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Medibank Private goes public

Back the truck up. Nearly any time the government wants to sell you an asset is probably a good time to load up and the Medibank Private float looks like such an occasion.

The Australian healthcare system spends almost $150 billion annually on hospital care, medical expenses and all manner of healthcare services. The government provides most of that funding but is increasingly looking to the private sector to take up some of the lifting to share the burden.

Medibank is relatively new to the game of doing this for a profit but that is one of the reasons why it would be worthwhile buying the shares. Taking costs out of the business, or at least not letting the cost pie grow is a key element of the group’s profit growth over the next few years.

The management expense ratio, as it is known, is a little higher than the industry average so Medibank knows it can improve its gross margin by improving this key metric.

As you might expect, a very small proportion of policyholders make an outsized proportion of the claims on the pool of premiums. Medibank says 2.2% of its 3.8 million policyholders (400 of whom are over 100 years old) make claims worth about $1 billion per annum, mostly on hospital stays where they are 3-4 times more likely to need treatment than other policyholders.

Medibank rightly reckons that by being innovative and more proactive about these policyholders, it can lower the hospital admission rate significantly thus getting a better outcome for everyone. Medibank has invested in what it calls ‘Provider Network and Integrated Care’ (PNIC) so that it can manage the provision of healthcare services to its customers much more efficiently.

Given that the company purchases around $5 billion of healthcare services from hospitals and other healthcare providers, it is imperative that Medibank receives a good price for those services that can be shared with its policyholders and now, its shareholders.

Pricing of private health insurance is closely controlled by a single government agency (PHIAC). Over the last 10 years, the private health insurers have applied for and been granted average annual price increases around 6% while inflation has average around 3%. That level of price increase is almost baked in to forecasts so the only question of how much profit growth can be achieved lands squarely in the management of costs. Medibank has promised to keep its total cost base to last year’s level of $520 million so that higher revenue and stable costs will deliver a better profit margin.

There are other ways and means of generating more profit such as expanding the reach of its aggregator brand, AHM or by growing market share.

With no debt on the balance sheet, Medibank could also contemplate making an acquisition but says this is not a priority.

The balance sheet has been shorn of excess capital by the government so shareholders only have profit growth and a sensible dividend policy through which to achieve gains. The indicative pro forma dividend yield of 3.5% to 4.5% isn’t bad and dividends will be fully franked.

The company makes a return on equity in the vicinity of 18% which has a very bank-like ring to it.

The price range indicated in the Prospectus is $1.55 to $2.00 per share and that will value the company at 16.5x to 21.3x forecast FY15 earnings. The market capitalisation of $4.2bn to $5.5bn makes this listing a heavyweight and will attract plenty of offshore interest.

The industry structure, on-going government support for private sector involvement and Medibank’s leading position in the industry all suggest it will do well as a listed entity.

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