One very big concern for Medibank Private buyers

This key factor might change the way you look at an investment in Medibank Private…

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The IPO of leading health insurance business Medibank Private has received enormous attention from investors and analysts. After roughly 750,000 people lodged their pre-registration interest in the IPO, interest once again peaked on Monday as the retail offer of shares opened up to mum and dad investors in what could certainly prove to be the biggest privatisation since Telstra Corporation Ltd (ASX: TLS).

Given the high level of excitement, the shares are likely to open at the upper end of their 'indicative' price, currently said to be between $1.55 and $2.00. Of course, retail investors who take part in the IPO are lucky in that their shares will be capped at $2.00, no matter the price that institutional investors will be required to pay.

So let's assume that the shares do open at $2.00. That will have the stock trading on a forecast P/E ratio of roughly 21.3 times earnings. That's very high considering other insurers, such as NIB Holdings Limited (ASX: NHF) and Insurance Australia Group Ltd (ASX: IAG), are trading on multiples of 18.9x and 12.6x, respectively.

But that's not the biggest issue. Instead, the company's growth prospects have also come under scrutiny which is cause for much greater concern for investors.

The very big concern…

While the business and the nature of Medibank's IPO has received significant attention, the insurer's sizeable investment portfolio has largely been ignored. Last year, Medibank Private generated 22% of its profit from its $2.2 billion investment portfolio – 18% of which is dedicated to growth assets while the rest is in more conservative asset classes.

Of course, this structure has benefited Medibank enormously in recent years as the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) has charged to multi-year highs, but it also leaves the company exposed to a high risk of underperformance from equities. Even if the market doesn't tank (I'm not one to even attempt to predict a market crash), Medibank's investment income remains partly leveraged to the stock market. Indeed, this will have a direct impact on the group's overall profits, too.

To expand on the subject of growth prospects, Motley Fool investment analyst Matt Joass put it perfectly last week when he said:

"Despite the company's dominant market position and growth, most of the excitement around the IPO comes not from what Medibank is doing very well, but from what it's doing poorly."

In order to justify its high valuation, Medibank would need to successfully cut costs and improve its underwriting margins, which are currently lagging behind those of its primary rivals. The insurer is also constrained by the government on how much it can raise its premiums which could also stunt earnings per share growth further.

It would be unreasonable to expect those fixes to occur overnight and could instead take some time for the company to deliver on the market's high expectations. This could certainly see shares drop in the medium term.

Although there is a high level of excitement surrounding this IPO, my most likely course of action will be to remain on the sidelines and see how the situation plays out over the coming months. I really don't see there being a drastic need to rush in and will continue to consider the plethora of other attractive investment opportunities presenting themselves in the meantime.

Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned.

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »