ValueEdge

16th December 2014

Raffles Medical Group

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Goh Tee Leng

Yeo Sui Chuan

Investment Thesis:
Despite Raes Medical Groups fundamentals and strong economic moat, we believe paying

a premium of 56% based on current market price is unjustifiable

Stronger growth in Hospital segment from FY2016E onwards with potential risks from
competition within the region

Company Overview
Est. in 1976, Raes Medical Group (RMG) has grown from only two clinics to be one of the
leading medical groups in Singapore with the largest private group practice. The Group operates
within three business segments, mainly healthcare services, hospital services and investment
holdings.

Healthcare
We have combined RMGs Healthcare segment to comprise of both healthcare and hospital
services. RMGs Healthcare segment contributes 97% to revenue, whereby 63% is from Hospital
Services and 34% from Healthcare Services.

The Healthcare segment has been relatively consistent over the past years, whereby we see only
a 1.4% fluctuation in terms of operating margins. Furthermore, we can observe the upwards
trend in terms of operating margins. This would be due to management placing greater emphasis
on the Hospital Services - their higher profit margin business, in recent years. Management have
been growing their premier private tertiary hospital with new specialists and centres catering to
the diverse needs of local and international patients. Going forward, we expect to see greater
growth in Hospital Services given the Raes Hospital Extension expected to be ready in 2016
and their investment and operation of tertiary hospitals in Shenzhen and Shanghai.

This is not to say that management has been neglecting Healthcare Services. Management has
been growing this segment through the acquisition of a site at Holland Village and integrating
medical services in heartland malls, bringing quality healthcare services closer to more people in
Singapore. Additionally, Raes Medical Shanghai and Raes Medical Hong Kong are growing
their network of medical centres too. Furthermore, another notable strategy to grow their
Healthcare Services would be the Raes Health Insurance (RHI) program. It is a new marketing
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model, integrating healthcare services and healthcare financing seamlessly in its Employee
Benefits Solution for corporate customers.

Industry Positioning
In general, Southeast Asia is seen to be one of the top medical destinations in the world, with
healthcare spending seeing double-digit growth. Singapores average annualised Healthcare
Expenditure growth rate (2009 - 2012) of 15% is greater than the Southeast Asia average of 14%.

With Singapores high cost structure, it has positioned itself in recent years as a superior-quality
and infrastructure healthcare provider, focusing on complex procedures such as organ
transplants neurosurgery, hematopoietic stem-cell transplants and cardiovascular surgery. The
additional draw is that English is widely spoken across the city.

Figure C: Average % Savings for most-traveled medical destinations against US

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Source: Patients Beyond Borders

Singapores high costs structure can be seen in Figure C, placing Singapore as the second-most
expensive medical tourism destination after Brazil worldwide and the most expensive within Asia.
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Hence, private hospitals stands to gain the most by targeting such premium, price-inelastic
clients in Singapore.

Economic Moat
Central to RMGs operating philosophy is its Group Practice Model, a mode of physician practice
adopted by internationally renowned medical institutes like the Mayo Clinic, the Cleveland Clinic
and the Memorial Sloan Kettering Cancer Centre in the United States. The Group Practice
harnesses the dierent strengths of the team caring for the patient. Specialists come together in
multi-disciplinary teams to ensure that each patient receives co-ordinated, quality and aordable
care. With this model, there is better deployment of individual talents and the team pools its
expertise to diagnose and treat illnesses quickly, eciently and accurately.

Furthermore, RMG operates a business model dierent from their peers. Apart from running a
fully-equipped hospital; Raes Hospital, they run clinics located all around Singapore. Informally
known as the hub and spoke model, RMG clinics would feed patients to its main hospital and
specialists centres. We believe that through RMGs operating philosophy and unique business
model, it has led to the successful brand name of Raes Medical and the built up of trust
between doctor and patient. Such branding can be seen through quantitative aspects of RMGs
strong and stable margins.

Previously, we mentioned that we observe only a 1.4% fluctuation in RMGs operating margins.
Computing RMGs margin stability compared to its peers, a margin stability of 10, this definitely
displays RMG being able to defend its economic moat well especially compared to its peers.

Valuation

We have selected some of RMGs closest competitors within Southeast Asia and conducted a
peer analysis in terms of valuations. EBITA values are based on the last 8-years of each company
except for Fortis Healthcare, where it has only been listed for 5-years. In the case of the
Enterprise Value multiple, we have excluded Fortis Healthcare from the calculation of the mean
due to it being a outlier, which would skew the results tremendously.

Personally, we have a strong inclination to use the Enterprise Value multiple due to empirical
research and how it allows for direct comparison of dierent firms regardless of capital structure.

Based on the Enterprise Value multiple, we would derive a fair value of SGD2,062m for RMGs
Healthcare segment.

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Based on the fair value calculated of SGD2,062m, we perform a sanity check using FCF yield. For
the case of RMG, we have used FCF derived from profits from operations before working capital
changes. Given RMGs growth in clinic expansions, it results in significant changes in net assets
year on year. Hence, using FCF derived before working capital changes would provide us with a
more meaningful analysis. Based on the 8-year average EBITDA of SGD47.7m, we derive a 8year average FCF of SGD42.2m, corresponding to a FCF yield of 1.9%. We deem this FCF yield
to be overvalued and we believe a more conservative yield would be approximately 5%. Working
backwards, a FCF yield of 5% would mean a valuation of SGD844.6m for RMGs Healthcare
segment.

Investment Properties

The Groups investment property comprises of 4,165.6 square metres of commercial space in
Singapore, leased out to external customers. One key point would be the hospital building at
North Bridge Road being both used as PPE for hospital services and investment property.
However, under operating segment breakdown, the company has classified it both under
investment properties.

Valuation

We have calculated the rental yield based on (1) Segment Assets (2) Solely Investment Property
Value to get an idea of rental yield range. Based on a fair rental yield of 7%, we deem believe the
value quoted under investment holdings of SGD100.4m to be fair. Furthermore, Investment
Properties are stated at fair value based on JLLs valuation on the basis of open market valuation
each year. The reason for the significant drop in asset value in FY2013 was due to the sale of the
units within Thong Sia Building valued at SGD98m; otherwise, over the last 3 years the
investment properties have been valued roughly around SGD190m with little fluctuation.

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SOTP Valuation
We value Raes Medical Group using a SOTP method based on a fair case for each segment.

Using a fair case scenario, we derive a SOTP valuation for RMG of SGD 1.73 per share,
translating to a premium of 56% based on current market prices.

Investment Risks
One of the key challenges faced by RMG would be the surge in new private and public hospitals
in the next few years. Furthermore, we see strong competition for medical tourists from
neighbouring countries where costs are also much cheaper. As shown by the data compiled by
Patients Beyond Borders; Figure C, Singapore is now the second most expensive medical
destination worldwide and the most in Asia. While it is advantageous being in the private
healthcare sector targeting such premium, price inelastic customers, such companies would also
be facing strong competition regionally such as Bangkok where hospitals are oering quality
premium healthcare yet at much lower prices. Frost and Sullivan has higher 2014-20E spending
CAGR forecasts for Malaysias (19%) and Thailands (18%) medical tourism industries than for
Singapores (13%).

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Furthermore, due to such rising competition for healthcare services in the region, it indicates
limited fee hikes for RMG. RMG has always assured investors that they could raise prices. Based
on the 20% gap between Raes Hospital and leading private hospitals, it has apparently been
able to close this gap to less than 10% based on the latest data on bill sizes and procedure costs
from the Ministry of Health. Looking at the data, Raes Hospital average bill sizes are roughly
within the average range in the industry.

Final Words
With the two new projects - RH Extension and Holland Village Development, we would see
RMGs floor space double by FY2016E. Upon completion, this increase in GFA, will definitely
drive growth from FY2016E onwards. Management expects to utilise about 25% of the new GFA
and is likely to lease out the remaining area. Due to the slower growth expected within its key
hospital segment, we see RMGs revenue growing at a slower rate, until the completion of Raes
Hospital extension in FY2016E.

Figure J: Raffles Medical Gross Floor Area (GFA)

700

RH + Clinics

RH Extension

Holland Village Development

62.7
525

sqft 000

222
350

175

317

317

Current

FY16E

Raes Medical Group is undoubtedly a solid company, especially with its low leverage of 1.1%.
Coupled with its strong economic moat and future prospects from FY2016E onwards, Raes
Medical Group would be a good company to add to our portfolios. However, the main question
would be how much of a premium would we be willing to pay for such a quality company after
factoring in its growth prospects? We did some rough estimations to derive the fair value of
Raes Medical Group after factoring in the expected growth from the two new projects.

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For the healthcare segment, we assumed that each segments revenue grew in the same
proportions as the expected increase in GFA for each - 100% for Medical Services and 18% for
Hospital Services. Additionally, we assumed that net profit margins for each segment remained
the same.

With regards to the first assumption, we understand that it may not be extremely logical
especially given how each segment comprises of other services and not just clinics and hospital
services. While the second assumption is reasonable given RMGs stable margins. With these
assumptions in mind, we derive FY2016E net profits to be SGD72.8m. This values the Healthcare
segment at SGD1,813m based on the current Price-to-Earnings ratio of 24.9x.

Following this, we calculated the SOTP valuation for FY2016E, based on a fair case scenario.
With regards to Investment Property, we valued it based on proportion of GFA used for rental at
cost. Whilst in terms of liabilities we factored in the expected cost it would take to develop both
of the two new projects. Based on the above mentioned assumptions, we derived a fair value of
SGD 3.31 per share, which means there is still a premium of 15.8% based on current market
prices.

From our rough calculations, it can be seen that even after factoring for Raes Medicals growth
prospects, current market price is still above fair value. One has to ask themselves if it is worth
paying this additional 15.8% premium now for the growth of a company that is only expected to
occur in 3-years time. In our own opinion, while Raes Medical Group is a great company with
long-term growth prospects, it is still expensive based on current prices.

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Disclaimer

All personal opinions are the authors own and do not represent any other individual, group or business. The authors
do not take responsibility for any factual inaccuracies made. Any opinions, conclusions or other information
expressed here does not constitute financial advice. They are given on a general basis and are subject to change
without notice. Past performance is no indication of future performance. You are recommended to verify all
information read and to consult licensed, professional financial services.

The authors do not take any responsibility for any loss or damage of any kind made based on the opinions or facts
published in this report

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