NIIT Limited: Our key assumptions

NIIT Limited (NIIT) is India's largest IT education and training company. The company has a presence across the country and caters to the retail, institutional (government) and corporate segments. NIIT also derives a significant portion of its revenues from international business (53% in FY05). It has a presence in over 30 countries. In FY04, the company segregated its businesses into software services and IT education. This was done in order to enable the company to focus separately on these two businesses. Based on the expected performance of the industry, the company and interactions with the management, we have incorporated the following key assumptions for the next three years.

Retail segment to drive revenues: We expect NIIT's retail segment to be the major driver of revenues over the next three years, from FY06 to FY08. This segment of NIIT tracks employment growth in the IT industry, albeit with a lag. The attractiveness of IT as a career has improved since the dot-com bust and students are beginning to enroll for long-term courses, such as GNIIT, the company's flagship course. The re-skilling segment (CATS) is also gaining prominence. With technology becoming obsolete at a fairly quick pace, the need for practicing IT professionals to upgrade their skills is pronounced. NIIT caters to this segment and has been witnessing a good growth here as well.

We expect the Careers segment's (GNIIT + re-skilling segment) share to increase to around 91% of total retail segment revenues by FY08, from 87% in FY05. The major drivers according to us will be an average 30% increase in enrolments each year from FY05 to FY08 (242,000 to 538,000) along with an increase in average revenues per enrolment. Given the fact that IT education in any case is a regular part of basic school curriculums, we expect the share of the Non-careers segment (IT literacy) to steadily reduce, a trend that is already playing out.

Margin improvement: We expect the operating margins of NIIT to improve from 11.9% in FY05 to around 16.0% by FY08. This is likely to be driven by the retail segment. This segment broke-even at the operating level in the December 2004 quarter and has witnessed expansion in margins. This business is characterised with a high operating leverage. Thus, the higher the capacity utilisation levels, the better will be the margins.

It should be noted that margins in this business are still at sub-optimal levels and the management, in a recent conference call, has said that it expects to achieve steady-state margins in the retail segment (between 20% and 25%). In 2QFY06, they were just a little over 13%, giving a lot of scope for further improvement. We expect that, as capacity utilisation increases to around 55% to 60%, the operating margins of around 20% will materialise, providing a further push to the overall margin profile. Other factors driving the improving margins include increasing proportion of revenues from self-owned centres as opposed to franchised centres and better pricing for higher value-added courses.

Institutional business subdued: We expect the institutional segment of NIIT to grow at around 10% annually till FY08, considerably lower than overall revenue growth. This is mainly due to the fact that this business tends to be lumpy in nature. The government takes time to make decisions and as a result, orders do not consistently flow through on a regular basis. Also, NIIT recently completed a big order (in Tamil Nadu) and as a result, revenues from the same will exhaust and to that extent, there will be a decline. This will further increase the volatility of this business and in the event of NIIT not being able to win further orders in the near future, there exists a risk to our assumptions.

Corporate business steady: We forecast NIIT's corporate business revenues to grow at a fairly steady clip of around 15% till FY08. Our interactions with the management have led us to believe that this segment will grow at about the same pace as the overall topline. It must be mentioned here that NIIT has forayed into the UK market for greater traction in this business, which till now, was almost entirely based out of the US. Hence, this will give NIIT some geographical diversification. The estimated market size for NIIT in the corporate segment is US$ 20 bn and given the continued strength seen in the US economy, there seems to be good untapped potential.

What to expect?
At the current market price of Rs 291, the stock trades at a price to earnings (P/E) multiple of around 8.4 times our estimated FY08 EPS. With strong visibility in the software industry, as a supplier of key human resources to the sector, NIIT is likely to benefit. However, slower-than-expected order wins in its institutional and corporate business are likely to result in the company not performing to our expectations and as a result, the stock's valuations getting adversely impacted.