Medibank IPO Preview
Peter Warnes/David Ellis  |  25/09/2014Text size  Decrease  Increase  |  

Peter Warnes: Welcome to Morningstar. My name is Peter Warnes and I'm the head of equities research for Australia and this morning I'm joined by David Ellis, our head of banks and insurance and we're here to discuss the upcoming IPO of Medibank Private. Welcome David.

David Ellis: Thank you. Thanks Peter.

Warnes: David, this is a very major IPO -- the largest since Queensland National Rail. It came on the list a few years ago. Can you just give me a brief introduction as to what the business is all about?

Ellis: Sure. Medibank Private is Australia's largest private health insurer, has a market around 30 per cent. It's long established. It's obviously owned by the Australian government and they are intending to IPO the business later this year and the program of the IPO is pre-registration, expected to open by the end of this month, by the end of September. And the prospectus is expected to be released by the end of October. And Medibank is expected to list on the ASX in December.

So, that's the process. So, at the end of September for pre-registration or the release of the pre-registration, prospectus end of October, listing on ASX in December.

Warnes: And Morningstar will have some discussion and some research out on all those steps, if you like, in the process from pre-registration to prospectus, to then covering once it's listed. Is that correct?

Ellis: Yes, that's correct. So, we'll have a detailed IPO preview report released this week, so released on approximately on 25 September. Just to precede the pre-registration period.

And then we will have an IPO report and then when the stock lists on the ASX in December full coverage will commence and we'll have a full company report in December.

Warnes: Excellent. So, we've got Medibank Private with almost 30 per cent of the market. We have the top 5 with 82 per cent. It sounds like a fairly cozy oligopoly. It's almost "bank-ish". Tell us a little bit about what you expect in terms of return on equity and the sustainability of that return on equity?

Ellis: Sure. Well, Medibank's most recent published accounts are of 30 June 2013 and the return on equity was just over 15 per cent. So looking forward, looking at our forecast, we would expect that return on equity to progressively improve to increase closer to 20 per cent. Medibank's only listed peer, that's NIB Holdings, its return on equity is a touch over 20 per cent, so that's what I would expect Medibank to progressively improve to.

Now how is it going to do that? Well, I think it's going to be a typical government privatization story. So I think there's going to be a focus on productivity improvement, on reducing costs, leveraging their scale, better pricing policy. I think looking back in time, some of the price increases that Medibank have approved or put in place have lagged the industry and that maybe because of its government ownership. So once it's privatized there will be more focus on as I said on productivity, on reducing costs and improving returns, and profits and return on equity will flow from there.

Warnes: And really, I mean, Australia's demographic trends are certainly a big tailwind, I would have thought for private health insurers, is that right?

Ellis: Absolutely. We have got obviously an ageing population. Looking at some of the Australian Bureau of Statistics stats, approximately 14 per cent of the population is over 65 now. Over the next 30, 40 years that's expected to increase to close to 25 per cent of the population. So you've got an ageing population, and obviously, the demand on the healthcare system increases exponentially as the population ages. You've got growing population as well. You've got government -- what we call carrots and sticks -- with their taxation policy. So there is encouragement to take out health insurance and there are penalties if you don't have health insurance.

And then overarching to this strong industry tailwind -- so good, long-term growth prospects -- overarching that is, is the regulatory system. So the health insurers apply for, each year they apply to increase their premium amounts through the government regulator. And so, all things being equal, the private health insurers are recovering their claims costs each year with premium increases. And then you have this concept of risks sharing across the industry so private health insurers that have got a high proportion of older -- more customers that are using the health system -- well then those insurers benefit from this risk.

Warnes: They subsidize. The guys that have got healthier policy holders.

Ellis: That's right. As an example, NIB, which targets the under 40 years age group for its policyholders, it actually pays into this risk-sharing arrangement and so last year it paid nearly $200 million, whereas Medibank, which has got an older demographic in its policy holder base, it actually received a payment of $100 million.

So, this risk sharing across the industry really does reduce the risk from an investor's perspective. And then on top of that, you've got the regulator aiming for a bottom-line net margin of between 3 per cent and 6 per cent across the industry. So, it's a low-risk industry. It's difficult really for a private health insurer to lose money. So, from an investor's perspective, it's very attractive. Private health insurers like Medibank should generate long-term modest premium growth, profit growth and of course dividend growth.

Warnes: So there will be a lot to read obviously in your next three reports and pre-registration, pre-IPO after the prospectus is out and then when we start covering it.

Alright David thanks very much. We look forward to reading a few pages of your reports in the future.

Ellis: Thanks Peter. Thank you.

Warnes: Thanks a lot.

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