Fitch Ratings has maintained the Rating Watch Negative (RWN) on Bright Scholar Education Holdings Limited's 'B' Long-Term Issuer Default Rating (IDR), senior unsecured rating and rating on the company's USD300 million 7.45% senior notes due July 2022 with a Recovery Rating of 'RR4'.

Fitch downgraded and placed Bright Scholar on RWN on 28 December 2021 following the company's proposal to dispose of its international and bilingual schools and not-for-profit kindergartens to a charitable organisation to comply fully with China's Implementation Rules of the Law for Promoting Private Education, effective 1 September 2021.

Fitch will resolve the Rating Watch upon completion of the disposal, which was delayed by slow progress in getting regulatory approvals. Delay in the disposal will continue to impair Bright Scholar's cash position, but we expect the company to have sufficient liquidity to repay the US dollar notes due in July 2022. Bright Scholar currently has close to CNY1 billion in cash offshore and is making progress in transferring cash from onshore to offshore. However, the remittance is subject to execution risks as it requires approval from the authorities due to China's capital controls.

Key Rating Drivers

Adequate Liquidity: Fitch expects Bright Scholar to have sufficient cash on hand to repay its outstanding US dollar bond due in July 2022 despite a slightly weaker cash position due to cash outflow at the listed company level without collection of services fees from affected schools since 1 September 2021. Bright Scholar's reported cash and restricted cash balance of CNY1.5 billion and short-term investments of CNY1.2 billion as of end-February 2022 were sufficient to cover its short-term loans of CNY0.6 billion and bond payable of CNY1.6 billion.

We estimate the company's cash outflow from March to July 2022 to be below CNY200 million. Bright Scholar is only entitled to collect service fees from affected schools upon completion of the disposal as collecting income from a related party for management services is not permitted under the latest rules

Diminished Scale, Lower Visibility: Fitch expects Bright Scholar to provide management services to affected schools after completion of disposal, which will offset some of the profit lost from discontinued operations. However, a prolonged delay or failure to complete the disposal would materially weaken the business profile as the remaining businesses are tiny and not cash generative.

We estimate the scale of Bright Scholar's normalised post-disposal EBITDA at CNY300 million-400 million annually, compared with consolidated EBITDA of CNY576 million in the financial year ended 31 August 2020 (FY20). We also expect higher cash flow volatility from providing management services than collection of tuition fees due to low switching costs and a lack of differentiation.

Continuing Operations Recovering: Fitch expects a gradual recovery in Bright Scholar's continuing operations, driven by the easing of travel restrictions in western countries, which support an increase in revenue from overseas schools and the overseas counselling business. The operating loss for Bright Scholar's continuing businesses, which are mainly overseas schools, complementary education services and domestic kindergartens and K-12 operation services, narrowed to CNY23 million in 1HFY22 from CNY115 million a year earlier.

Limited Impact from Privatisation Proposal: Bright Scholar received proposal from its largest shareholders, Ms. Huiyan Yang and Ms. Meirong Yang, in April 2022 to take the company private. The company has formed a special committee to evaluate and consider the proposal. Although the proposal has no direct impact on Bright Scholar's financial profile, we expect disclosures to be less transparent once it becomes a private company.

Derivation Summary

Bright Scholar has a much weaker business profile than Meinian Onehealth Healthcare Holdings Co., Ltd. (B+/Stable), which is the leader in China's private health check-up industry. Bright Scholar has less growth potential and revenue visibility than Meinian, resulting from an unfavorable regulatory environment. We expect Bright Scholar's post-disposal EBITDA to be much smaller than Meinian's EBITDA. Bright Scholar's ratings are constrained by its small scale and weaker market position in a highly fragmented industry following restructuring.

Bright Scholar has a better liquidity profile than China Grand Automotive Services Group Co., Ltd. (B-/Negative) with a net cash position, justifying the one-notch difference. However, Bright Scholar's business profile is much weaker than China Grand Auto's and its scale is much smaller.

Key Assumptions

Single-digit revenue growth in FY22 and faster revenue growth in FY23 due to collection of service fees

EBITDA to improve in FY23, supported by recovery in overseas operations and collection of service fee income

No dividend for FY22-FY25

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

The Rating Watch Negative will be resolved upon completion of the disposal

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Material deterioration in cash position due to, for instance, higher-than-expected cash outflow

A prolonged delay or failure to complete the disposal resulting in an inability to earn service fee income from affected schools by end of 2022

If the disposal is completed and results in a materially lower service fee income than Fitch's expectation

Deterioration in operating performance of its continuing businesses

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity: Bright Scholar's reported cash and restricted cash balance of CNY1.5 billion and short-term investment of CNY1.2billion as of end-February 2022, were sufficient to cover its short-term loan of CNY0.6 billion and bond payable of CNY1.6 billion.

Issuer Profile

Bright Scholar was previously a K-12 school operator in China and is going through a restructuring due to the latest regulations.

Summary of Financial Adjustments

Fitch is using the multiple approach to capitalise leases for Bright Scholar and assess leverage on an adjusted basis. We think the multiple approach is more appropriate for education-service companies such as Bright Scholar under the generic navigator, as leasing school and facility premises form a core element of its operations. A multiple of 8x was used as the company is based in China.

Bright Scholar typically collects tuition and fees at the beginning of the semester and there are usually large 'contract liabilities' on its balance sheet. We have classified these as 'not readily available', and this amount is excluded from net debt calculations.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

RATING ACTIONS

Entity / Debt

Rating

Recovery

Prior

Bright Scholar Education Holdings Limited

LT IDR

B

Rating Watch Maintained

B

senior unsecured

LT

B

Rating Watch Maintained

RR4

B

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Additional information is available on www.fitchratings.com

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