I have been very bullish on Educomp (CMP Rs 1035). Over the past few weeks I had tried to do some introspection on the metioric rise this company has seen. The company was initially funded by "Carlyle"  and their experience with this investment had been bad.

 

This is what Wayne Tsou of Carlyle Asia Venture said on  Educomp .

 

“  The company dramatically underperformed. We felt the entrepreneur or promoter wasn't someone we could work with professionally. The toughest job for a VC is where to spend your time. For ones in the loser category, we liquidate. We took a haircut [by selling the stake back to the company]. You need to make sure they want your oversight on corporate governance”

 

http://www.vccircle.com/blog/_archives/2005/11/9/1362257.html

 

Generally these things do not bother me – companies deal with plenty of people each day and there are several opinions because at the end of the day it is these opinions that make up a market.

 

I therefore did some prospecting and what I found is interesting. Please note that I am not saying that all this illegal because all that the company has done is well within the rules of the land but as a far as general accounting practices go things could have been handled (presented) in a better way

Now the problem is that the company had changed the method of charging depreciation to straight line method from the written down method. This was before it came out with an IPO and is very well documented in the IPO document.

I am also told that Educomp writes off its fixed assets (computers, printers, UPS, monitors etc) at 18%. Earlier they used to write them off at 23%.Now all of us know that these things should be depreciated at more then 30%. I am not sure at what rate Infosys depreciates its equipment but it would be more then that.This practice of under depreciating the asset will make the company’s profits only optical in  nature and each year it would have to raise capital..

All this leads me into the following observations:

1)       Carlyle is a well known VC. Their bitter experience should call for some thinking.

2)       The company had a good well known auditor BSR & Co, Why did it change it into an unknown name. Anupam Bansal & CO. Something that gives me comfort is when the auditor is one of the Big 5. But with some unknown name the curiosity increases.

3)       The rate of depreciation should be far higher and at 18% the company would be left with over valued assets after a period of 3-4 years.

Now why did I overlook all this earlier? I looked at it earlier (not in such depth) but had ignored it since valuations were in favor. But now at 33 times Fy 08 we are certainly looking at an overvalued stock compared to 9 times Fy 08 when it was at Rs 260.

This stock could still go up and up and up but we need to do our homework each day.

 

Edited by basant - 03/Jan/2007 at 7:13am

Basantjee,
How much do you anticipate is the impact on the profits because of this under depreciation of computers?
Also, can you highlight a couple of pointers which should be viewed more closely to (from the balance sheet) understand management intentions. I know that already a list of this is available elsewhere on the site, but anything beyond that would be useful.

I get your point.At this moment there is no Margin of safety. Not from the valuations and not from corp governance perspective. However just for discussion sake, if tommorrow managment changes the depreciation policy in line with industry norms, will the governance concern go away? In any case, by charging less depreciation, the management is doing a disservice to the company as they have to pay higher tax, unless they are maintaining 2 separate books. Normally companies try to charge more depreciation(reliance did it very well until MAT was introduced).

Basant sir, have you laid down all these things in front of the Educomp management in e-mail or tele conversations? If yes, what was the answer like. I think at least talking once to these guys shall give an impression on what's on  their mind?