Abstract
This article is a field case on business valuation woven around the dilemma for a young EdTech firm to choose between the two opportunities that came out as collaterals to the nCOVID-19 pandemic in 2020. The selection would be based on the principle of firm value maximization, for which the opportunities needed to be valued. Students will learn the application of the venture capital (VC) model used for start-up firms. Students are challenged to apply the discounted cash flow (DCF) model and the relative valuation (RV) model, and, in the process, learn to estimate the cost of equity using the capital asset pricing model (CAPM). The case provides an opportunity to learn how to build the narrative around numbers by augmenting a discussion on the impact of a pandemic on various input variables used in the valuation exercise. The case is most suitable for the course on business valuation in management and doctoral programmes.
Discussion Questions
Calculate the valuation of EDSAI’s existing business—AcceSchool India—using the discounted cash flow model:
Suitable discount rate to be used in DCF valuation, Forecasted free cash flow to equity, Terminal value at the end of the forecast horizon (Y5), The operational intrinsic value of the business, and The non-operational intrinsic value of the business.
Calculate the valuation of EDSAI’s existing business—AcceSchool India—using the relative price-earnings multiple model.
Determine the valuation of tablet-based Edolve using the VC model.
Calculate the increment valuation that EDSAI can get by pursuing AcceSchool Global’s development.
How does the business valuation, measured under different models, change due to pandemics such as nCOVID-19?
The nCOVID-19 Outbreak
The year 2020 started on the wrong foot with the spread of the nCOVID-19 virus. On 30 January 2020, the World Health Organization declared the nCOVID-19 outbreak a public health emergency of international concern. As its outbreak widened, various countries enforced a complete lockdown that resulted in an abrupt halt of their economic activities. By 24 March, the virus had affected 385,136 people globally. Though late in catching the flu, India declared it an epidemic on 13 March 2020, with 82 infected cases and two death, and announced a 21-day lockdown, starting 24 March 2020, to contain its outburst. The capital markets could not spare the whip and were quick to reciprocate the overall sentiment. By 23 March 2020, Indian equity markets, represented by S&P BSE SENSEX, plummeted 37% to 25,981.24 from its all-time high of 41,465.9 on 12 February 2020. All businesses were forced to halt their operations, except those part of ‘essential services’ such as telecom, information technology and fast-moving consumer goods (FMCG). Educational institutions such as colleges, schools, afterschool coaching centres and prep providers were the first to shut down, and resumption felt like a thing of the distant future.
The Indian EdTech Industry
The education industry in India comprised three segments, namely, schools aka K–12, higher education (undergraduate and postgraduate programmes) and the lifelong learning segment, which included upskilling and re-skilling courses for working professionals. With more than 1.5 million schools catering to 260 million students, the school segment comprised more than 50% of the overall industry. Online education, which meant technology-propelled access to educational content, also referred to as EdTech, contributed a small share to the overall pie. However, this small base of 1.6 million users contributing US$247 million (in 2016) was set to grow to 9.6 million users by 2021 valued at US$1.96 billion (KPMG & Google, 2022). India was the second largest market for online education after the United States and was poised to scale to US$3.5 billion by 2022. Availability of data at cheaper rates, expanding smartphone user base, wider reach of internet and the government’s focus to increase India’s gross enrolment ratio using digital initiatives were some of the primary reasons for this growth. Foreign investments, in the form of FDI, worth US$3.24 billion between April 2000 and March 2020, was another major contributor. India was home to 4,450 EdTech start-up firms, which employed different business models to render innovative solutions (Exhibit 1). Private firms such as BYJU’S, Vedantu, Unacademy and Toppr were some of the prominent players, especially in the K–12 segment. Pre-nCOVID-19 was a bull run for Indian EdTech companies, with US$49 million in 2017 (for 18 deals) and US$700 million funding in 2018. The pandemic propelled investment into this sector. Between January 2020 and August 2020, venture capital (VC) investors invested US$1.19 billion against US$409 million during the same time in 2019.
EDSAI Education
Amit Mathur was a brilliant code writer, and he enjoyed activities such as hacking websites and turning college servers off during examinations. Hailing from a humble background and having seen the toughest of times on the personal front, Mathur raised quite a few eyebrows by quitting from the placement process in his final year of engineering. After graduation, he decided to work on his idea that was similar to the aggregation model of the contemporary times. While the unit statistics of his concept was in place, investors did not see much opportunity back then, in the year 2000, partially due to the pessimism instigated by the failure of internet companies, more famously known as the dot-com bubble. Mathur decided to put his entrepreneurial journey on pause. He took up a job with Dell Inc. in 2001 and worked there for seven years in different IT and analytics profiles. He moved jobs to an education consulting firm in the year 2008 into a profile that offered Mathur greater ‘intra-preneurial’ satisfaction. Mathur started getting exposure to the global best practices in school education, aka K–12, which fascinated him with the associated business opportunity in India (Exhibit 1). Mathur realized that there was a lot of stress on the syllabus and very little on the curriculum. By the fall of 2011, sub-prime crisis well past behind, the Indian economy had started revving up with digital themes. Digital platforms were swaying Indian consumers, and Mathur wanted to explore this opportunity. He felt that it was time to resume his once-dropped entrepreneurial plans. EDSAI Education was thus founded in 2012.
Mathur started working with schools on reconceptualizing their curriculum, up to Grade III, by meticulously carving it into micro-lesson planning. Happy with his work, clients started referring him for other assignments including whole school planning and teacher training. For eight years, EDSAI was able to secure a good name for itself with a client list containing Pearson Education, Dubai-based GEMS Education, NIIT, Bharti Foundation (Bharti Airtel Group), Bella Mente chain of schools, Verismo Tech and Sri Aurobindo Institute. In 2014 came a breakthrough when a global education client wanted to develop a school integrated learning ecosystem and sell it to Indian schools. AcceSchool, the platform, integrated the school, its children, and their parents for teaching, learning and assessments. EDSAI was engaged by the client to conceptualize and develop this platform end-to-end, which later became super successful in the Indian market. In the last four years, it consumed Mathur’s entire time and effort, but gave him a robust top-line with a healthy bottom line (Exhibit 2). The success of AcceSchool for the client in India had given EDSAI a preferred supplier status.
Opportunity Landscape
EDSAI, like other start-up firms, faced a decision dilemma to either build upon the already acquired skills or tap the untapped market with greater potential for growth. In the year 2019, the client had expressed interest to engage EDSAI for global expansion of AcceSchool. Post the outbreak of nCOVID-19, a lot of schools, globally, had shut their campuses for the rest of the year. As the impact of the pandemic deepened, the potential gain from this global expansion had become more convincing. The assignment was promising, with more extensive scale, longer engagement tenure and better margins for EDSAI. AcceSchool Global was the first of the two opportunities that EDSAI focussed on.
EDSAI’s second opportunity was in the fast-growing tablet-based English language learning market. Mathur believed that the potential for teaching English was very high in India since good spoken English had become a requirement for all age brackets, in all regions, across all income classes. The market for online language learning in India was expected to be US$29 million by the year 2021 (KPMG & Google, 2022). Over the last few years, curated content on gadgets had started replacing the age-old in-person, after-school tuition centres, and this trend was expected to magnify post nCOVID-19 outbreak, owing to reduced social interaction norms. There were a few other start-up learning platforms in India, namely, LingosMio, Multiphase, English Helper, Kings Learning and so on, which offered a variety of content but with no identifiable USP, and so they did not bother Mathur much. In his early years into EDSAI, Mathur had registered a brand name, Edolve, in 2012 for EDSAI’s language solutions, for which the English curriculum for K-12 was digitally designed into micro-lessons tagged with specific learning outcomes. He thought of converting this content into video lectures and making it attractive through high-tech animation using cartoon characteristics. Subscribers were given a pre-loaded tablet that had a unique feature to hear the pronunciation and direct the learner to iterate until the desired proficiency level was achieved. This technology-driven model was expected to be an instant hit in tier-II and tier-III towns where finding a good English teacher was a big challenge. This gave EDSAI its second big opportunity.
Mathur decided to use Ansoff’s Matrix (Ansoff, 1957) to map EDSAI’s opportunity landscape (Exhibit 3). On one hand, there was AcceSchool Global, a classic case of ‘market expansion’, which promised to provide business efficiencies by acing the learning curve through already developed domestic products. On the other side was Edolve, a case of ‘product expansion’, wherein Mathur’s entrepreneurial gut could see a huge potential in the untapped language learning market. Mathur realized he would be able to accept only one of the two new opportunities (AcceSchool Global or Edolve) without giving up the existing business of AcceSchool India. The choice would be based on the principle of firm value maximization, for which Mathur wanted to get the opportunities valued.
Task Ahead: Evaluating Past, Present and Future
A. Existing Market: AcceSchool India
With AcceSchool, three years’ earnings before interest, taxes, depreciation, and amortization (EBITDA) averaging 44% to sales, EDSAI never had to burn cash. The higher share of variable cost ensured a lower degree of operating leverage avoiding losses even in the initial years where revenue stability was a challenge. Mathur estimated the revenue from Indian assignments to grow at 30% over the next two years, followed by a growth of 20% in the subsequent three years. EDSAI had used an optimum mix of on-roll employees and long-term retainers. Owing to the unemployment post nCOVID-19, he was hopeful of saving 5% in content development cost, in relation to sales, from its three-year average of 39.3%. He wanted to keep his remuneration at the current level for the next two years after which he expected it to increase by ₹0.5 million. Since AcceSchool would continue to be a significant source of revenue, the annual marketing expenses would not track the sales and would stabilize at ₹1 million, mostly for business networking and conference sponsorships. A new office in a prime commercial complex in Gurugram resulted in a four-fold increase in the admin expenses for FY19, due to higher rent. These expenses were expected to grow at 10% in the near future. To meet the aforementioned business projections, Mathur estimated a replacement capital expenditure of ₹80,000 every year, which would, along with the existing assets, depreciate at 25% of its written down value. An effective tax rate of 26.75% was expected. Mathur estimated that two months’ annual billing would be in arrears and that payment for content development would also be made with the same lag. Being a cautious promoter himself, Mathur diversified the surplus funds in mutual funds, and their market value was 110% of the recorded value. He planned to pay whatever little debt he had in the next year. However, there was little visibility beyond FY24. To arrive at a more sustainable valuation for AcceSchool India, Mathur was advised to average out the valuation using the discounted cash flow (DCF) model and price earning (PE)-based relative valuation (RV) model. There were not many education companies listed in India, and fewer were technology based. He requested one of his banker friends who identified three listed players with a business model similar to EDSAI’s (Exhibit 4). The 10-year G-Sec rate prevailing in the country was 6.29%. As per a global survey conducted in 2020 that included 81 countries, India’s equity risk premium was found to be 7.0% (Fernandez et al. 2020). A global rating agency forecasted India’s real GDP growth rate to be 7% for FY23 and FY24. Including inflation, a long-term sustainable growth rate of 8% seemed achievable for EDSAI.
B. Market Expansion: AcceSchool Global
Globally, schools were in a dire need for an integrated learning platform, such as AcceSchool, and were willing to pay more to get it sooner. The situation would translate into higher margin for EDSAI’s client and, in turn, for EDSAI. Mathur thought of applying AcceSchool India’s DCF template to value AcceSchool Global. He estimated ₹60 million as the revenue for the next two years. For the subsequent three years, he was confident of growing revenues at the same rate as his Indian business. Owing to a higher mark-up on global projects, the content development cost, in relation to sales, was generally lower by 10% compared to similar projects in India. Besides, the project would attract an additional 3% cost in relation to sales, for hiring local resources in various countries to handle linguistic challenges in implementation. The office space would have to be increased, which would cost ₹1 million, with an expected inflation of 10%. Since Mathur’s focus would primarily be the global piece, a manager would be needed to manage the Indian business whose compensation would be linked to the Indian revenues to keep EDSAI’s start-up spirit alive, estimated to be 4%. Investment in IT equipment was expected to be ₹2 million in the first year, with a replacement CAPEX at ₹0.1 millions per annum thereafter. Billings for the work on global development would follow a similar tax regime as existing work for the Indian version. There would be no incremental expenditure on marketing or administration. Post FY24, a more extensive but mature market would keep the long-term growth rate to 5%. The taxation impact, as well as arrears in billing and payment for content development, would be similar to Indian operations.
C. Product Expansion: Tablet-based Edolve
As of March 2019, there were 66 million internet subscribers in India in the age bracket of 5–11 years. The aforementioned estimates gave Mathur the much-needed confidence to make estimates for the next five years (Exhibit 5). The cost of converting the Edolve content into its digital avatar would need a considerable amount of content development effort, whose back-of-the-envelope estimate was ₹85 million. EDSAI was a 250+ employee organization, primarily dominated by a sales force on the ground backed by a very efficient customer service desk. Content was refurbished regularly, for which Mathur had factored sufficient allocation in his calculations. Mathur was suggested to employ the VC model for Edolve based on the average performance of listed peer set (Exhibit 4). A friend of his told him that VC firms would be happy with a thumb rule of 30% rate of return (IRR) with a horizon of five years, after which EDSAI could plan for a public offering.
The Dilemma
Mathur was in a dilemma about how to employ valuation models for the two opportunities in order to decide which one to accept. It was 25 March 2020 with only one day left before Mathur’s meeting with a group of investors. The sum-of-part valuation of EDSAI, if attractive enough, would provide Mathur with a strong pitch to induct a strategic investor partner through his partial stake dilution. Mathur wondered if choosing AcceSchool Global would provide his firm the benefits of learnings achieved from the already developed domestic product. He was also concerned about the cost of letting go of an opportunity to tap the English language learning market through Edolve. Mathur wondered how this pandemic would impact his firm’s valuation. As Mathur continued to ponder the best option for EDSAI, he knew that the decision was not going to be easy, considering the uncertainties looming around macro-and micro-level variables.
Footnotes
Declaration of Conflicting Interests
The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article.
Funding
The authors received no financial support for the research, authorship and/or publication of this article.