RESULT UPDATE Dipen Shah dipen.shah@kotak.com +91 22 6218 5409 NIIT LTD (NIIT) PRICE: RS.84 RECOMMENDATION: BUY TARGET PRICE: RS.96 FY18E P/E: 10.3X NIIT's 4QFY16 performance was a mixed bag for us with revenues beating estimates but margins falling short. Revenue growth was largely led by CLS, which saw revenues grow by 12% YoY in CC terms. S&C also reported growth of 5% on a YoY basis, bettering the 2.5% growth witnessed in 3Q and 0.6% growth in 2Q. Margins improved by 217bps on a YoY basis, below expectations. NIIT invested Rs.22mn in on-line initiatives without any corresponding revenues, impacting overall profitability. NIIT has shown improvement in revenue growth and margins over the past four quarters. We remain optimistic on the future prospects of NIIT. NIIT has also launched new programs in S&C business and added new clients in CLS, which should support future growth. We await more clarity on growth prospects and the corresponding profitability in the Skills business as well as the on-line business, though. Our FY17 and FY18 EPS estimates stand at Rs.6.5 (Rs.6.8) and Rs.8.2, respectively. Our DCF-based PT stands revised to Rs.96 (Rs.92 earlier). We maintain BUY. 4QFY16 results - Mixed bag Summary table (Rs mn) FY16 FY17E FY18E Sales 10,069 11,202 12,449 Growth (%) 5.2 11.3 11.1 EBITDA 711 901 1,156 EBITDA margin (%) 7.1 8.0 9.3 Net profit 652 1,068 1,352 EPS (Rs) 3.9 6.5 8.2 Growth (%) (147.0) 63.7 26.5 CEPS (Rs) 6.9 9.5 11.3 BV (Rs/share) 48.6 53.2 59.3 Dividend / share (Rs) 1.8 1.8 2.0 ROE (%) 8.5 12.7 14.5 ROCE (%) 1.3 6.7 9.4 Net cash (debt) (918) 207 1,344 NWCapital (Days) 13.6 14.0 13.8 P/E (x) 21.3 13.0 10.3 P/BV (x) 1.7 1.6 1.4 EV/Sales (x) 1.5 1.2 1.0 EV/EBITDA (x) 20.8 15.2 10.8 Source: Company, Kotak Securities - Private Client Research NIIT's 4Q revenues beat estimates but margins disappointed (Rs mn) 4QFY16 3QFY16 QoQ (%) 4QFY15 YoY (%) Income 2389 2623-8.9 2235 6.9 Expenditure 2256 2460 2159 EBIDTA 133 163-18.4 76 75.0 Depreciation 116 117 151 EBIT 17 46-63.0-75 -122.7 Interest 0 0 0 Other Income -14-67 -47 PBT 3-21 -114.3-122 -102.5 Tax 14 5-12 PAT -11-26 -110 Share of profit 169 163 154 Adjusted PAT 158 137 15.6 44 259.2 E O items 0 0-1556 Shares (mns) 165.2 165.2 165.2 EPS (Rs) 1.0 0.8 0.3 EBIDTA (%) 5.6 6.2 3.4 EBIT (%) 0.7 1.8-3.4 Net Profit (%) -0.5-1.0-4.9 Source: Company S&C revenues reported YoY growth for third successive quarter S&C revenues grew by 5.2% YoY, after reporting a 2.5% growth in 3Q and a 0.5% rise in the previous quarter. This is the third successive quarter of YoY growth in this business and reflects the benefits of the turnaround strategy adopted for the domestic and Chinese markets. The growth rates of S&C are being driven by the Beyond-IT courses and Skill courses. Beyond IT business grew by 41% YoY and formed 45% of revenues (38% in 3Q, 40% in 2Q and 39% in 1Q). Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 8
The muted growth in IT course revenues reflects the continuing negative sentiments in the minds of the prospective students. We opine that, despite some momentum in the revenue growth of IT services exports industry, recruitments have not picked up as companies try to improve utilization rates, look at just-in-time hiring and also increase non-linear revenues. While the higher capacity utilization levels at major IT companies in recent quarters do provide an opportunity, the bend towards non-linear revenues can pose a challenge to S&C, going ahead. However, we do believe that, if the IT services exports continue to do well, the positive sentiments will rub-off on NIIT over the next few quarters. Overall enrolments were at 65,942, in line with the 65,989 enrolments in the previous quarter. The capacity utilization of own centres was at around 34% in FY16 as against 31% as at FY15-end. New programs to support growth in Beyond-IT NIIT has been introducing new programs to improve the growth rates in the Beyond-IT business. In 4Q, it launched DigiNxT, a program entailing training on future technologies like Big Data, Robotics, Virtual Reality, Java Enterprise Apps with Dev ops, Artificial Intelligence, machine Learning, etc. During the previous quarter, it introduced new programs with HP and Metascale. While the partnership with HP has led to a new certificate course in Software Testing, NIIT has attacked the Big Data market through its tie-up with Metascale. We believe these are high-growth opportunities, with Big Data professionals seeing significant demand in the new Digital world. We expect these programs to attract significant enrolments, in line with the demand seen for 'StackRoute.' StackRoute and Niit.tv scaling up NIIT has already introduced StackRoute - a specialised program offering training across various technologies. This is directed at IT companies, which can use this program to re-skill their employees, especially in emerging areas of digital technologies. Individual students can learn the full stack of digital technologies, with a view to enter the start-up world and also develop IPs. The first batch of 72 students was initiated in 2Q (average fees Rs.200,000 / student) and two new batches were started in 3Q, which have been oversubscribed already. According to the management, as at 4Q, multiple batches have been oversubscribed. Niit.tv is an initiative which is offering courses free of charge (as of now) on the net. It is an extension of the cloud-based training being currently offered to NIIT students. This initiative has increased visibility for NIIT and will help the company in moving ahead towards its target of skilling 10mn students over the next five years. As at FY16 end, Niit.tv had 235,000+ users across 161 countries. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 9
Investment on Rs.22mn in on-line initiatives NIIT has invested Rs.22mn towards its on-line strategy in 4Q, without any corresponding revenues. NIIT plans to continue investing in its on-line initiatives in FY17 and we believe that, the overall investment is expected to be around Rs.70-80mn. The management expects a negative impact of Rs.50mn at the EBIDTA level in FY17. We expect a part of this to be capitalized and the balance to impact the profitability of the company, as minimal revenues are expected to accrue during FY17. The management has guided for a commercial launch of this initiative in 1QFY17. CLS revenues (USD terms) grew at 12% QoQ in CC terms Revenues in the CLS business grew by 12% YoY in CC terms, which is impressive. Revenues were marginally higher than estimates. Revenues rose as the contracts won in the past few quarters started scaling up at a rapid pace. The business has been scaling well, especially in the back-drop of good order wins by the company in Managed Training Solutions (MTS) business. Managed Training Services has continued to be the growth driver for NIIT. Revenues from MTS formed 90% of CLS revenues in 4QFY16 as against 91% in 3Q, 90% in 2Q and 89% in 1Q. After transferring the Element K business, the company has been left with about 1/3rd of the overall revenues in CLS. Of this, about 90% is contributed by Managed Training Services (MTS), which has been growing at a very fast pace. The business signed 4 new customer in 4Q, the largest number of customers signed in a quarter, till date. It had added one customer each in the past three quarters. NIIT is developing into a major player in the MTS business with 31 clients. Most of these are large corporations. We believe that, with the developed economies likely stabilizing, the opportunity is huge and demand may pick up over the next few quarters. The contribution of CLS to NIIT's EBIDTA was at about 76% in FY14 and 128% in FY15 (S&C reported negative EBIDTA) and is expected to remain significant at about 84% in FY17 / 80% in FY18. Thus, CLS profitability will greatly influence NIIT's margins in the near term. We expect CLS profits to grow strongly in FY17 and FY18. NIIT is now turning its focus to the domestic markets and will be offering learning solutions to corporates in India, on a selective basis. Revenue break up (Rs mn) 3QFY16 4QFY16 4QFY15 Skills & Career 828.00 728.00 692.00 Institutional 209.00 301.00 386.00 Corporate 1586.00 1360.00 1157.00 Source: Company Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 10
SLS (Institutional) business reported strong QoQ growth SLS revenues grew by almost 50% on a sequential basis to Rs.301mn. On a YoY basis, they were down sharply, though. The YoY de-growth came about due to discontinuance of 2 state Government projects of 698 schools in 1QFY16. The company had completed 2 school projects each in 1QFY16 and 4QFY15. These projects had covered 698 and 531 schools, respectively. The QoQ growth came about on the back of increased traction in non-government schools and also seasonality (1QFY17 revenues will be lower QoQ). The focused IP-led private schools business contributed about 36% of 4Q revenues and 28% of FY16 revenues. This was at 20% in 3Q and at 26% in 2Q. The business added 122 non-government schools to take the total number to 2963. The company witnessed continuing momentum in IP based orders. N Guru, the company's offering in the private schools business is gaining increasing acceptance, as is reflected in the additional schools bookings. Details on strategic initiatives for K-12 business awaited NIIT has hived off its K-12 learning business (Revenues of Rs.209mn) into a separate subsidiary named MindChampion Learning Systems Ltd. This separate subsidiary will invite strategic partners and chart its own independent growth path. We await further details on the same. However, we feel this is an emerging business with significant potential. NIIT to participate in 'Skill India' initiative; finer details awaited NIIT has announced that, it will impart skill-based training to 10mn students in 16 different sectors over the next 5 years. These sectors are largely in the services arena though the company will also provide skills in manufacturing sectors at a later date. NIIT is clear that, it will be selective in choosing courses and will select only those courses wherein the working capital requirements are minimal. We are encouraged by this decision of the company. NIIT is already working with the Government on the Skills initiative. However, a significant scale up will be seen only over a period of time, we understand. We would like to get further details on the scale up plans of NIIT, funding commitments, profitability levels in this business, etc. The funding of courses will be important because the Government may not be able to fully or substantially fund these numbers. Thus, it remains to be seen as to how many students are able to fund their skill requirements. There may be initial headwinds which may restrict the pace of growth in this business and there may be a corresponding impact of the profitability levels of the business. We have assumed steady growth in the S&C business as well as improvement in margins in FY17 and FY18. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 11
Cloud expected to be a growth driver for S&C NIIT is now focusing on the Cloud Campus as the next growth area for this business. The company has invested significantly in building the Cloud infrastructure which had impacted margins during FY13. About 70% of the physical outlets are now cloud-enables and so are 78% of the courses. 80 courses are now QP-aligned. We expect this to be a driver of future revenue growth. We believe that, successful acceptance of this model can lead to faster roll-out of programs, wider reach of programs as well as better employee productivity, leading to higher revenues and margins. Margins rose YoY; came in lower than estimates Headline margins for the quarter were higher by 217bps YoY to 5.57%. The main contributor was the S&C business where company reported (-)2.6% margins as compared to (-)11.3% in 4QFY16. S&C margins have shown YoY improvement for the third successive quarter and that is a positive. CLS maintained margins at about 11.6% QoQ. CLS had the tailwind of the depreciating rupee and that helped margins sustain on a YoY basis. NIIT has been reinvesting the benefits of the rupee, to improve growth rates. In fact, CLS margins have been stable for the past 8 quarters now. The rise in margins comes on the back of an improvement in profitability in the first three quarters also. The company had initiated a restructuring exercise in 4QFY15 and had reorganized its business. This had a beneficial impact on profitability in 1QFY16. Consolidation, including capacity recalibration, had led to lower cost during the quarter. NIIT has reduced several of the low-margin owned centres as well as reduced number of business associates. It has also reduced geographical presence by shutting down smaller locations. Moreover, the company has also cut down on the number of courses offered from 200 to about 100. Increased implementation of Cloud Campus also helped in restricting the impact on margins. The company has exited several geographies and is also rationalizing capacity to cut costs and improve profitability. The fixed cost base in 3QFY15 in this business was about Rs.550mn, which included people, facilities and marketing spends. NIIT has brought the same down by about Rs.60mn on a quarterly basis. With the cost rationalization exercise, NIIT was looking at annualized savings of about Rs.252mn over the next few quarters. The same was already achieved in 1Q. EBIDTA margins (%) 3QFY16 4QFY16 4QFY15 Skills & Career 0.60-2.61-11.27 Institutional -11.96 5.32 4.92 Corporate 11.60 11.62 11.67 Source: Company Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 12
Future prospects We have our tweaked our FY17 and FY18 earnings. We have built in an improved scenario for the S&C and CLS businesses (on assumption of improvement in developed economies) and have also assumed profitability improvement due to the cloud initiative. We expect the S&C business to report 6% growth in revenues in FY17 and an 8% growth in FY18. CLS revenues are expected to rise by 14% and 13%, respectively. Revenue break up (Rs mns) FY15 FY16 FY17E FY18E Skills & Career 3284.00 3326.00 3518.38 3792.96 Institutional 1412.00 1064.00 1181.55 1262.94 Corporate 4878.00 5679.00 6486.91 7345.99 Source : Company, Kotak Securities - Private Client research We have assumed margins to improve to 8% in FY17 and 9.3% in FY18. The cloud initiative is expected to help improve the S&C margins. Also, the recent restructuring initiatives like exit from various locations and rationalization of capacity should support margins. NIIT has achieved annualized savings of Rs.250mn from these initiatives. On the other hand, SLS margins are expected to rise on higher contribution of private schools and lower bought-outs. CLS should see margins improve due to higher proportion of MTS revenues. The on-line initiative is expected to negatively impact margins in FY17 and to a lesser extent, in FY18. After accounting for its 24% share in NIIT Technologies' profits, we expect the net profit to be at Rs.1.35bn in FY18. EBIDTA margins (%) FY15 FY16E FY17E FY18E Skills & Career -5.4 1.5 2.7 3.9 Institutional 4.0 2.2 7.0 8.0 Corporate 11.6 11.6 11.8 12.6 Source: Company, Kotak Securities - Private Client research We maintain BUY on NIIT Ltd with a price target of Rs.96 Valuations and recommendation The performance in FY16 inspires optimism. The initiatives taken by the new management have led to consistent improvement in revenue growth and earlier-than-expected benefits on margins. We are optimistic about the growth in CLS as well as on the S&C business. While we have upgraded our estimates for the CLS and S&C businesses, we await more clarity on growth prospects and the corresponding profitability in the Skills and online businesses. At our TP of Rs.96, FY18E earnings will be discounted by 11.7x which, we feel, is reasonable. We maintain BUY. Concerns A slower-than-expected recovery in the global economy could impact revenue growth of NIIT. Steep rupee appreciation v/s major global currencies may impact the financials of NIIT. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 13