We reviewed the acquisition of the 330ha campus of Oriental University City (OUC). It is clear that OUC is behind on the conditions set in the sales agreement and will remain a large cashflow burden to Raffles Edu for years to come. We expect annual OUC payments to exceed the operating cash Raffles Edu generates annually basis. Also, Raffles Edu has been raising equity to pay off its debt even though its gearing is only 35% and the interest on its debt is 5%. Maintain SELL.

OUC behind targets. After going through the announcements that Raffles Edu (RLS SP - S$0.40 - SELL) made upon acquiring OUC in 2007, it is clear that not all sales conditions have been satisfied to date. Only two out of the four new schools permits have been obtained so far and none of the schools have opened yet. As a result of this and the non-inclusion of two schools they were promised, the Rmb2bn acquisition (10x the average price of its previous acquisitions) is expected to generate only Rmb65m in profit in FY09, significantly below the profit guarantee of Rmb140m, which has since been revoked.

Cashflow remains concern. Even after the dividend scrip scheme and the recent S$30m equity raising, cashflow will remain tight in the coming years. The annual OUC payments are likely to exceed the cash that Raffles Edu generates from its operations. The company’s focus on paying off its S$200m debt when its interest payments are 5% and its gearing is 35% seem unjustified especially since the company has another Rmb1.5bn to pay for OUC.

Core growth at risk. We expect Raffles Edu’s student body to shrink by 2% in FY10, as we believe fewer students will be able to afford the up-to-US$10,000/year programs. Historically, enrolment in vocational programmes in China has dropped during bear markets. As getting admitted to Raffles Edu programs is relatively easy, the company would be particularly vulnerable to a slowdown in demand.

Valuations expensive. Raffles Edu remains expensive based on our discounted-cashflow-derived target price of S$0.35, which implies another 15% downside. Raffles Edu is trading in the lower range of where education companies trade, which we believe is justified, given the cashflow constraints and expected negative EPS growth in FY10.