Ajay Relan | Outlook Business
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Vishal Koul

My Best Pick 2015

Ajay Relan
CX Partners' managing partner feels Careerpoint is back on track with a stronger business model

For this year’s edition of My Best Pick, my search for a multi-bagger took me far longer than usual. The reason being that all the stocks that represent the attributes that I find attractive are already priced at stratospheric levels thanks to the rally seen over the past one year. So, this time around, I decided to pick a fallen angel — a company once the darling of the bourses, eventually faltering in its business, leading to its stock price dropping sharply. But now its business model is back on track with improved metrics and, more importantly, the stock is still cheap.

Before I discuss the company that I have chosen to put my money on, it is worthwhile to recount the characteristics a company should have for it to be an alluring investment bet. First, I like companies working in the services sector as opposed to manufacturing, simply because as an economy, India is globally competitive in the services arena.

Second, I like companies that can grow and scale up without consuming capital and are aggressive free-cash generators. Third, their customers should not be other businesses but thousands of consumers, enabling them to have pricing power (that is, if they have nurtured a brand that delivers superior service consistently) and resulting in healthy and sustainable profit margins.

Course correction

After a major drop, Ebitda margin has begun to improve with enrolments picking up

And, finally, their business should be in services that are recession-proof and not dependent on the overall growth of the economy. Of course, the overarching criterion is that the stock should be inexpensive with the potential to yield an internal rate of return of, at least, 30% every year over the next four years.

I picked up Career Point because it meets all the attributes that I have listed here. Unlike IT, financial services or healthcare, the education industry — despite its early promise — has not lived up to its potential. As a consequence, investor interest waned in this sector, leading to tepid valuations. Career Point is a prime example of this malaise. It was flying high until 2011, with peak enrolments of 32,000 students for its test preparation tutorial classes — IIT-JEE, AIEEE and pre-medical.

The company had a very impressive margin of 38%. The next year was catastrophic. A change in government policy for admissions to the IITs and other engineering colleges led to a precipitous drop in enrollments, which kept falling and touched 20,000 in 2014 — a drop of more than 35%. Simultaneously, the company started investing in fixed assets such as building schools (3) and colleges (2). 

We saw a double whammy here — a steep fall in Ebitda margins as capacity utilisation in its asset-light tutorial business dropped to less than 50% and Ebitda margins eroded to 3%. And, at the same time, the company embarked on the cash-guzzling, asset-heavy business of setting up formal educational infrastructure with uncertainties around its break-even period. Its stock price, which was ₹700-plus in October 2010, plunged to ₹60 by August 2013.

 

Branching out

Career Point's diversified offerings across verticals make its business model very attractive

However, that was then. Today, at approximately ₹121, the stock is still cheap. Here’s why. It is one of the few companies in the services sector to be priced below its book value. In fact, the company is trading at about 40% discount to its tangible net worth. More importantly, the business model that was broken as a consequence of government action is now on the mend.

Enrolments have seen a jump of about 15% and the company should end the fiscal year with 23,000 students. It would take, in the worst-case scenario, another two years for the company to return to its previous peak. Meanwhile, its formal education assets have also started to contribute to the bottom line as they are now in their third year of gestation.

The company’s management recognises the value of an asset-light business model by divesting its formal education assets. It is a step in the right direction, although the company has done so by selling them to a sister institution and lending it the money to fund the purchase and charging the purchaser a flat annual fee of 15% of revenue made by the institutions.

The loan is interest-bearing and is expected to be repaid in four years. If the loan of ₹150 crore is retired on schedule and the company decides to sell its assets of about ₹50 crore, that are not in use (land and buildings), it will realise ₹200-odd crore in cash versus its market capitalisation of ₹220 crore. Effectively, you will be getting the company’s cash-generating asset-light business — supported by an excellent brand — virtually free. I expect Career Point to achieve a net profit of ₹30 crore by FY17.

Applying reasonable earnings multiples of between 20-25X, the stock should have a business value of about ₹600 crore-₹750 crore. And if you add cash value of approximately ₹200 crore, the company should ideally have a market capitalisation of ₹800 crore-₹950 crore, which is about four to five times its current valuation. 

In this forecast, I have ignored Career Point’s futuristic but excellent e-learning and distance-learning solutions. Career Point is much stronger than it used to be three years ago as its service offerings are more diversified today, spanning several verticals and a more natural, captive tutorial enrolment base because of the in-house formal education infrastructure currently in place. It may still be vulnerable to changes in government policies with respect to admissions in premier engineering and medical colleges and this remains the single-most significant threat to an otherwise attractive business model. 

Neither CX advisors nor I in my personal capacity hold a position in this stock.

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