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Extract from "Alan Kohler Weekend Briefing 2014-11-01"
Medibank Private
Despite some criticism of the retail conditions of the Medibank Private float -- including in Eureka Report from Scott Francis (see How the Medibank float works against the private investor) and Robert Gottliebsen (see Medibank IPO first impressions: Low yielding and not cheap), the demand from investors has been pretty amazing. Broker bids for stock on behalf of retail clients totalled $12 billion, more than twice the whole company. Only $1.5 billion was allocated on Thursday.
In addition to that, 750,000 investors have pre-registered for the direct retail allocations, which close in two weeks. Following that, there will be an institutional book build that will set the price, although it seems likely it will be hard up against the upper cap of $2, for a total of $5.4 billion. In effect retail investors get three bites at the cherry – the broker allocation for rich private clients, direct retail allocations for the less well-off who tend to use online brokers, and then the institutional book build, which brokers can join.
Institutions will get about 20% of the float, or about $1.1 billion. They set the price because, according to the lead managers who are running the process, they are used to pricing securities and they tend to focus on value (and therefore won’t bid too much – that’s the theory anyway). They can be pretty sure there will be a lot of unmet demand from both retail and institutional investors – especially foreign ones – and therefore there’ll be a strong secondary market, so the float is likely to be cleared at or near the top end of the price range, which is $2.
In addition to that the lead managers reckon there will be about $500 million in index fund demand because of its size (index funds do not participate in an IPO – they buy later once the percentage of the index is established).
I’m not suggesting you should ignore the issues raised by Bob and Scott, but if you haven’t pre-registered yet, you probably should. It’s true that you have to pay your money before knowing the price, but assume it’s at the top end – $2. It might not pop from there for the stags, but I think the downside is limited.
To reiterate what I’ve said before: the investment case for Medibank Private is all about post-privatisation cost reduction. Health insurance premiums, and therefore revenue, is regulated and will keep increasing at 6% a year, no more and probably no less. Also its dominance in the Australia market means there is little opportunity to increase market share. So the Medibank Private growth story is about cost-cutting, not revenue growth.
There are two basic costs: the cost of running the business and the cost of claims. The administration costs total about $500 million and have been steady at that level for years. George Savvides has been a good CEO, but there is clearly some public ownership fat that he can only remove after privatisation.
The largest potential for cost reduction is in claims. I went through this in my email to you three weeks ago, but it boils down to working with GPs to keep patients out of hospital and screwing down the hospitals’ costs by refusing to sign contracts with the inefficient ones.
This will not be another CSL, which has delivered a 25% compound return, before dividends, since it privatised in 1994. With dividends the total compound annual return has been 27%. To get that you need a lot of revenue growth on top of post-privatisation cost-cutting. But it won’t be a Qantas either. Maybe a Commonwealth Bank – 11.3% compound capital return since it was privatised in 1991, plus $42.68 in dividends per share. Total compound return of CBA has therefore been 13.4%.
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