The federal government has set an indicative price range of between $1.55 and $2.00 for the float of its Medibank Private shares in what could well be the biggest initial public offer (IPO) of the decade.
With more than two weeks remaining for investors to submit their bids, more than $12 billion worth of bids have already been received from stockbrokers highlighting the enormous level of interest the stock has received. But the question needs to be asked:
Is the stock really worth $2 a share?
As it stands, there's a 29% difference between the indicative high and the indicative low.
At $1.55, investors would be getting a bargain. The shares would be trading on a forecast P/E ratio of 16.5 times earnings and those who submitted their bids would be getting a quality business in a fast growing industry with strong competitive advantages.
At $2.00 however, investors are paying up for a company which may not live up to its potential. It would be trading on a forward P/E ratio of 21.3 times earnings and command a market capitalisation of roughly $5.5 billion, making it one of Australia's top 70 companies by size. There would also be an enormous expectation surrounding the company's ability to reduce costs, improve productivity and start catching up with some of its rivals, including BUPA, NIB Holdings Limited (ASX: NHF) and HCF in terms of growth.
When investors subscribe for their parcel of shares, they have no idea how many shares they will get. But given the high level of interest, it's only fair to assume the shares will open at the higher end of the range – or maybe even above $2.00. Of course, the price is capped there for retail investors, but it's still a high price to pay.
A seller's market
It should also be noted that this is a seller's market. Have you ever noticed how IPOs only occur when the market and investor confidence are both riding high? Just look at the flurry of IPOs which have occurred over the last year including the likes of Veda Group Ltd (ASX: VED), OzForex Group Ltd (ASX: OFX) and Healthscope Limited (ASX: HSO). The government will no doubt get a good price for the sale of Medibank Private, but the buyers might not be so lucky.
I'd be willing to bet that the shares will start off strong, and then experience a setback at some point, presenting investors with a more compelling entry point.
Of course, I might be wrong. The shares could open up significantly higher than $2.00 on the IPO day and never fall below that price ever again. But at the same time, I'm paying close attention to the risks facing the business and I don't believe there is a great enough margin of safety at the higher end of the indicative range.