Singapore Equity: Overseas Education

Quick update to the portfolio including the latest addition, Overseas Education:Equity Portfolio

Portfolio Comments
1.  Ho Bee’s appreciation (along with Wing Tai) was due to buy calls by the sell side on these 2 stocks being potential privatisation targets due to cheap valuations and qualifying certificate regulations (not applicable to Ho Bee as I have mentioned previously).

2.  Compact Metal appreciated due to the passing of the resolutions at its EGM including the placement of 160m shares to Mr Douglas Ong at SGD 5 cents per share. I was at the EGM and the chairman mentioned that Mr Douglas Ong is a shrewd person (not easy to get him to part with his money) and this is the first time he is investing in a penny stock.

Company Name: Overseas Education
Share Price: SGD 0.830
Market Capitalisation: SGD 345m

Overseas Education chart

You can find an initiation report from Maybank KE here:
http://research.maybank-ib.com/pdf/document/OEL_initn_260614_6302.pdf

Overseas Education (OFS) is a private foreign system school (“FSS”) in Singapore offering the K-12 International Baccalaureate (“IB”) curriculum (1 of 5 FSS offering full IB curriculum) and the International General Certificate of Secondary Education (“IGCSE”) programme within a globalised multi-cultural environment to children aged between 3 and 18 years of expatriate parents who are senior executives and professionals working and living in Singapore.

Half of its student population are Asian and no students of any single nationality represent more than 20% of the School’s total student population.

OFS is one of the top three FSSs in Singapore in terms of revenue and has 10.3% of the market share in the FSS industry in Singapore.

Tuition fees have grown at a 5 year CAGR of 5.7% from FY2009 to FY2014 and OFS has seen yoy growth in student numbers since it commenced operations in 1991, except during the Asian Financial Crisis.

In terms of education quality, OFS doesn’t appear to as good a reputation (at least from online musings) compared to larger competitors such as United World College and the Singapore American School.

OFS is very flexible with no pre‐eligibility tests compared to other FSSs and parents are allowed to enrol their children at any time during the academic year.

Nevertheless, OFS still ranks No. 3 in terms of market share, has very experienced management (see below) and charges lower tuition fees relative to competitors so they cannot be too bad?
As a Hokkien saying goes: “No fish, prawn also good”.

Investment Rationale (Why buy this stock and why buy it now?)

1.  Defensive business with strong cash flow, price inelastic demand and an imminent price catalyst
OFS’s new campus in Pasir Ris (relocated from Paterson Road) will be completed (TOP) by end April 2015 and revenue growth from higher capacity (from 3,940 to 4,800 students or 22% increase) will kick in from August 2015 (start of new academic year).

Ample residential developments (e.g. Vue 8) near the campus ensures that there will be plenty of demand for places in OFS.

2.  Potential takeover target by private equity firms
Co-founders Mr. David Alan Perry (Executive Chairman and CEO) and Ms. Irene Wong Lok Hiong (Executive Director) own 32.6% and 31.3% of Overseas Education respectively – just need 1 of them to sell out for a general offer (GO).

Mr Perry will be 73 years old (over 25 years of experience in FSS) and Ms. Wong will be 60 years old (over 35 years of experience in FSS) in 2015 and they do not appear to have any successors in the company.

3.  Strong demand by expatriates for private education in Singapore and solid reputation of the education industry
Singapore ranks highly as an expatriate destination (3rd most ideal after Australia and the US) according to a HSBC Expat Explorer Survey back in 2011 – thanks be to the late LKY 🙂

It was ranked second after Germany in the Top 10 Destinations for Raising Children Abroad (Leading Expat Explorer, 2013).

According to the HSBC Expat Explorer Survey 201117 cited in Frost & Sullivan’s Report, Singapore is an ideal destination for expatriates relocating for money prospects as approximately 50% of those surveyed earn over S$200,000 per annum.

The latest requirement for local schools to reserve almost all their places for local students will push more expatriate students to international schools. OFS’s management disclosed that OFS has been enrolling more and more students from China.

4.  Demand for private education is greater than supply
The total number of students in Singapore’s FSS industry is expected to grow at a CAGR of 8% from 42,500 students in Academic Year 2011/2012 to 58,050 students in Academic 2015-16, according to Frost & Sullivan forecasts.

On the other hand, Maybank KE forecasts that the number of seats in FSS schools will increase at a 3.7% CAGR in FY14E-16E, which translates into 47,800, 50,120, and 51,120 student seats in FY14E, FY15E, and FY16E, respectively.

Risks
1)  Besides the risks highlighted in the initiation report (above), I believe the key negative is the accounting headlines after OFS’s new campus commences operations in August 2015.

There will be incremental depreciation expenses of around SGD 9m per annum (land lease: 37m, school building: 234m, total capex: 271m) and other potential start-up costs.

Interest expenses from the bond of SGD 7.8m per annum will also be recognised instead of being capitalised into fixed assets although this will be almost offset by the rental lease savings of its Paterson Road campus of SGD 6.8m.

While the above has no impact on cash flow and the valuation of the stock, the headline net profit figure may not grow significantly despite the higher capacity and may even decline.

2)  The other key risk is worse than expected competition (in terms of tuition fees) from new entrants, GEMS Education and Dulwich College.

Valuation
Using a 3 stage DCF valuation model with WACC of 7.13%, I derived a fair value of SGD 1.29 per share which represents potential upside of 55.4% from the last traded price.

Do note that shareholders will be entitled to the final dividend distribution of SGD 2.75 cents per share as long as they have purchased the shares before 08 May 2015.