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NIIT Limited: Change in focus! - Views on News from Equitymaster

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NIIT Limited: Change in focus!
Aug 4, 2006

Performance summary
NIIT Limited (NIIT) recently announced its consolidated financial results for 1QFY07. The company has recorded a fairly sluggish growth in its net revenues, which was mainly a result of a gradual de-focus on the institutional government business. This business declined by nearly half, while the performances of the other 2 businesses – individual and corporate – were fairly strong. Margin expansion was seen this quarter, entirely a result of strong operating leverage witnessed in the key individual business, where margins powered ahead by nearly 12%. However, despite the stronger margins, a considerable fall in other income and higher depreciation charges led to the bottomline remaining virtually stagnant.

Consolidated financial performance: A snapshot
(Rs m) 1QFY06 1QFY07 Change
System-wide revenues 1,566 1,637 4.5%
Net revenues 1,064 1,102 3.6%
Expenditure 920 948 3.0%
Operating profit (EBDITA) 143 154 7.5%
Operating profit margin (%) 13.4% 14.0%  
Other income 46 23 -50.9%
Depreciation 86 106 22.1%
Profit before tax 103 71 -31.0%
Tax 7 (6)  
Share of profits from associates 35 54 56.1%
Profit after tax/(loss) 131 132 0.3%
Net profit margin (%) 12.3% 11.9%  
No. of shares (m) 19.3 19.3  
Diluted earnings per share (Rs)*   21.4  
P/E ratio (x)*   16.9  
* On a trailing 12 month basis

What is the company’s business?
NIIT is India’s premier IT training company and is nearly four times the size of its next-largest competitor, Aptech. The company has a major presence in the fast-growing retail segment, which, by and large, caters to the staffing requirements of the Indian IT and BPO sectors. The company derives a significant share of its revenues from the international retail segment as well. NIIT also operates in the institutional/government segment, where it executes projects relating to provision of IT education to schoolchildren throughout the country. Apart from the above segments, the company earns nearly 40% of its revenues from the corporate segment, where it provides learning solutions, e-learning and content development solutions to technology and other companies mainly in the US and the UK.

What has driven performance in 1QFY07?
‘Institutional’ misery: In 1QFY07, NIIT recorded a mere 4.5% YoY growth in its gross (owned plus share of franchise revenues) revenues, while net revenues (revenues from owned centres) grew at an even slower pace of just 3.6% YoY. The major reason for this poor performance has been a clear de-focus by the company on the government segment. This business saw a decline of over 46% YoY, and was the chief culprit in net revenue growth being sluggish this quarter. Excluding the institutional business, NIIT’s revenues from the other 2 segments, viz. individual and corporate, grew by a strong 25% YoY. The management has said in the conference call that the company is looking at de-focussing on the government business, which is highly capital-intensive, low-margin and highly competitive. The business is also characterised by lumpiness and significant levels of volatility. NIIT is focussing more on the private schools business in this segment, which grew at a decent 24% YoY. The order intake this quarter was just Rs 13 m, and the outstanding order book stood at Rs 1,487 m at the end of the quarter, with around 44% executable over the next 12 months.

As regards the individual segment, it saw the strongest growth of over 33% YoY in net revenues in 1QFY07. This business continues to expand at a rapid pace, driven by the strong growth witnessed in the Indian software services industry. In fact, the India business saw a scorching 58% YoY growth, and the management has said that this is in line with the company’s goal to grow at a faster pace than the software services industry. Revenues from China grew by a strong 25% YoY as well. The ‘Careers’ segment continues to contribute the lion’s share of revenues to the individual business, at 91% in 1QFY07.

On the other hand, the corporate business also continues to see strong traction, growing at a decent pace of over 17% YoY during the quarter. The company saw an order intake of US$ 15.1 m this quarter, while the outstanding order book stood at US$ 35.0 m, at the end of the quarter, with around 61% executable over the next 12 months. NIIT won 8 new customers, including 2 technology companies, during the quarter.

Segment-wise performance…
(Rs m) 1QFY06 % of total 1QFY07 % of total Change
Individual
System-wide revenues 874   1,028   17.6%
Net revenues 371 34.9% 494 44.8% 33.1%
OP 12 8.0% 74 48.0% 542.6%
OPM 3.1%   15.0%    
Institutional          
Net revenues 319 30.0% 171 15.5% -46.4%
OP 61 42.3% 12 7.5% -81.0%
OPM 19.0%   6.7%    
Corporate          
Net revenues 373 35.1% 438 39.7% 17.4%
OP 71 49.7% 69 44.5% -3.6%
OPM 19.1%   15.7%    
Total          
System-wide revenues 1,566   1,637   4.5%
Net revenues 1,063   1,102   3.8%
OP 143   154   7.6%
OPM 13.5%   14.0%    

During the quarter, NIIT also ventured into 3 major new businesses – banking and finance training, e-learning and testing services. The objective is to leverage its strong training expertise and utilise this in newer verticals. NIIT has set up three institutions – IFBI (Institute of Finance, Banking and Insurance), NIIT Imperia (Centre for Advanced Learning) and Litmus, to cater to the respective areas mentioned above. The company expects these new businesses to contribute around 15% of its revenues by FY09. During the quarter, NIIT commenced short-term programs through IFBI, training 587 sponsored candidates. The company will publicly launch this business in 2QFY07 through 6 centres. NIIT Imperia has also entered into 2 premier tie-ups with the Indian Institutes of Management, Calcutta and Indore (IIM-C and IIM-I), and is also launching in 2QFY07 through 6 centres. Litmus, on the other hand, has prospective customers in the pipeline, and will commence business in 2QFY07.

Margins empowered by ‘individuals’: During the quarter, NIIT recorded a marginal 50 basis points (0.5%) expansion in its operating margins This was entirely contributed by the individual business, which continues to witness substantial operating leverage. Capacity utilisation in this business increased from 39% in 1QFY06 to 59% this quarter, and the results are clearly visible – a near-12% expansion in margins in this segment, and operating profits in absolute terms up by more than six-fold.

The company has, in the past, mentioned that steady-state margins in this segment would be between 20% and 25%, at 65% capacity utilisation. Therefore, going forward, there is still further scope for improving margins in this segment. Given the strong performance of the Indian IT-BPO industries and expectations of continuing strong performances in future, and NIIT’s leadership position in the industry, this appears to be well within the company’s grasp.

However, the institutional business margins totally reversed the trend, witnessing a significant 12% fall in margins. Operating profits in absolute terms were down by as much as 81.0% YoY. The corporate business, on the other hand, saw a 3.4% fall in margins. Thus, this quarter, it was entirely the individual business that contributed to the margin expansion.

Lower other income, higher depreciation weaken the bottomline: Despite the higher margins, the bottomline this quarter increased only marginally. This was mainly due to considerably lower other income (down by over 50% YoY) and higher depreciation charges.

Performance in the recent past…
  2QFY06 3QFY06 4QFY06 1QFY07
System-wide revenue growth (%, YoY) 12.1 12.6 11.0 4.5
Net revenue growth (%, YoY) 11.9 22.2 10.0 3.6
Operating margins (%) 14.1 11.3 14.4 14.0
Profits growth (%, YoY) 11.7 14.1 1.2 0.3
Employees (Nos.) 1,995 2,103 2,259 2,424

What to expect?
At the current market price of Rs 362, NIIT’s stock is trading at a price to earnings multiple of 16.9 times its trailing 12-month earnings. This quarter, the company has announced that it has acquired a company, Element-K, which is a US-based provider of learning solutions, having clients in the US and Canada. The company has over 3,500 recognised courses, and records US$ 80 m in annual revenues. NIIT has acquired the company for a consideration of US$ 40 m, thus giving the transaction a price-to-sales multiple of 0.5, which seems quite reasonable. However, it should be noted that Element-K has very low operating margins. In fact, it has just turned around, and NIIT expects it to be EBITDA-neutral in FY07, and earnings-accretive in FY08. The combined size of the entity would be US$ 250 m, amongst the top few learning solution companies globally.

Going forward, given that the IT industry is expected to show strong growth between 25% and 30% annually over the medium-term, the improvement in sentiment for IT as a career and favourable trends in recruiting IT personnel, we believe that NIIT, with its market leadership position, could be a major beneficiary. The increase in corporate spends on training in the US, new product launches by technology majors like Microsoft and greater interest in training outsourcing from European corporates also provide NIIT with a good opportunity to grow at a faster rate in the medium-to-long term. Long-term initiatives, such as partnering with technology giants like Microsoft and Intel, and expanding its global footprint into newer regions like Europe, are expected to give newer revenue-enhancing areas to NIIT. The new business initiatives taken by the company also enthuse us. However, risks, such as the volatile nature of the Institutional business and its lower margins, could play spoilsport. Overall, we maintain our positive stance on the company.

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