Raffles Education - Hold: Addressing Concerns over Oriental Century

REC addresses concerns over Oriental Century — REC hosted a conference call this morning to discuss the latest development of associate Oriental Century, specifically, its Chairman & CEO Mr. Yuean Wang’s resignation and Oriental Century's statement to the SGX that Mr. Wang had "inflated sales and cash balances and had diverted unspecified amounts to an interested party," according to Bloomberg. On the call, REC management confirmed that Mr. Wang had misappropriated Oriental Century’s funds and redirected these to his own company. Other than the potential write-off and reduced associate profits, REC stated that it is not otherwise exposed and its cash balance is not at risk.

Considering likely heightened investor concern over this incident until Oriental Century’s audit investigation is concluded, despite REC’s reassurances, we change REC’s risk rating to Speculative (from High) and lower our TP to S$0.40, (from S$0.60) based on 0.35x PEG (9x CY09E P/E). REC shares were suspended this morning and will resume trading in the afternoon.

Quantifying financial impact — REC holds a 29.9% stake in Oriental Century and has been a passive investor. Oriental Century contributed S$2.0m in net profit, or 2% of REC’s total, in FY08. Per REC's press release: "In the worst case, where Oriental Century ceased to be a going concern, RafflesEducationCorp will need to write-off fully its investment. Should this happen, this would result in a write-off of S$34.6m...", which would represent its S$30.2m cash investment plus share of accumulated profits. This would be a non-cash charge. The timing and possibility of a partial write-off depend on the audit investigation.

Potential related concerns — REC stated that its cash balance is protected, and that each of its Chinese subsidiaries/schools’ operations are monitored by a checks & balances system. Shares may be depressed should concerns persist.

REC has limited role in investigation — REC management said they have been in contact with the lead independent auditor in charge of the Oriental Century audit investigation. While REC has advised for Oriental Century to be kept as a going concern, considering its students’ welfare, its involvement is very limited.

REC cash management efforts continue — Although not directly related to this incident, REC management explained that they are still actively managing the company’s cash flow, with intent to pay down all bank borrowings in four quarters, partly with cash conserved from the scrip dividend scheme. While deferral of outstanding payments for the OUC acquisition by 1 year was confirmed at its 2Q results in Feb, REC indicated that they are still negotiating for longer deferral, made easier by the financial crisis.

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