With high margins, low capex and a negative cash conversion cycle, we believe RMG is a cash cow that generates significant FCF of S$30-40mn/year. Our leveraged buyout (LBO) and discounted cash flow (DCF) valuations suggest significant 51-288% potential upside to the current share price. We believe it has the potential to narrow its valuation gap with Parkway by unlocking its franchise value through regional expansion and increased transparency in operational metrics.

In our view, Raffles Medical Group epitomises the defensiveness of healthcare and will be least affected by the current downturn, due to: 1) a wide primary care network with defensive corporate contracts; 2) competitive pricing for high-end care; and 3) operating leverage and cost efficiencies. On a 10.3% 2009-11 revenue CAGR, we forecast a three-year EPS CAGR of 17.6%, driven by operating leverage.

As valuations become inexpensive, we believe Raffles Medical is well-positioned to acquire hospital assets in the region, with a net cash position of S$18mn. Management’s prudence over the years has been encouraging, and we believe that this is an opportune time to elevate the group to the next level, possibly with help from its strategic investors Temasek and Qatar Investment Authority.

RFMD is trading at a trough valuation of 11.4x FY09E P/E with a sustainable dividend yield of 4%, supported by an FCF yield of 9%. Recognising the bearish market sentiment, we base our price target valuation conservatively on actual cashflows to investors.