MediBank Private

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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

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Medibank faces value spotlight
THE AUSTRALIAN OCTOBER 20, 2014 12:00AM

Health insurance by numbers
Health insurance by numbers Source: TheAustralian
INVESTORS in pursuit of shares in Medibank Private will today begin the serious work of weighing up the merits of the company, when the $5 billion-plus government-owned health insurer lodges its prospectus.

The document will allow fund managers and investors to secure a sense of how much in costs can be cut from the business, and a clearer picture on strategy — whether the company will aggressively pursue growth through increasing market share, driving pricing higher or through mergers and acquisitions.

Under scrutiny within the document will also be the fees paid out to the lead brokers on the deal Macquarie, Goldman Sachs and Deutsche Bank in what is likely to be a hefty windfall for the trio.

The pricing range was expected to be set at the weekend, but banks have been very tight-lipped on the government deal.

In previously released research, Deutsche analysts valued Medibank at 16.5-20.5 times 2015 net profit, or between $4.2bn and $5.3bn. NIB Holdings, the only listed private health insurer, is trading at just under 18 times.

The float is expected to be in favour with fund managers, given government-owned firms typically offered the opportunity for a level of costs to be stripped out of the business to boost its earnings.

Edited by Bridget Carter

carterb@theaustralian.com.au

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Medibank Private offer may raise more than $5 billion
BUSINESS SPECTATOR OCTOBER 20, 2014 1:35PM

Mitchell Neems

Business Spectator Reporter
Melbourne
Is Medibank a healthy investment?

THE federal government could reap more than $5 billion from the privatisation of Medibank Private, according to its prospectus.

Finance Minister Mathias Cormann unveiled the prospectus in Melbourne today, revealing an indicative price range of $1.55 to $2 per share.

At the indicative price range, the indicative market capitalisation of Medibank Private would be between $4.269bn and $5.508bn, placing it among the top 100 companies on the Australian Securities Exchange.

Analysts had estimated the sale would raise at least $4 billion.

“They [the government] are pitching it at a lower level, which makes it more attractive, but they are again anticipating big demand,” said Robert Hook, portfolio manager at SG Hiscock & Co.

“And also you are looking at a situation where the government doesn’t want to be accused of selling something too cheap, [and] at the same time not too high, [where] there will be less enthusiasm.”

The floating of Australia’s largest private health insurer is the most significant privatisation since the $4.6 billion sale of Queensland rail freight company QR National in 2010.

The offer of shares will open on October 28, and the public will have until mid-November to apply for shares. The expected first day of trading on the ASX is November 25.

A little more than three quarters of a million people pre-registered for the prospectus, giving them preferential treatment in the allocation of shares.

Fund managers are able to meet with the company from this week to further examine the offer and financial details.

“The key thing for us is to understand whether they can grow volumes better than they have recently -- they struggle to grow volume in line with the industry,” said Donald Williams, chief investment officer at Platypus Asset Management.

“The other one is how much cost-out [there will be] in subsequent years,” he said, noting he is going to front the company on Wednesday.

“The gap between the high and the low is 25 per cent, so there is a big difference between owning the business at the low end of the range and at the high end of the range,” he said. “At the bottom of the range it’s very attractive, [but] at the top of the range I don’t think we would invest.”

SG Hiscock’s Mr Hook said there was clearly demand for the Medibank offer, and he expected the price to be set at the upper end of the range.

“It will probably be somewhere towards the upper end, judging from the interest, but it may not be fully at the upper end. It just depends on how much they give to individual [investors].”

Medibank Private expects to pay a fully franked dividend of 4.9c a share for the seven months to June 30, 2015.

That amounts to a dividend yield of between 4.2 per cent and 5.2 per cent, and puts the potential share price at between 16.5 and 21.5 times the company’s expected earnings.

The insurer plans to pay out between 70 and 80 per cent of its earnings as dividends in the future.

Medibank Private expects to make an operating profit of $282.1 million for the 2014-15 financial year, up from $255.3 million in 2013-14.

Net profit is expected to remain flat at $258.2 million.

Revenue is expected to grow 4.2 per cent to $6.64 billion.

Medibank Private managing director George Savvides said the company had 29.1 per cent of the private health insurance market and provided cover for 3.8 million people.

He said the privatisation would provide an opportunity to invest in the growing healthcare sector.

“The healthcare economy in Australia is strong and stable and has shown good growth over the past decade,” he said.

“It’s a sector where limited investment opportunities for Australians exist and hence our entry into the top 100, we believe, will be very much welcomed.”

Mr Savvides also said the private health insurance sector had produced stable and consistent premium revenue growth over the past decade, while there had been relatively little volatility in the amount it paid out in claims.

Medibank currently pays out around 87c of every dollar it receives in claims.

Senator Cormann said the price range meant retail investors would not pay more than $2 per share, though the price for institutional investors may be higher.

The government says the privatisation will remove its conflicted role as both the largest health insurance provider and the market regulator, and will also free up funds to reinvest in major infrastructure.

The joint lead managers of the offer are Macquarie Capital, Deutsche Bank and Goldman Sachs.

With AAP

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http://www.sharecafe.com.au/cafetake.asp?a=AV&ai=32226

Feature: Medibank Private IPO
BY JAMES DUNN - 22/10/2014 | VIEW MORE ARTICLES BY JAMES DUNN

Longer-term, it should do well on the stock market, without shooting the lights out, and reward the patient investor – remember that Medibank Private operates in a highly competitive market.
When the Australian Government floated the first tranche (portion) of CBA in September 1991, the shares cost $5.40 (subsequent tranches sold for $9.50 and $10.00). Investors who backed the initial CBA float and held the shares now have shares that trade for about $77, more than 14 times the purchase price. But the initial investors have also received a total of $42.48, for a total return of $119.48, or more than 22 times the purchase price.
The CBA dividends alone have paid off the original $5.40 purchase price more than seven times.
Another Australian government privatisation, CSL (the former Commonwealth Serum Laboratories) has rewarded shareholders even more handsomely.
CSL was floated at $2.30 in June 1994: a three-for-one share split in 2007 means that was effectively 77 cents. CSL now trades at $74.29 - meaning original shareholders have made 96.5 times their money, just on the share price. But original CSL shareholders have also received $8.275 in dividends: that makes a total return of 107 times your money!!
The original Telstra retail shareholders, who paid $3.30 in two instalments starting with $1.95 in November 1997, are showing a capital gain of 65% on the shares at $5.45, bit they’ve also received $4.385 in dividends. That makes their total gain just short of tripling their original investment.
Telstra 2 retail subscribers paid a total price of $7.40, paid in two instalments, October 1999 and October 2000. They’re still underwater on the share price, to the tune of 26%, but the $4.075 they’re received in dividends more than covers that loss, and puts them ahead by 29%.
Shareholders who entered the stock through the Telstra 3 issue, in November 2006, paid $3.60 in two instalments. At $5.45, they’re ahead by 51% on capital gain alone, but add $2.255 worth of dividends to this and they’re up by 114% in total.
OK, so we’ve established that government privatisations can do OK on the stock market.
Now let’s look at Medibank Private.
First of all, some progressive types might mourn the fact that the insurer is leaving “public” ownership for the more aggressive “private sector,” and will be run from now on for profit. I was asked by a TV news reporter whether this would be the case. I said, “I should hope so.”
Few people remember – and it is certainly not being shouted from the rooftops at the moment – that when the current chief executive officer, George Savvides, took over at Medibank, in 2002, it had lost $175 million and was on the edge of breaching its prudential capital requirement – meaning that the prudential regulator could have shut the business down or at least taken over. It would have been very embarrassing for the federal government for that to happen to its own health fund, so Savvides and his management team got the licence to do a complete rebuild.
Which they have, and then some. Medibank has paid dividends of about $450 million to the government over the past two years alone – including a 'special dividend' of $300 million paid in August 2013.
So, let’s look at the company and its float.
Medibank Private is the largest health insurer in Australia, offering insurance under the Medibank and AHM brands. Out of about 40 private health funds, national market share is about 30%, with its nearest competitor being BUPA Australia with about 27% of the market.
Medibank Private is not a not-for-profit company: it was fully corporatised – meaning it operates like a commercial business – by the Rudd government In October 2009. For this reason, Medibank Private’s premiums rise with the market.
Medibank Private expects to lift its revenue by 4.2% to $6.64 billion for the 2014/15 financial year. From that, it expects to earn operating profit of $282.1 million – up 10.5% from $255.3 million in 2013/14. But net profit is projected to be static, at $258.2 million.
The insurer plans to pay out between 70 and 80 per cent of its earnings as dividends in the future. For the seven months to June 30, 2015, Medibank Private expects to pay a fully-franked dividend of 4.9 cents a share.
At the indicative price range of $1.55–$2 a share, that equates to a dividend yield of between 4.2%–5.2%, and puts the potential share price at between 16.5 times–21.5 times expected earnings.
At the indicative price range, Medibank Private will come to the stock market worth somewhere between $4.3 billion–$5.5 billion.
All well and good, but how do we make sense of those numbers?
There is one direct comparison with Medibank Private that is already listed on the stockmarket – NIB Holdings (NHF), which is about the fourth-largest health insurer, with a 7.6% market share.
Workers at BHP Steelworks, Mayfield, established the Newcastle Industrial Benefits (NIB) Hospital Fund in 1952. Newcastle-based NIB was the first (and so far only) Australian health fund to demutualise and list on the ASX, which it did in November 2007.
NIB has been an outstanding performer on the stock market. Its five-year total return (capital gain plus dividends) figure is 28.3% a year. Over three years, it has returned 35.2% a year, while over the last 12 months it has delivered 43.5%.
About 280,000 of NIB’s 330,000 policyholders became shareholders. Institutions got the shares at 88.5 cents following a book-build: the shares opened at $1.14. The stock now trades at $3.02.
For the financial year 2013-14, NIB lifted earnings per share (EPS) by 4% to 15.9 cents, and its dividend by 10%, to 11 cents (plus a 9-cent special dividend). Revenue rose by 15% to $1.53 billion, while claims were up 12% to $1.2 billion.
NIB’s final return on assets (ROA) figure for the financial year was 12.4%, while return on equity came in at 27.8%.
The analysts’ consensus expectation for NIB’s earnings and dividend in the current financial year complied by (Thomson Reuters) place it on a forecast price-earnings (PE) ratio of 17.9 times earnings, and a fully franked dividend yield of 3.8%.
So Medibank Private is priced on a more attractive yield, and in the same ballpark in terms of PE, depending of course, on the final price.
That tells you that the government is prepared to be a little but more generous than it has to be on yield, while pitching the price in a neutral area, neither screamingly cheap nor overly expensive.
ROE is harder to figure out, because Medibank's most recent published accounts were for the year ended 30 June 2013, in which the return on equity was a touch over 15% – a long way short of what NIB can generate now.
Then there is the fact that as an insurer, Medibank Private generates almost 40% of pre-tax earnings from its investment portfolio: this can be a volatile source of profit – as recently as 2008-09, at the height of the GFC, its investment portfolio lost money for the year. This volatility complicates earnings projections.
There will certainly be demand from the stock market for the float. How much unsatisfied demand there will be depends on how much of the stock institutions get. Investors looking for a nice IPO premium on the day will need to see institutions scaled back in their demand for the stock – and hope that the US market does not fall 2%–3% on the night before Medibank Private’s debut.
Longer-term, it should do well on the stock market, without shooting the lights out, and reward the patient investor – remember that Medibank Private operates in a highly competitive market. Above all, don’t expect it to be another CSL – back then, the government had no idea what it owned, and what CSL could do with Brian McNamee at the helm.

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IPO a portfolio boost – at the right price
Expert view John Wasiliev
1450 words
1 Nov 2014
The Australian Financial Review
AFNR
English
Copyright 2014. Fairfax Media Management Pty Limited.
John Wasiliev

Hundreds of thousands of do-it-yourself superannuation fund investors are starting the process of applying for Medibank Private shares. If there is one thing the $5 billion-plus float of the government-owned health insurer highlights, it's the importance of the 540,000 fund, $560 billion DIY super sector in the financial system.

"Self-managed super funds are expected to play a major role in the Medibank float given they now represent a significant majority of private investors in shares," says Michael Roe, a senior investment adviser with Morgans Financial at Spring Hill in inner-city Brisbane.

As retail investors, their applications must be lodged by November 14 with money upfront at a nominal price of $2 a share. Eleven days later, on November 25, they will know if they are entitled to any refund based on the share price the government decides to sell the shares for. They will also know if they've got all the shares they applied for – it is possible there could be limits on some applications if the demand is as strong as the 750,000 prospectus applications for Medibank Private suggest.

One of the features of the float is important decisions that will still need to be made by the government once investors have put up their money.

After retail investors, including DIY funds, have indicated how many shares they want for which they are prepared to pay at least $2, professional investors like big fund managers will participate in a bidding process for the number they would like to buy and how much they are prepared to pay with a range of prices of between $1.55 and $2 as a guide. This process is described as a book build.

What big investors offer will lead to a recommendation to government of a price retail investors will be asked to pay for their shares. This will come from managers it has employed from the private sector to help with the float.

It's a price, however, that the government may or may not accept. If the recommended price from the managers is $2 a share, it may decide to set the price at $1.80 to make it more attractive to retail investors who will receive a refund of some of their application money.

This possibility is a key point of difference between the float of a business by government compared to a float by private enterprise, says Paul Taylor, the long-time manager of the $3.7 billion Fidelity Australian Equities Fund.

Government floats will often include a sweetener for potential buyers in the form of a discounted price – meaning they're not squeezing every dollar possible from a public share offering as is often the case with a float from the private sector.Hold off until trading option

This private sector motivation, says Taylor, is why many professional investors are often negative about company floats, preferring instead to hold back on supporting them until the shares start trading on the market.

In these circumstances, the share market will often prove to be a more fertile place for an investor to buy, says Taylor, rather than a float because the buyer is deciding whether it is the right time to invest. This contrasts with many floats where the seller is attempting to make all the decisions and set the pace.

Taylor thinks the Medibank Private float is probably a more balanced transaction where the investment favours neither buyers nor the seller.

Fund manager John Abernethy, a director of Clime Investment Management, says while that is a view he might normally have about a government float, what's different about this is the professional investor bidding process and the random price it could come up with.

Abernethy says there is a big difference in value for the shares at $1.55 and $2.

His analysis of Medibank's historical and forecast income statements from the prospectus concludes that at $2 the shares are over-priced. It could even be, he reckons, that this upper price level has been randomly set to give retail investors the impression a discount at this price is a bargain.

He believes the real price based on company's performance is between $1.50 and $1.70. It is a good buy at the lower price and a reasonable investment at $1.65. Another consideration is that there won't be a dividend until September next year.

That said, it still shapes up as a good business that seems to be managed efficiently compared to other government enterprises. It also compares favourably with competitors in the private health insurance industry.

The average mum and dad retail or self-managed super investor, says Elio D'Amato, managing director of share investment research service Lincoln Indicators, is unlikely to base a decision to invest on the detailed commentaries and analysis, and complex financial summaries contained in the 200-plus page Medibank Private prospectus.

They will be influenced by the positive approach being adopted by every sharebroker and many advisers.

D'Amato believes what will be relied heavily upon to sell the story is the perception that government investments tend to be sold cheaply to try to guarantee a good investing experience – especially for first-time, less sophisticated investors.

With the exception of the second tranche of Telstra shares, most government floats (Commonwealth Bank, CSL and the two other Telstra offerings) have done well.

While Medibank Private ticks the boxes as an interesting investment in a few ways, Abernethy says it will only be a good news story if the price is right.

With any new share investment, one question many investors are likely to ponder upon is how many shares they should buy. The minimum investment in the Medibank Private float is $2000 worth – which is 1000 shares at the nominal $2 maximum price retail investors will be asked to pay. But brokers say applications from cashed-up DIY super funds are likely to be about $10,000 worth. Big purchases may be as high as $50,000.

While there is the possibility of share applications being scaled back if there is too much demand, Michael Roe from Morgan Financial believes the government will do its best to satisfy the sort of demand an average DIY fund investor might have. If an investor applies for $20,000 worth of Medibank shares, for instance, initiatives such as share allocation to stockbrokers being reduced to redirect them to retail investors should limit any scale back. Any dramatic reduction would be regarded as a disappointing outcome by investors.

For retail investors a big scale back is only likely with an application of, say, $100,000 worth of shares.

Fidelity fund manager Paul Taylor says if investors like the company, they should not be distracted by the possibility of a scale back. If this happens there is always potential to buy on the market – often after a float settles, the share price comes back to a level where investors are happy to buy. Patience is important, especially for a long-term investor looking to profit from future price gains from improved profit and dividends. For someone looking to make a decision on how many shares to buy in a more scientific way, suggests Taylor, if you like a company like Medibank you might start by committing half of 1 per cent of the value of your super portfolio. That's a $5000 investment for someone with a $1 million fund.Increase holding overtime This could be expanded over time as the company proves itself. With any new investment the golden rule, says Taylor, is to continually re-examine the investment based on why you bought it and whether this still stands.

Share investing should be regarded as a marathon rather than a sprint. While some people may make money by speculating, the majority do so by making an investment and then adding to it over time as it proves itself.

One opportunity for speculation in the Medibank listing is buying shares in the float and looking to sell them almost immediately for a small profit over the next couple of months when the shares experience index fund buying. This strategy require traders to monitor when shares are likely to be added to an index portfolio like the ASX 200, the ASX 100 and the ASX 50 and then hoping that the buying by managers will give the shares a boost.

Depending on the price of the shares, Medibank Private is likely to initially rank between 65 and 75 in the ASX 100 and ASX 200 indices.


Fairfax Media Management Pty Limited

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Meet the CEO of Medibank Private
PUBLISHED: 11 NOV 2014 12:43:01 | UPDATED: 11 NOV 2014 14:55:37

Meet the CEO of Medibank Private
It’s the biggest privatisation in five years but George Savvides wants to temper expectations. Photo: Wayne Taylor
MATTHEW SMITH

When the Australian government announced its intention to float Medibank Private, investors began rubbing their hands together in anticipation of the opportunity to grab a slice of the growing private health insurance market. As the months since the share offer announcement have passed, the investment community has become increasingly sceptical about whether there’s enough value built into the company and if the pre-IPO shares are priced at an appropriate level. As the biggest float of this year hurtles towards listing, Smart Investor talks to chief executive George Savvides

What is the story investors are buying into if they have invested in the Medibank float?

Healthcare is a $147 billion sector in Australia. And it’s very hard when it comes to private health insurance to buy a share in that sector. Only one out of 34 health funds are listed on the ASX. The rest [of the sector] is dominated by an overseas mutual in Bupa and a whole lot of local mutuals. There are some great companies in the sector but in healthcare investing, opportunities are limited and until we arrive, there’s nothing in the [ASX] top 100.

Then there’s the story that with an ageing population and their consumption of health services, we know the demand for health services will grow. Today Australia is on the modest end of consumption among Western countries for healthcare. With the arrival of the baby boomers, this sector is only likely to continue to grow and the companies that can manage that growth and costs well will be good companies to follow and be a part of in future.

How will you get costs down? Will you be chopping away at management costs?

We’ve come down nearly two whole percentage points – mid 10 per cent to mid 8 per cent – in the last couple of years. So it’s been a pretty severe reduction in the management-cost ratio. The commentary around government businesses being over-funded could be an overstated point to investors. Even with a national distribution network, which 30 of the 34 heath funds don’t carry, we’re already at industry average. I would caution people about getting too excited that there are rivers of cost coming out of the business because I think the rivers have already come out.

But there is an expectation efficiency will help drive value for shareholders, how else can you do it?

Costs we have been alluding to are not so much in the overheads but more in the area of purchasing our services more effectively for the 87¢ in the premium dollar we pay out in claims. This includes services through contracts with major hospital groups – they come from day surgeries and a host of ancillary providers like dentists and optical. It’s in that area where we will be asking, can we purchase more effectively and use our scale?

With government privatisations, the narrative investors keep hearing is it’s all about removing costs. Is this the wrong way to look at Medibank?

I don’t think that’s what they should be focusing on.

Are your internal systems up to scratch? Will there be any nasty capital expenditure surprises for investors?

Over the past four to five years the significant core system investments were the hospital claims engine, medical specialists claims engine and the ancillary claims engine. We did those one after the other, the last was finished with the ancillary claims engine. That gives us the most modern claims engine in the industry. We don’t key in our claims – they are automatically processed. When the claims come through they can be adjudicated without the need for human intervention.

The last piece, which is outlined in the prospectus, which will be rolled out over the next couple of years is the CRM product and contributions management. It means we will be able to service customers no matter where they come from and that means it will be aligned and integrated; currently it’s disjointed because it’s reflected in different platforms. It gives us stronger marketing abilities.

How does a modern claims engine relate to the company’s ability to be more efficient and potentially create future shareholder value?

This last core systems upgrade is all customer-oriented, whereas the previous items I described were very much back office. For instance, you might have come to Medibank through a comparison website and bought an AHM [Medibank’s low-cost brand] product and within the first 12 months you might have tried out an ancillary item like optical or physio.

We will make contact with you to find out more about your needs, because after coming in on a comparison website, you don’t really get down to talking about your health needs, what you use it for and what you need it for. So this system allows us to engage with you better and offer benefits in your plan or a new plan that covers your benefits more closely. These systems do this much better than what we already have . . . it’s a platform that allows us to anticipate your needs.

So what does all this mean for investors? More cross-selling opportunities?

Keeping people in more comprehensive products to cover their needs rather than downgrading into inadequate products and being exposed to jeopardy when they need to claim. So that’s value in terms of the business. It’s also value for the customer.

Medibank will be testing these intuitive systems for the first time as a public company. Is there a risk they won’t work or will not live up to the expectation?

Remember, what we are doing is we are replacing manual activity that is episodic with much more of a system-based approach. So the experience is known to us. The actual efficiency of it and being more comprehensive is the future intent with the future platform.

How important is making relationships with doctors and how are you doing that?

Working with doctors is really important for health funds. While GP coverage is excluded from healthcare policies by the Private Health Insurance Act, we know intuitively you can’t treat a patient holistically if the GP is not there.

So we’ve worked with GPs, running chronic disease management programs and more recently, high needs patient programs. That’s been great because the GP has been telling the health fund: “This is your member and you’re right, they do need extra services. I’m going to advise your member to take on those extra services as your GP.” That’s the kind of cultivation of relationships we are working towards.

Is that working? What challenges are you encountering?

Well it’s new, no one else is doing it. In the first phase of that in Queensland we had 40,000 members in the state use the service in the six-month period we established it. The feedback is they loved it, they appreciated getting to a doctor more quickly and not experiencing a co-payment because the experience was organised by Medibank.

We were able to get feedback from some GPs about members that have special needs. And out of that feedback we have been able to be more valuable has a health fund.

How are you positioned if the government decides to reduce spending on healthcare?

We’re pushing to be much more involved in primary care because we think that a more proactive approach lowers the frequency of admission into acute care. It’s often because of the inadequate access to primary care they end up defaulting into acute care which costs the system a lot of money but also isn’t a great place for the individual to be.

Can people keep paying health insurance premiums at the current rate?

We share affordability concerns deeply with our customers, we survey them and they tell us what they need. The indexation of the private health insurance rebate does aggravate the year-on-year premium increase by adding a percentage point above those that have the rebate because it’s diluting every year. So a 6 per cent premium increase is actually more than 7 per cent by the time the individual gets it because of the rebate indexation.

The industry and ourselves have asked the government to review the indexation and remove it and go back to a restored rebate. The government has said it will restore it once it gets the economic fundamentals of the nation sorted out, but every day is a day too long for us and we’d like to see that done quickly.

That just underscores how much your business is influenced by the whims of the government, doesn’t it?

We want to see the participation rate in private health insurance stay around the 50 per cent levels where it currently is. For anyone who leaves private health insurance the government has to fund 100 per cent of those costs. So I think we are aligned – the answer is I don’t think it’s in the government’s interest to see the participation rate decline either.

This story first appeared on Smart Investor.

The Australian Financial Review

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Medibank priced at $2.15 to raise $5.7b
PUBLISHED: 3 HOURS 57 MINUTES AGO | UPDATE: 1 HOUR 1 MINUTES AGO


BIANCA HARTGE-HAZELMANAND PHILIP BAKER

Mathias Cormann. Photo: Chris Hopkins

Professional investors have found out they will be paying $2.15 for a piece of Medibank Private before the initial public offering of the country’s biggest private health insurer on Tuesday.

Finance Minister Mathias Cormann announced the final price and share allocations for the float of Medibank Private at a special news conference in Perth, saying the share offer would raise $5.679 billion.

On Thursday, the indicative price range for institutions was lifted to $2-$2.30 a share and thanks to the way the initial public offering had been structured, retail investors were set to pay no more than $2.

The confirmation of the institutional offer price means mum and dad investors will pick up shares at a 7 per cent discount to fund managers, which is likely to deliver them a paper profit when the stock begins trading at noon on Tuesday.

But some fund managers told Channel Nine’s Financial Review Sunday program that Medibank shares could tank if the price did not hit the right mark.

“At $2.20 I would be reasonably indifferent because what we’ve essentially got is a business that is fair value, according to the way that we think about stocks,” said Raaz Bhuyan, principal and portfolio manager at Wavestone Capital.

“At $2.50, I’d say you’re putting a lot into a business which has got low margins.

“Yes, it’s in a great industry and it’s a good business and I think there’s a lot in it, but clearly I’d be a happier taxpayer than investor at that point in time.”

Professional investor Richard Coppleson warned that if the company was priced too high, some investors would look to lock in what is called a “stag profit”. This occurs when investors see an immediate profit due to under-pricing or heavy demand for the listing stock.

“If Medibank comes on at $2.20, it’s a buy. $2.25 it’s a buy, even at $2.30 I think it’s still going to be a buy for retail investors. If it comes on at $2.40, $2.50, the staggers will sell. They won’t be able to help themselves, it’s too tempting.

“But if you’re a long-term holder in this company and you like the story, and it is a good story, you will actually have to hold that temptation and you will do well in the long-term.”

The founder of 452 Capital, Peter Morgan, said he was quite nervous about how the float would go because of the hype that had come in the past couple of weeks.

“You’re valuing it on an individual basis in a market that is high and valuations are high and interest rates are low,” he said. “So the overall market is expensive and this is a company that has got a lot of hype around it and is tied to that sensitivity. And that worries me.

“To that end, I’m quite cautious about going aggressively at it in the first week of trading.”

Talal Yassine, managing director at Crescent Wealth and non-executive director at Australia Post, told Financial Review Sunday: “I don’t think Medibank Private is a fat and lazy organisation ready for the cull. More things can be done in a for-profit environment – that’s different to the fiction common among some people.”



The Australian Financial Review

BY BIANCA HARTGE-HAZELMAN
Bianca Hartge-Hazelman
Bianca covers markets from our Sydney newsroom.

Stories by Bianca Hartge-Hazelman

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PHILIP BAKER
Look at Medibank like a fund manager
PUBLISHED: 9 HOURS 25 MINUTES AGO | UPDATE: 2 HOURS 33 MINUTES AGO


PHILIP BAKER
Medibank priced at $2.15 to raise $5.7b
Six charts to look at before buying Medibank shares
Medibank’s high price will make life tough for management

You’ve only got to spend an afternoon at a barbecue to realise just how much time we spend thinking about money. And one way to make a quick buck is cashing in when a company makes its debut on the ASX.

No float captures the attention of retail investors more than privatisations and Medibank is just another example of what happens when the government sells off a household name, making its shares available for the public.

Suddenly normally market-shy small investors sit up and take notice, while thousands of others become investors for the first time.

SEE IT FROM A PROFESSIONAL’S POINT OF VIEW
The sale of Medibank has put privatisations firmly back in focus but for retail and first-time investors it might be worthwhile to look at the company the way a fund manager does when trading begins on Tuesday.

Wavestone Capital principal Raaz Bhuyan points out there are a few very good reasons to buy the shares but warns they are also priced at close to fair value.

Using his methods to value companies, he can get to $2.20 a share, just above the $2.15 fund managers have been allocated stock and 10 per cent above the $2 that retail investors have paid.

But if they trade much higher than that $2.20 level, the stock starts to look like all the good news is in the price.

What also worries a lot of fund managers is the hype that surrounds this float.

BEWARE OF THE HYPE
At close to $1.55, the low end of the original indicative range, the stock is cheap, trading at close to 16 times forward earnings. But now it’s closer to 23 times. Many professional investors think that all management can do to improve the bottom line is cut costs.
Bhuyan points out that insurance companies trade at 15 times earnings and hospital operators at 25 times, so he thinks a range of share prices for Medibank is $1.50 to $2.50.

But he’s happier to be a taxpayer rather than an investor at closer to $2.50.

For sure, the healthcare sector is attractive, given the demographics of the country, and the fact that we are a wealthy nation it’s a good industry to be involved in.

Over the past five years, revenue has grown at 8 per cent per annum and Bhuyan thinks that top-line growth will likely be sustained in the near term – at least at mid-single digit thanks to population growth.

He also thinks the risk to earnings is low in the short term given the conservative forecasts in the prospectus.

“The balance sheet is strong, business is ungeared – therefore, there is the potential for Medibank to pay higher dividends in future,” he adds.

BUT THERE ARE A FEW NEGATIVES
“Underlying margins are low at 5 per cent. Roughly 87¢ out of every $1 of premium goes out to meet claims expenses and so, any errors around product design or pricing can materially affect margins. Whilst the company has plans to manage claims better, arguably with risk equalisation there hasn’t been the incentive for the insurers to focus on this aspect so far. Any benefits will likely be long dated,” Bhuyan says.

Medibank also benefits from its earnings investments but these are outside the control of management.

Bhuyan also points out that it’s the government that decides pricing and there is some ambiguity about what happens when the Private Health Insurance Administration Council gets merged into the Australian Prudential Regulation Authority (APRA) on July 1, 2015. APRA has committed to no change till July 1, 2016.

Assuming revenue can grow at around 6 per cent; there is some improvement in gross margin and costs can be cut; there are no missteps in product design or regulatory changes which are hard to forecast, then Bhuyan gets to that valuation of around $2.20.

“Paying more than that will mean that there is a lot of hidden value in Medibank’s future role in healthcare which is hard to justify,’’ he concludes.

Investors are also valuing this company in a market that’s on a roll, where valuations aren’t as cheap as they were and interest rates are low.

Medibank has a lot of hype surrounding it and how it performs is sensitive to that.

The Australian Financial Review

BY PHILIP BAKER
Philip Baker
Philip is a markets columnist in our Sydney newsroom.

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Medibank float has a lend of newbie buyers
THE AUSTRALIAN NOVEMBER 26, 2014 12:00AM

Andrew Main

Wealth Editor
Sydney
Chris Gottlieb
Investor Chris Gottlieb, in Sydney, was allocated Medibank shares worth $25,000 and wonders when he will see the rest of his $450,000. Picture: James Croucher Source: News Corp Australia

CHRIS Gottlieb was down about $2000 on the Medibank float yesterday before Finance Minister Mathias Cormann had even rung the bell to start trading, because he had $450,000 sitting in government coffers for what might turn out to be a month.

And because of a huge scaleback of allocations to cope with demand, he ended up with just under $25,000 worth of shares.

As a retail investor, Mr Gott­lieb bid for $450,000 worth of shares. So by last night’s close, the Sydney-based strategy consultant was up 14c a share at the closing price of $2.14, but marginally behind by the time he calculated the opportunity cost of lending the government almost half a million dollars for a month.

Retail investors paid a guaranteed maximum $2 a share for stock, getting 60 per cent of the 2.8 billion shares issued.

Strong demand for Medibank stock by institutions after the retail price was set saw the bigger players paying $2.15 a share.

The stock opened yesterday at $2.22 but by close of trading was just below the price the institutions had paid, shedding 8c in afternoon trading. On a day when most big stocks finished down, most observers considered this a success.

“I completely get the outcome and the share allocation, and it’s absolutely fair that the government is trying to spread the ownership network of Medibank as widely as possible,’’ said Mr Gott­lieb. “But what frustrates me is that they are sitting on a good chunk of our life savings for what could turn out to be a month, and may not be in a hurry to give back the balance of our money.’’

Most government selldowns work that way: investors put up their money, get told how many shares they are getting, and then weeks later are reimbursed the uninvested money.

Despite having secured his shares, Mr Gottlieb is not in a position to sell out today or tomorrow since, like many Medibank investors, he does not have an account with a broker and has yet to be sent a holder identification number that facilitates a sale.

In other words, the system has yet to catch up fully.

As the message at Australia’s biggest online broker CommSec put it yesterday: “If you did not supply your holder identification number, you will have to wait until you receive your shareholder reference number from the share registry, which will be sent to you from December 4.’’

It’s not so bad for people who already have a relationship with a broker, apparently, since the broker can more easily check whether the investor has been allocated the shares and therefore can be confident selling them on the ­investor’s behalf.

But since Medibank shares will trade this week on what is called a deferred settlement basis — because of the delay in registering them to the 400,000-odd new owners — some keen sellers may accidentally break the law.

That is because short-selling shares subject to the deferred settlement rule — selling shares you do not own — is illegal.

Given yesterday’s turnover was a massive $1.28 billion of shares, or more than 20 per cent of Medi­bank Private’s issued capital, brokers’ back offices will have a busy and challenging few days.

[greengiraffe]

Soft landing for Medibank
THE AUSTRALIAN NOVEMBER 26, 2014 12:00AM
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Michael Bennet

Reporter
Sydney

Finance minister Mathias Cormann with Medibank managing director George Savvides at the listing of Medibank Private in Sydney. Source: News Corp Australia

MEDIBANK Private’s long-time chief George Savvides has played down the prospect of driving growth through acquisitions, as the nation’s biggest private health insurer whipped a trading frenzy on its stock exchange debut.

In one of the most hotly ­anticipated listings ever after the government sold $5.7 billion worth of shares through the float, Medibank shares yesterday ended on a ­downer at a ­session-low $2.14, with 450 million swapping hands.

Weighing on Medibank after opening at a healthy $2.22 a share was a 0.5 per cent fall in the ­broader stockmarket, a large fund taking profits in late trade and other institutions selling smaller than desired allocations of stock, sources said.

But despite the decline, Medibank represented a healthy paper gain for retail shareholders who paid $2 a share in the most hyped IPO since Myer’s flop in 2009 and the Queensland government’s sale of coal hauler Aurizon in 2010.

In contrast, institutional investors paid $2.15 after hot demand for the deal — led by Macquarie, Goldman Sachs and Deutsche Bank — enabled the government to raise the price from the initial range of $1.55-$2.

It made Medibank, which will join the prestigious top-100 index, the nation’s second-biggest initial public offering ever, behind the government’s sale of Telstra in 1997, and the world’s third-largest float this year.

“It is extraordinary,” Mr ­Savvides told The Australian after ringing the bell at the stock exchange in Sydney with Finance Minister Mathias Cormann in a packed ceremony.

“We inherit now the new 440,000 shareholders and we’ve got a job to do to make their ­investment deliver on their ­expectations.”

The pressure is on Mr Savvides after the pricey float and more than a decade leading the insurer, which commands about 29.5 per cent of the market — above Bupa and HCF — but has in recent years suffered lower margins and soft policyholder growth.

At $2.15, Medibank’s price ­represented almost 23 times the forecast profit for the 2015 financial year of $258 million, which some fund managers believe is ­expensive.

“People on the street have made a tidy profit in the short term and the institutional buyers are pretty much square,” said John Sevior, the head of Airlie Funds Management. “It’s a terrific company with a great market position in a decent industry. The issue for us was around pricing.”

Tim Samway, managing director of Hyperion Asset Management, which also did not buy shares, said he was turned off by the ­uncertain longer-term outlook, ­including that Medibank was a “price taker”.

“The success of this float is not measured really by the first day unless you sold and took a stag profit,” Mr Samway said.

“Insurance is a commodity business. It’s very price-sensitive, there’s a lot of aggregators in this market and it’s a product sold on price and therefore it’s open to higher levels of competitive pressure, which makes the long-term earnings less certain.

“A lot of it was sold on cost-out and the management have been there a long time, so why are things going to improve now?”

Mr Savvides said the company had invested in its executive ranks since becoming for-profit about five years ago, helping to increase its valuation to $5.9bn, from $1.5bn in 2005.

When asked if acquisitions were a key growth avenue, Mr Savvides said: “We haven’t made any commitment around M&A and we don’t require that to pursue our sort of growth goals.

“I think the principle area of cost is the 87c in the dollar that we pay out in claims every year.

“As market leader and the largest purchaser of health services ... we need to make sure we have some kind of scale advantage in the procurement of those health ­services.’’

The sale, which has been mulled since the early 2000s, is unlikely to be the government’s last, with scoping studies under way for big-ticket businesses such as the Australian Securities & Investments Commission. The government plans to reinvest the $5.7bn from Medibank in infrastructure. “It has long been the government’s policy to sell Medibank Private because in our judgment Medibank Private in private ownership will perform even better as a business,” Senator Cormann said.

Revealing the tension in pricing government floats, former ASIC chairman Alan Cameron said of Medibank: “Any price above $2.50 would have seen the government accused of selling out too cheaply, and any price below $1.90 would have produced about 400,000 angry shareholders.”

The IPO was the first notable opportunity for the general public to buy shares in a major float after Myer’s disastrous offering in 2009 all but shut the IPO market until last year, meaning it was keenly watched by bankers and fund managers.

Additional reporting: Andrew Main