Medibank – a healthy IPO

Co-founder of the Switzer Report
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I like Government privatisations. Commonwealth Bank I, II and III, Telstra I and III, QR National (now Aurizon), NSW TAB (now Echo Entertainment), GIO (now IAG) and even Qantas delivered investors a healthy post-float return. The only real dog was the second instalment of Telstra, which was pitched at $7.40 at the height of the “internet boom” in 1999.

Whether it is because governments don’t want to disappoint voters and feel the need to leave something on the table when they set the final price, or there really is an opportunity to boost the performance of these entities under new ownership, government privatisations, in the main, produce strong returns for foundation shareholders. Last Wednesday, Finance Minister Senator Cormann announced Medibank Private will be sold through an IPO, probably in the final quarter of 2014. So instinctively, my inclination is to set aside some money for this IPO.

What happens to a company post privatisation? Firstly, everyone pays themselves more (the board and senior executives), which is obviously a negative for shareholders. Next, the company finds the “courage” to really cut the fat. Thirdly, they generally increase their prices – because government entities tend to price their services at, or around, the lowest in the market place (social conscience?). Finally, they get the freedom to expand into adjacent services or markets.

Medibank Private may, however, be a little different. While there is probably an opportunity to cut the fat, the government will continue to regulate health insurance premiums and in the Minister’s own words, “there is no evidence that premiums would increase as result of the sale of Medibank Private”. Also, Medibank is already offering services in adjacent markets.

A closer look at Medibank Private

Medibank is Australia’s largest heath insurer, with 3.8 million customers and a market share of 29%. With its Medibank and AHM health insurance brands, it competes against 34 heath funds. Medibank Health Insurance has won Canstar’s award for ‘Outstanding Value’ for the last four years.

Private health insurance premium revenue of $5.3 billion accounted for 91% of gross revenue in the year to 30 June 2013. It also earned $498 million in revenue from its ‘Health Solutions’ business, which provides healthcare services to businesses, government and communities across Australia and New Zealand. It has a team of healthcare professionals providing a national network of healthcare clinics, as well as through telephone and online channels. For example, it operates ‘The Travel Doctor’, NURSE-ON-CALL, Healthline in New Zealand, workplace health services and co-ordinates healthcare services for the 80,000 Australian Defence Force members.

Medibank also provides life insurance, travel insurance and pet insurance, which it sells on a commission basis.

Medibank’s financial results for the last two years are detailed below:

Valuation

Newcastle based NIB Holdings (ASX Code NHF) earns 95% of its revenue from health insurance, and has 578,000 policyholders (compared to Medibank’s 3.8 million). According to FN Arena, it is trading on a forecast PE for FY 14 of 17.6 and 16.3 for FY 15.

Applying a multiple in the range of 13 to 16 to a 2014 profit estimate of around $225 million (Medibank has said that investment earnings will be impacted by the payment of a $300 million special dividend to the Government in August 2013), generates a valuation for Medibank in the range of $3.0 billion to $3.6 billion.

Interestingly, NIB has delivered outstanding returns to shareholders since listing, as the following chart demonstrates.

And the IPO?

Until we get to see the offer document and the pricing is announced, it is too early to make any real commitment to the IPO. While there may not be an enormous opportunity to lift revenue from the health insurance business and Medibank is already exploiting other adjacencies, the cutting of the fat, plus the momentum and energy that come from being freed of any government shackles, should be enough to give this business a boost.

Moreover, it has 3.8 million customers to exploit and a pretty strong brand name.

And if these reasons aren’t enough, this is also the first privatisation from the Abbott Government, so it is hard to imagine that they would want to disappoint investors. I am setting aside some money for this IPO.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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