19-10-2014, 10:27 PM
This is an upcoming IPO - a privatisation by Aussie government
Cost scrutiny as investors eye Medibank
Anthony Macdonald and Jessica Gardner
1428 words
20 Oct 2014
The Australian Financial Review
AFNR
English
Copyright 2014. Fairfax Media Management Pty Limited.
Medibank Private has a parting gift for the federal government. When the private health insurer's prospectus is lodged on Monday morning, it is expected to confirm that Medibank's owner will collect one last dividend, worth about $100 million, before selling its shares at the company's float.
That's $100 million on top of the $441.7 million taken during the 2013-14 financial year, and the $1 billion it has stripped out in the past five years.
But if Medibank boss George Savvides thinks he has had to deal with demanding shareholders so far, then leading Australia's newest top-50 stock could come as a shock.
If nothing else, the government's latest charge will have prepared Savvides for a barrage of questions about an arguably lazy balance sheet, not to mention the badgering to come from his new owners about capital management and special dividends.
The pressure to pay out dividends will only ramp up. It is one of the key things on investors' minds as they consider taking part in the biggest federal government privatisation this decade.
The biggest question though is what, if anything, will change when Medibank hits the ASX boards late next month. Can new ownership spark market share growth, address rising claims, cut overhead costs and ensure management has the incentive and freedom to grow the business?
Potential investors will seek answers in Medibank's prospectus. Fund managers, who will determine Medibank's listing price at a book-build next month, have had the customary head start. They met Medibank management in July and have already seen the company's latest financial results.
The 2014 annual report will be tabled in Parliament this week, but its 2013-14 performance will also be released publicly for the first time in the prospectus.
Medibank made $258.5 million net profit after tax in the year to June 30, up from $243.9 million in 2013. Group revenue was up 8.8 per cent to $6.4 billion.Privatisation dividend
Investors know the initial public offering is not a silver bullet. But it is an opportunity to capitalise on the company's market-leading position while it is still the industry's No. 1 player, and to make the most of strong macroeconomic factors underpinning private health insurance in Australia.
While Medibank is not expected to come to market cheap, early indications are that fund managers – and 750,494 retail investors – want to be there when it floats.
Privatisations sharpen the focus of managers on shareholder returns and there are usually relatively easy gains from commercial discipline – widely dubbed the "privatisation dividend".
Aurizon Holdings, Commonwealth Bank of Australia and others have shown that privatised assets often trade strongly in their first year as public companies. This means Savvides will have an easier introduction to listed life than the bosses of most $4.5 billion companies coming to the market. But he probably only has six to 12 months to convince investors to stick around for the next three, five or even 10 years.
In pre-IPO meetings, Medibank's pitch has centred on health expenditure. Australians, including governments, spent $147 billion on healthcare in 2013. It was worth nearly 10 per cent of gross domestic product and has almost doubled on a decade earlier.
The health spend theme is strong and widely understood by investors in Australia and offshore. Private equity-backed Healthscope raised $2.25 billion on a similar story in July.No claims gain without pain
But what investors are more worried about is what Medibank management actually controls: costs. Lower costs means higher operating margins and lower premiums, which should make it easier for Medibank to retain customers and win back market share.
Managing costs means predominantly looking at claims. Medibank paid $4.88 billion in claims in 2013-14 on $5.6 billion in premium revenue.
Claims eat up about 87 per cent of what private health insurers earn from premiums. Medibank has worked hard to get to this mark, but still lags its nearest rival. A mere 1 per cent saving on Medibank's claims paid would lift annual group profit by 14 per cent, according to Deutsche Bank analysts. Deutsche Bank is one of Medibank's three joint lead managers, with Goldman Sachs and Macquarie Capital.
Rival Bupa, the second-largest private health insurance player with 26.8 per cent market share, is understood to be at 84 per cent to 85 per cent and looking to go lower.
Medibank has identified four ways to target claims, but each carries some risk to the organisation and its relationship with customers and other important stakeholders.
Savvides's team reckons it can reduce claims by renegotiating and managing relationships with private hospitals, tinkering with policy claims limits, better managing policyholders with chronic diseases, and cutting false or improper claims.
Getting tough on hospitals is potentially dangerous territory. Although most contract negotiations occur behind closed doors, if they spill out into the public Medibank risks its reputation by picking fights with healthcare providers that the community trusts to do what is right by their health.
Members may also not take kindly to their local private hospital being cut out of the picture if it does not meet Medibank's criteria. Some hospital operators have shown interest in promoting their businesses on the basis of transparency around quality, but there are few executives that have warmed to Medibank's aggressive approach.
Managing claims is also a double-edged sword. Claims are a big part of Medibank's margin, which underscores the insurer's premium rate increases. Annual premium increases are approved by the industry regulator based on each insurer making an acceptable profit margin. Macquarie analysts reckon that margin is between 4.5 per cent and 6 per cent.
The lower the number of claims experienced, the less premium rates increase. However, it is understood Medibank's management reckons lower premiums will be good for the insurer in the long term and have evidence to suggest that premium increases that are greater than the industry average are bad for business.
Medibank also runs its dual-brand strategy, with its fast-growing AHM brand targeting low-cost policyholders.Management to trim the fat
Management expenses, or what Medibank spends to administer policies, are the other part of the cost equation and are also expected to be targeted as part of the IPO.
The company is not coming at its management expense ratio (MER) from a standing start. Savvides's "fit for purpose" cost-out strategy cut $49 million out of the costs of Medibank's biggest unit, the private health insurance business, in 2013-14 and analysts expect more in 2014-15 and 2015-16.
The 2013-14 expenses push saw Medibank's private health insurance MER drop from 9.2 per cent to 8.7 per cent, which is closer to the 8.4 per cent industry average.
Rival Bupa has told fund managers it should be able to shave another 200 basis points off the industry average MER, but it is unclear just how long it would take, and whether Medibank can do the same. Medibank has similar scale to Bupa, but the question remains to be asked whether Savvides and his team are up to the job.
Macquarie analysts told fund managers that Medibank's private health insurance employee costs should fall 5.1 per cent in 2014-15 and advertising expenses could drop 6.1 per cent. The insurer is also part-way through an IT system revamp due to finish in 2015-16.
When Medibank's prospectus comes out on Monday this week, fund managers will flick straight to the pricing. It's understood the float will be priced somewhere between Medibank's much smaller listed rival NIB Holdings, at about 17 times forecast profit, and the big private hospital operators, at about 25 times.
The final price is expected to be closer to NIB than either Healthscope or Ramsay Health Care, given the hospitals expect about 9 per cent revenue growth in 2014-15, while Goldman Sachs forecasts Medibank's to be up to 7 per cent.
Detail on the price alone might be enough for investors who just want the privatisation dividend. But those considering a longer-term exposure will turn to the investor roadshow, which will kick off this week locally, before Medibank management and its advisers turn their attention offshore.
Savvides should be prepared for tough questions.
Fairfax Media Management Pty Limited
Document AFNR000020141019eaak0000i
Cost scrutiny as investors eye Medibank
Anthony Macdonald and Jessica Gardner
1428 words
20 Oct 2014
The Australian Financial Review
AFNR
English
Copyright 2014. Fairfax Media Management Pty Limited.
Medibank Private has a parting gift for the federal government. When the private health insurer's prospectus is lodged on Monday morning, it is expected to confirm that Medibank's owner will collect one last dividend, worth about $100 million, before selling its shares at the company's float.
That's $100 million on top of the $441.7 million taken during the 2013-14 financial year, and the $1 billion it has stripped out in the past five years.
But if Medibank boss George Savvides thinks he has had to deal with demanding shareholders so far, then leading Australia's newest top-50 stock could come as a shock.
If nothing else, the government's latest charge will have prepared Savvides for a barrage of questions about an arguably lazy balance sheet, not to mention the badgering to come from his new owners about capital management and special dividends.
The pressure to pay out dividends will only ramp up. It is one of the key things on investors' minds as they consider taking part in the biggest federal government privatisation this decade.
The biggest question though is what, if anything, will change when Medibank hits the ASX boards late next month. Can new ownership spark market share growth, address rising claims, cut overhead costs and ensure management has the incentive and freedom to grow the business?
Potential investors will seek answers in Medibank's prospectus. Fund managers, who will determine Medibank's listing price at a book-build next month, have had the customary head start. They met Medibank management in July and have already seen the company's latest financial results.
The 2014 annual report will be tabled in Parliament this week, but its 2013-14 performance will also be released publicly for the first time in the prospectus.
Medibank made $258.5 million net profit after tax in the year to June 30, up from $243.9 million in 2013. Group revenue was up 8.8 per cent to $6.4 billion.Privatisation dividend
Investors know the initial public offering is not a silver bullet. But it is an opportunity to capitalise on the company's market-leading position while it is still the industry's No. 1 player, and to make the most of strong macroeconomic factors underpinning private health insurance in Australia.
While Medibank is not expected to come to market cheap, early indications are that fund managers – and 750,494 retail investors – want to be there when it floats.
Privatisations sharpen the focus of managers on shareholder returns and there are usually relatively easy gains from commercial discipline – widely dubbed the "privatisation dividend".
Aurizon Holdings, Commonwealth Bank of Australia and others have shown that privatised assets often trade strongly in their first year as public companies. This means Savvides will have an easier introduction to listed life than the bosses of most $4.5 billion companies coming to the market. But he probably only has six to 12 months to convince investors to stick around for the next three, five or even 10 years.
In pre-IPO meetings, Medibank's pitch has centred on health expenditure. Australians, including governments, spent $147 billion on healthcare in 2013. It was worth nearly 10 per cent of gross domestic product and has almost doubled on a decade earlier.
The health spend theme is strong and widely understood by investors in Australia and offshore. Private equity-backed Healthscope raised $2.25 billion on a similar story in July.No claims gain without pain
But what investors are more worried about is what Medibank management actually controls: costs. Lower costs means higher operating margins and lower premiums, which should make it easier for Medibank to retain customers and win back market share.
Managing costs means predominantly looking at claims. Medibank paid $4.88 billion in claims in 2013-14 on $5.6 billion in premium revenue.
Claims eat up about 87 per cent of what private health insurers earn from premiums. Medibank has worked hard to get to this mark, but still lags its nearest rival. A mere 1 per cent saving on Medibank's claims paid would lift annual group profit by 14 per cent, according to Deutsche Bank analysts. Deutsche Bank is one of Medibank's three joint lead managers, with Goldman Sachs and Macquarie Capital.
Rival Bupa, the second-largest private health insurance player with 26.8 per cent market share, is understood to be at 84 per cent to 85 per cent and looking to go lower.
Medibank has identified four ways to target claims, but each carries some risk to the organisation and its relationship with customers and other important stakeholders.
Savvides's team reckons it can reduce claims by renegotiating and managing relationships with private hospitals, tinkering with policy claims limits, better managing policyholders with chronic diseases, and cutting false or improper claims.
Getting tough on hospitals is potentially dangerous territory. Although most contract negotiations occur behind closed doors, if they spill out into the public Medibank risks its reputation by picking fights with healthcare providers that the community trusts to do what is right by their health.
Members may also not take kindly to their local private hospital being cut out of the picture if it does not meet Medibank's criteria. Some hospital operators have shown interest in promoting their businesses on the basis of transparency around quality, but there are few executives that have warmed to Medibank's aggressive approach.
Managing claims is also a double-edged sword. Claims are a big part of Medibank's margin, which underscores the insurer's premium rate increases. Annual premium increases are approved by the industry regulator based on each insurer making an acceptable profit margin. Macquarie analysts reckon that margin is between 4.5 per cent and 6 per cent.
The lower the number of claims experienced, the less premium rates increase. However, it is understood Medibank's management reckons lower premiums will be good for the insurer in the long term and have evidence to suggest that premium increases that are greater than the industry average are bad for business.
Medibank also runs its dual-brand strategy, with its fast-growing AHM brand targeting low-cost policyholders.Management to trim the fat
Management expenses, or what Medibank spends to administer policies, are the other part of the cost equation and are also expected to be targeted as part of the IPO.
The company is not coming at its management expense ratio (MER) from a standing start. Savvides's "fit for purpose" cost-out strategy cut $49 million out of the costs of Medibank's biggest unit, the private health insurance business, in 2013-14 and analysts expect more in 2014-15 and 2015-16.
The 2013-14 expenses push saw Medibank's private health insurance MER drop from 9.2 per cent to 8.7 per cent, which is closer to the 8.4 per cent industry average.
Rival Bupa has told fund managers it should be able to shave another 200 basis points off the industry average MER, but it is unclear just how long it would take, and whether Medibank can do the same. Medibank has similar scale to Bupa, but the question remains to be asked whether Savvides and his team are up to the job.
Macquarie analysts told fund managers that Medibank's private health insurance employee costs should fall 5.1 per cent in 2014-15 and advertising expenses could drop 6.1 per cent. The insurer is also part-way through an IT system revamp due to finish in 2015-16.
When Medibank's prospectus comes out on Monday this week, fund managers will flick straight to the pricing. It's understood the float will be priced somewhere between Medibank's much smaller listed rival NIB Holdings, at about 17 times forecast profit, and the big private hospital operators, at about 25 times.
The final price is expected to be closer to NIB than either Healthscope or Ramsay Health Care, given the hospitals expect about 9 per cent revenue growth in 2014-15, while Goldman Sachs forecasts Medibank's to be up to 7 per cent.
Detail on the price alone might be enough for investors who just want the privatisation dividend. But those considering a longer-term exposure will turn to the investor roadshow, which will kick off this week locally, before Medibank management and its advisers turn their attention offshore.
Savvides should be prepared for tough questions.
Fairfax Media Management Pty Limited
Document AFNR000020141019eaak0000i