Overseas Education Limited (RQ1.SI) // 9.4% Per Annum play for a potential privatisation

September 24, 2019

Where can you find a stock that pays you 9.4% per annum to wait for a potential privatisation or re-rating of share price?

 

We have decided to perform a review and an initiation on a relatively popular small cap stock as we have noticed that many of our readers have significant levels of defensive long positions. With REIT stocks having run up significantly in 2019, we thought this could be a potential investment to consider.

 

This stock provides not only a high dividend payout but also has catalysts to deliver out sized returns.

 

Please note that unlike other initiations, we are not currently vested in the stock due to our investment strategy. However, we are may initiate a long position ourselves at the right juncture. Due to the nature of the investment, we will only be providing a target price and not a time frame.

 

Background

 

Overseas Education Limited operates Overseas Family, a leading private foreign system school (FSS) in Singapore with an operating history of over 25 years. The school offers a variety of curriculum for ages 2 to 18.

 

Previously based at Paterson Road, OFS moved to its new Pasir Ris campus in June 2015. The Company currently has only one school in its portfolio. The School has ~2300 students currently enrolled, this number has been declining from a high of ~3000 when the school was at its previous location.

 

Investment thesis

 

(i) Well managed business performance despite fundamental headwinds

 

 

With the move from Paterson Road to Pasir Ris, the student population declined due to the poorer location and subsequently declined every year since then. The Company mitigated this shortfall of revenue by reducing operating expenses ranging from personnel expenses, upkeep and maintenance.

 

The Company also reduced capital expenditure spend to conserve cash, this flows through into the books as a lower depreciation expense. The Company has also been buying back its bonds to reduce finance cost. It also recently refinanced its borrowings which is expected to lead to cost savings of $1.6m in FY19 as the interest rate decreased from 5.2% to 3.8%.

 

 

 

(ii) Near bottom and possible turnaround


The industry in Singapore to a large extent is dependent upon the ability of Singapore to continue to attract foreign direct investments. With the economy expected to under perform in 2020 and subsequently recover in 2021, companies may start to invest in Singapore again in 2020. The influx of foreign manpower tend to also increase after Singapore’s election which is slated to be held in 2020.

 

(iii) Possible privatisation play


The two founders are both in their seventies and hold a combined stake of 65%, as with any other similar listed companies, we have seen a trend of founders selling out. The industry is also filled with private equity who may perform a leveraged buyout.

 

(iv) Others


(a) Government actively manages supply and size of licenses/schools


With a current oversupply in the industry, it is also unlikely the government will provide new land sites
or licenses in the near term.


(b) Competitor is up for sale at a lofty valuation


Canadian International School has been put up for a strategic review which could lead to a sale by Southern Capital at a valuation of US$500 million. Based on our calculations, we think the EV/EBITDA valuation is around 12x. For OEL, based on an EBITDA of S$26.4m and a valuation multiple range of 10-12x, we have obtained a valuation range of $0.63-$0.76 per share for OEL. Applying a judgmental small cap discount of 10%, we obtain a valuation range of $0.56-$0.69.

 

(c) Growth levers


The Company is looking to expand its business and operations by pursuing growth opportunities within the existing market. They intend to increase student enrollment through pursuing growth strategies to fill up capacity of approximately 5,000 students at our Pasir Ris campus. The current utilisation is approximately 46% which is below an industry target of 65-75%.

 

In cities with a high demand, the utilisation range is 90-100%. Due to the large asset base, OEL has high degree of operating leverage, as such, additional student numbers will impact bottom line positively. The Company may also leverage its expertise and extensive experience in the education industry to explore opportunities for collaborations, joint-ventures, acquisitions and investments in Singapore.

 

(d) Is the dividend sustainable?


In FY18, The Company made a EBITDA of $26.4m, net profit of $6.9m. The Company has cash of $41.6m and borrowings of $118m.


The Company generated operating cashflows of $25m, spending $1.1m on capex, $6.5m on interest expense and $11.5m of dividends.


We expect cash outflow for interest expense in FY19 to be approximately $5m.


Therefore, remaining cash flow after capex & interest expense is $19m. Remaining cash reserve after dividend payout is $7.5m which is conserved to repay borrowings together with its cash buffer of $41.6m.

 

Conclusion


Overall, despite the fundamental headwinds impacting revenue, the business has taken multiple steps to rightsize and manage its cost base. With a current share price of $0.29 and a valuation range of $0.56-$0.69, a possible privatisation will lead to a 100% gain.

 

Furthermore, you are being paid 9.4% p.a. to wait.


Any content should not be relied upon as advice or construed as providing recommendations of any kind.

 

 

 

 

 

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