High valuation makes Tree House offer a case to stay away

K.Venkatasubramanian | Updated on August 10, 2011

Investors can refrain from subscribing to the initial public offering of Tree House Education & Accessories (Tree House), a pre-school education provider given the expensive valuation of the issue.

The company's limited offerings in the educational value chain, competition from entrenched players and relatively low barriers to operate in the industry resulting in heavy fragmentation are added deterrents.

At the upper end of the price band (Rs 135-153), Tree House asks for a price-earnings multiple of over 42 times its FY11 financials on a pre-offer equity base and 56 times on a fully diluted basis. This is at a steep premium to large-sized entrenched players such as Educomp Solutions and Everonn Education, which are in the broader education sector, and are available at 7-13 times trailing earnings in the secondary markets. Tree House has had a fairly impressive growth in its financials over the last 3-4 years, albeit from a low base. The company's revenues have grown at a compounded annual rate of 96.5 per cent over a three-year period to Rs 41.2 crore in FY11. Net profits stood at Rs 9.2 crore.

Business challenges

Tree House is predominantly an operator of a chain of pre-schools – 223 of them. Of this 149 of them are self-operated, while the rest are let out as franchisees. It has also recently forayed into broader K-12 system.

The company's strategy of driving its own ventures rather than adopting a franchisee model has helped it have a certain level of quality control.

The K-12 education system comprises levels from kinder-garden to grade 12. The company's focus on pre-school therefore limits its offerings to one end of the value-chain.

This means that Tree House would not find it easy to drive scale and revenues as its model makes it dependent mostly on fees paid by students joining its institutions as also derive periodic increases, which may not be easy.

Educomp, for example, offers multimedia driven content for subjects across the K-12 spectrum, apart from operating schools and having a major presence in the pre-school segment.

Everonn too has significantly wide range of offerings, though at a lower scale compared to Educomp.

Also, competition from the likes of Educomp, Kidzee and Kangaroo Kids would mean pricing pressure on the company.

The pre-school industry is expected to grow at annual rate of 20.6 per cent to Rs 13,300 crore by FY16, according to a report from Crisil. These are not scorching growth rates compared to other educational segments.

Even if Tree House grows at a much faster clip, it would still be a stretch in terms of justifying valuations.

The other key challenge before organised pre-school players is that the segment is highly fragmented. There is a considerable number of small players across cities that operate pre-schools, given that the segment does not require huge investments on infrastructure and also remains largely unregulated.

Many regular schools themselves have started having a pre-school section to cater to demand, which could further erode the market share for the likes of Tree House.

The company also has a concentration risk by having 104 of its pre-schools in Mumbai alone. Although this market may be deemed lucrative, it limits the potential to become a pan-India player as the company does not drive growth through franchisees.

The issue

Tree House is looking to raise about Rs 129 crore from the IPO for expansion of its pre-school business, construction of infrastructure for an educational complex and repayment of loans among others. JM Financial Consultants and Motilal Oswal Investment are the book running lead managers to the issue. The offer closes on August 12.

Published on August 10, 2011

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