Tree House Education to enter into the capital market with an IPO of 8,432,189 equity shares

• Tree House Education & Accessories is coming up with a 100% book building; Initial Public Offering (IPO) of up to 8,432,189 equity shares of face value of Rs 10 each in a price band of Rs 135-153 per equity share.
• Not more than 50% of the issue will be allocated to Qualified Institutional Buyers (QIBs), including 5% to the mutual funds. Further, not less than 15% of the issue will be available for the non-institutional bidders and the remaining 35% for the retail investors.
• The issue will open on August 10, 2011 and will close on August 12, 2011.
• The shares will be listed on BSE and NSE.
• The face value of the share is Rs 10 and is priced 13.5 times of its face value on the lower side and 15.3 times on the higher side.
• Book running lead managers to the issue are JM Financial Consultants Private Limited, Motilal Oswal Investment.
• Company Secretary and Compliance Officer for the issue is Deepali Chandrakant Hanchate.

Company Profile:

Tree House Education & Accessories was originally incorporated as a private limited company on July 10, 2006. Tree House Education & Accessories is the leading providers of educational services in India. It operates the largest number of self-operated pre-schools in India. As of December 31, 2010, the company had 177 pre-schools under the brand name of “Tree House” across 23 cities in India. Of 177 pre-schools, 108 are operated by the Company, or self operated, and the rest are operated through its franchisees. The self-operated pre-schools serve more than 5,000 students, which does not include the students at the franchisee operated pre-schools, primarily in the age group of 1.5 to 6 years. In recent years, the company has branched into providing educational services to K-12 schools and as of December 31, 2010, the company provided such services to 12 schools which had over 5,000 students, in 4 cities in India.

For the pre-schools, the company offers standardized services and innovative teaching methodologies. It offers playschool and nursery facilities, vacation camps, mother-toddler classes, hobby classes, day care facilities and teacher training course at the pre-schools. Of all the courses and facilities offered at the pre-schools, a few including mother toddler classes and teacher training course are only available at select pre-schools. As of December 31, 2010, the Company had a team of more than 350 teachers at the self operated pre-schools.

The company provides continuous training to all of the pre-school teachers on teaching methodologies and early child care, to keep abreast with the changes in teaching methods and student needs. The company’s pre-schools are largely concentrated in the states of Maharashtra, Gujarat, Karnataka, Rajasthan and Andhra Pradesh.The company provides a wide variety of educational services to K-12 schools which include, designing curriculum and providing teaching aids, supplying methods for imparting education, organising extra-curricular activities for students and teacher training. The Company generates revenue by way of service or consultancy fees which is usually based on, (i) per child admitted to the school, for services forming part of service agreement; and (ii) lumpsum basis for services beyond the scope of service agreement. It has contracted to provide educational services to additional seven K-12 schools, based in Jaipur, Jhunjhunu, Vadodara and such other cities that will be identified by the K-12 school operators, by Fiscal 2013. In Fiscal 2010 and for nine months period ended December 31, 2010, the company’s revenue from providing educational services to K-12 schools was Rs 7.04 million and Rs 8.71 crore, respectively.

IPO Grading:

CRISIL has assigned an IPO Grade 3 to Tree House Education IPO. This means as per CRISIL, company has 'Average Fundamentals'. CRISIL assigns IPO grading on a scale of 5 to 1, with Grade 5 indicating strong fundamentals and Grade 1 indicating poor fundamentals.

Proceed is being used for:

The Company intends to utilize the proceeds of the Issue, after deducting Issue expenses for the following objects:(a) Expansion of its pre-school business;(b) Acquisition of office space;(c) Procurement of exclusivity rights to provide educational services;(d) Construction of infrastructure for educational complexes in Rajasthan and Gujarat;(e) Repayment of loan; and(f) General corporate purposes

Industry Overview:

India spends nearly 3.5% of its gross domestic product on education. The central government has been investing in promoting literacy and education; however its efforts remain largely focused on elementary schooling. Secondary and higher education have not been key priorities for the central government as in the opinion of the central government it is necessary to first create adequate infrastructure and provide incentives to universalize elementary education.

The education system in India comprises of formal, vocational and informal education. While all levels of formal education are highly regulated and fall under the purview of Ministry of Human Resource Development, Government of India (MHRD), non-formal education is unregulated.

Formal education comprises of K-12 (mainly schools), higher education and post graduation. This segment is highly regulated by various statutory bodies formed by central and state governments. The K-12 segment represents education from kindergarten to class XII and forms the largest segment within the education space in India. Meanwhile, the Informal education includes pre-schools and coaching classes for competitive exams.

In the Eleventh Five Year Plan, the central government has earmarked Rs 2,700 billion for the education sector. Elementary education (i.e., class I–VIII) will account for 50% of this spend, while secondary and higher education will account for 20% and 30%, respectively. Over the years, the central government has been making dedicated efforts to promote literacy and elementary education, resulting in highest spend on this sector. Allocation of funds for the K-12 segment grew at a CAGR of 22% from Rs 27 billion in 1999 to Rs 218 billion in 2009. Meanwhile, government expenditure on secondary school education grew at a CAGR of 18% from Rs. 9.9 billion in 1999 to Rs. 56 billion in 2009.

In order to improve the literacy rate in India, plans like SSA, MDM have been introduced by the central government. The increased focus on education has resulted in the K-12 enrolments in public institutions to grow steadily at a CAGR of about 6% from 2001-02 to 2007-08. The number of public institutions also increased at a CAGR of 7.1% to 1.06 million in 2007-08 from 0.71 million in 2001-02. The total GER improved to 67% in 2006-07 from 46 % in 2001-02. While GER for elementary education rose to 77% in 2007-08 from 50% in 2001–02, GER for secondary education went up to 39% in 2007-08 from 32% in 2001-02.

Pros and Strength:

Focus on self-operated pre-schools - The Company’s business model is focused on operations primarily through self-operated pre-schools. As of June 15, 2011, the company had 223 pre-schools under the brand name of “Tree House”, of which 149 were self-operated which represents 66.82% of company’s pre-schools. The company principally opens self-operated pre-schools in metro cities within India. According to CRISIL research, company-owned model of pre-schools have certain key advantages over the franchisee model. The company-owned model helps a company to maintain quality, hygiene and safety control.

Brand awareness and geographical presence - The Company has been successful in establishing “Tree House” as a brand which is recognized in the market for pre-schools and its quality teaching methods. The company believes that its has a proven track record of delivering quality pre-school education which has helped it grow its geographical presence across the country. The company has increased its presence by opting to establish self-operated pre-schools in metro cities and franchisee operated pre-schools in non-metro cities. It is very selective in appointing franchisees to operate its pre-schools. The company’s first pre-school was set up in 2003 which served 51 students and as of June 15, 2011, the company has grown to 223 pre-schools, out of which 149 self-operated pre-schools. As of March 31, 2011, 110 self-operated pre-schools served more than 5,000 students.

Scalable business model- The Company’s business model is scalable as the company has expanded its presence from 1 city in 2003 to 33 cities (as per municipal limits) in 2011. The number of students in company’s self-operated pre-schools increased from 51 in 2003 to 5,355 students as of March 31, 2011. In a similar manner, the number of teachers at the self-operated pre-schools increased to 378 as of March 31, 2011 from four in 2003. Towards this end, the company follows a standard design and architecture across its pre-schools. Further, the company follows a central procurement process for furniture, toys and teaching. The company’s model of centrally procuring all the material for its pre-schools assists it in economizing the costs. This uniformity adopted in running the pre-schools aids in making our business scalable.

Quality education through standardized and innovative teaching methods - In a sector which is largely unorganized in India, the company has adopted standardized and innovative methods for quality education at its pre-schools. The company implements a standardized curriculum across its pre-schools. To ensure quality education, the company maintains an average teacher student ratio of 1:14 at its self-operated pre-schools.  It trains its teachers in-house, and employ supervisors and quality control team to monitor the services in the preschools and curriculum designers to design the curriculum.

Weakness:

Limited operating history in providing educational services to K-12 schools- The company commenced the business of providing educational services to K-12 schools in 2008. As of June 15, 2011, it was having exclusivity rights to provide certain educational services to 12 K-12 schools and propose to provide such educational services to additional seven K-12 schools by Fiscal 2013. As of March 31, 2011, it had paid Rs 200.06 million as fees towards these exclusivity rights for the 12 K-12 schools. Compared to its experience in setting up and operating pre-schools, it lack experience in providing educational services to K-12 schools, which involves various risks, including execution and financing risk. The company may not have sufficient experience to address these risks, including its ability to provide educational services to schools successfully along with quality control.

Rapid expansion of the private education sector - The private education sector in India is growing rapidly due to the demand for quality education. The organized market for pre-schools is expected to grow at a CAGR of approximately 45% to reach Rs. 45,000 million in 2015-16 from Rs. 4,800 million in 2009-10. It has been projected that the total number of private institutes will further reach 0.43 million by 2015-16 and private sector enrolments to touch 127.3 million during that period. Coupled with the demand for quality education and overall increase in income levels in India, the number of pre-schools and K-12 schools is set to grow. If the number of pre-schools in India increases, the company may face competition from other pre-schools on various factors including fees. Since parents are usually sensitive towards rise in tuition fees, the company may be forced to benchmark its fees as per the market standards and it may lose its flexibility to decide the fees for its pre-schools which in turn may have a material adverse affect on the business and revenues.

Dependence on rented property for pre-schools- Of the 149 self-operated pre-schools of the company, 148 self-operated pre-schools, constituting 99.33% of the total number of selfoperated pre-schools, operate from rented properties, including premises which have been taken on rent from the Promoters. The company typically enters into leave and license agreements or lease agreements for its premises which are usually for a period of 11 months to 5 years. Further, students at its pre-schools are usually from areas in and around the location of its pre-schools. If any of its occupation arrangements are terminated or not renewed on acceptable conditions, it may be required to relocate those pre-schools and suffer disruption in the operations. The company may be unable to acquire new premises for these pre-schools and may be forced to close down some of these pre-schools, which may affect the number of students enrolled in such pre-schools.

Dependence K-12 school operator- the company is dependent on four K-12 school operators for its business of providing educational services and the performance of their obligations. As of June 15, 2011, It has entered into service agreements with four K-12 school operators for providing educational services to a total of 12 K-12 schools. Under these agreements, it pays a one-time fixed fee to the K-12 school operators to acquire exclusivity rights for providing educational services to their K-12 schools for a specified period. The fixed fee paid by it is based on management estimates and it cannot assure that it will be able to make expected rate of returns on the fee paid by the company. Further, a K-12 school operator is required to pay it  an annual service fee based on the number of students enrolled with the K-12 school or for courses conducted by the K-12 school. Any loss or financial difficulty faced by any of the K-12 school operator may have impact on the profitability.

Peer Group Comparison (Rs. in Millions)

Outlook:

Tree House Education & Accessories is the leading providers of educational services in India.  The Company’s business model is focused on operations primarily through self-operated pre-schools, that is one of the major plus point for the company. Also the Company’s business model is scalable as the company has expanded its presence from 1 city in 2003 to 33 cities in 2011. Above all The Company has been successful in establishing “Tree House” as a brand which is recognized in the market for pre-schools and its quality teaching methods.

On the concern side, the company is a new entrant in K-12 school and will be investing a good sum of issue proceeds for the purpose. Its pre-schools are mainly operating from the rented properties and any kind of lease agreement issue may force the company to shift or completely close the unit. Further the company proposes to utilise Rs. 248.90 million out of the Net Proceeds to set up an educational complex in Jhunjhunu, Rajasthan on a land, a portion of which cannot be used for educational purposes. If the approval for the conversion of land is delayed or not received, it may disrupt the schedule of development of the educational complex and limit the ability to deploy the Net Proceeds.

Tree House Education & Accessories is coming with a public issue of 8,432,189 equity shares and has fixed price band at Rs 135-153 per equity share. The issue constitutes 25.01% of the fully diluted post-issue paid up capital of the company. Based on the basic EPS of Rs 4.09 for the year ended March 31, 2011 the P/E at the lower price band comes at 33.01x while at the higher price band it comes at 37.41x. However few of its established peers are available at a better valuation. The company has an established track record of expanding branches and has strengthened its position by entry into the K-12 (Kindergarten to Class 12) segment, teacher training and other ancillary services. Though there is stiff competition in the segment because of low entry barriers and low investment required in the segment, also operating pre-schools and providing educational services to K-12 schools is currently unregulated but the governments may introduce a regulatory framework. Any such government regulation may adversely affect the operating revenues of the company as it is the sole line of its business. There is a strong demand outlook for education services in India, especially in the preschool and K-12 schools the company is present in and Tree House Education & Accessories, due to its largely self-operated model, enjoys a cost advantage over its peers who mainly follow the franchisee route. Hence we will have a positive outlook for the issue and will favour of subscribing it.

Financial performance (Rs. in Millions)