhatia.

The couple started the first THEAL pre-school in Mumbai with their life savings after looking at the lack of

quality pre-schooling opportunities for toddlers.

THEAL has attracted strong PE interest in the company from FY08 and has been consistently receiving funds

from PE investors till 2012. THEAL had come out with an IPO in August 2011to the tune of Rs.112 Cr and thestock was listed in both NSE and BSE.

Promoters are extremely confident of the business and this can be seen from their increasing stake in the

company through Warrant Issuances and Open Market buying. In fact Warrants were being issued around

the current Market price which should give us some confidence.


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Financials


Earnings Projection P&L Account


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Earnings Projection P&L AccountTHEALs revenues are expected to grow by

43% and 32% in FY14 & FY15 driven by

improved capacity utilizations and

contributions from new centers.

THEAL has EBITDA margins in the range

54%. We estimate EBITDA margins of about

54.5% in FY14 and FY15 on the back of

improved economies of scale.

THEAL is likely to report PAT of Rs.47.09Cr

in FY14 and Rs.60.78Cr in FY15 with an EPSof Rs.13.09 and Rs.16.90 in FY14 and FY15

respectively.

THEALs interest cost in FY 13 was at

Rs.6.62 Cr and is expected to be about

Rs.9.79 Cr and Rs.12.97 Cr in FY14 and FY15

respectively.

THEALs depreciation in FY13 was at

Rs.13.38Cr and is likely to be at Rs.17.95 Cr

and Rs.23.77 Cr in FY14 and FY15

respectively.


Particulars FY12 FY13 FY14E FY15E

Net Sales 77.21 114.28 163.16 216.09

% Chg 96.76 48.01 42.77 32.44

Total

Expenditure 35.19 52.47 74.24 98.32

% Chg 57.66 49.10 41.49 32.44

EBITDA 42.02 61.81 88.92 117.77

EBITDA

Margins(%) 54.42 54.09 54.50 54.50

Interest 6.5 6.62 9.79 12.97

Depreciation 7.8 13.38 17.95 23.77

PBT 31.17 48.65 68.25 88.09

PAT 21.66 33.34 47.09 60.78

EPS 6.43 9.27 13.09 16.90

Concerns & Reasoning


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g


1.) Steep increase in competition :

The education sector in India is largely unorganized and the business of pre-schools is highly fragmented

and competitive. In addition to competition from unorganized players in the pre-schools business, THEAL

faces a lot of competition from organized players in the market where it competes with various pre-schoolslike Kidzee, Euro Kids, and Roots to Wings.

2.) Geographic al Concentration:

Of the total 379 pre-schools, more than 40% are located in and around Mumbai metropolitan. This

suggests a geographical concentration risk to the company.

3.) Regulatory Changes:

Circulation Operating pre-schools and providing educational services to K-12 schools are currently

unregulated, but the government may introduce a regulatory framework in future. Any such government

regulation, and THEALsinability to comply with the same, may adversely affect its revenue.

4) Expansion Risk:

The company plans to invest in pre-schools nationally to de-risk its business. However, due to increasing

competition and lack of knowledge on the local market may result in the companies business not being able

to scale upto expectations. The inability of the company to scale up its business in new geographies will

adversely affect its margins and profitability.

Price Chart


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THEAL had corrected sharply during the past year from

Rs.302 to Rs.217 after a sharp run post its IPO.

The Stock has exhibited volatility during the year and we

believe that the current share price is a great accumulation

zone for Investors with a long term perspective.

Technically the stock has strong support at Rs.210 levels

and hence there is limited downside risk at the current

Market price of 220 Rs.


Share Holding

%

Dec Sep Jun Mar

2013 2013 2013 2012

Promoters 30.87 29.27 27.75 27.75

FII 1.16 1.19 1.28 1.56

DII 10.22 10.65 10.87 10.94

Others 57.75 58.89 60.10 59.75

Conclusion


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Indiasdeveloping economy has created several Niche sub-sectors which are growing at a very fast rate

owing to increased Urbanization, Affordability, Aspirations etc. Companies which are market leaders in these

Sub-segments are companies which can deliver strong Investor returns. These are generally good hunting

spots for Multibagger Investors as most of these companies are currently Small-Cap and they have the

potential to grow into a Blue-Chip over the next 10 years. Most of our Multibagger ideas can be fit into thistemplateAstral Poly, Cera Sanitary ware, Poly Medicure, Mayur Uniquoters, PVR etc.

Similarly Pre-Schools is one such segment which has the potential to become a really large business

going forward. THEAL being the countrys largest self-operated Pre-School chain has the potential to grow

multifold going forward. More importantly, THEAL being in Education sector gives it the added advantage of

Revenue stability and lower earnings risk. We would like to view THEAL as a young Apollo Hospitals or PVR

in the making.

THEALs biggest positive is the high Return on Capital nature and Free Cash flow nature of its Pre-

School business. The company has other advantages in the form of healthy Balance sheet, credible

Management, strong Growth etc. The companysexpansion plans also provides decent visibility on earnings

growth and an improved scale of business.

Despite being a Small cap stock, THEAL doesnthave the usual risks associated with Small cap stocks

such as Governance issues, high Earnings volatility, Investor neglect etc. We believe that the companys

earning growth of 30%+ should deliver strong Investor returns and any improvement in its valuation is just

an added bonus. Price risk is lower and Earnings growth combined with a Re-rating would help the

company to deliver strong Multibagger returns to Investors.


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