Just two days are remaining for investors to get their applications in for a share of the Medibank Private initial public offer (IPO), in what is looking like being one of the biggest IPOs seen since the turn of the century.
Despite the rather lofty price tag on the shares, demand for a stake of the government-owned health insurer has been enormous. Institutions lodged bids for roughly $12 billion worth of shares (more than twice the expected value of the float) while mum and dad investors are also hoping for a piece of the pie in anticipation of an increasingly likely 'stag profit' – which is slang for a speculative gain.
Although there has already been an enormous level of bidding activity for the stock, there will no doubt be more applications lodged over the coming days in the lead-up to the 11:59pm deadline on Friday. Investors still considering whether to buy a parcel of shares should first consider the following pros and cons of doing so…
The Pros
- First-day profits. Clearly, the likelihood of the stock popping on the day of the IPO is incredibly appealing. The shares are capped at $2.00 for retail investors, yet Fairfax media reported that the stock is currently trading in a pre-listing shadow market operated by IG markets at $2.15. There is potential, but it's far from certain.
- Privatisation. Companies that have been sold by the government have an incredible track record for delivering long-term gains. Medibank could soon join that list which already includes Commonwealth Bank of Australia (ASX: CBA) and CSL Limited (ASX: CSL).
- Growth. The Australian healthcare sector is growing at a strong rate, resulting in buoyant growth in our private health insurance industry. Expect this trend to continue as Australia's population continues to grow and age.
- Market Share. Medibank Private provides health insurance to over 3.8 million Australians and controls 29.1% of the market.
- Room for improvement. The insurer could grow profits substantially by focusing on reducing costs and improving margins – a strategy that has been highlighted by management. This could drive earnings substantially over the coming years and justify its current high valuation.
Now that we've considered those rather impressive advantages, let's let a look at why this investment could go south…
The Cons
- Price. There's the appeal of a nice first-day profit, but then what? With an indicative price range of $1.55 to $2.00, the stock will be trading on a P/E ratio between 16.5 and 21.3 times forecast earnings. That's pretty pricey for a good, but by no means spectacular business, which could limit long-term returns.
- Strategy. The question that needs to be asked is, why haven't management focused on reducing costs and improving productivity over the last decade? Why will they necessarily improve simply because the company lists on the ASX?
- Aggressive growth. Medibank has a sizeable investment portfolio which is largely dedicated to growth assets. This has been beneficial in recent years as the ASX has climbed to fresh heights, but poses as an enormous risk to profits as volatility begins to return to the markets.
- Expectations. That investors are willing to pay such a high price reflects their enormous expectations surrounding the business, and its ability to resolve its issues in the relatively near term. I would suggest the problems won't be solved that quickly, and a pullback in price could be on the cards.
- IPO trends. To extend on that point, recently listed companies often retreat in price after the initial excitement dies down. It happened with Veda Group Ltd (ASX: VED) and OzForex Group Ltd (ASX: OFX) earlier this year, and I suspect the same could happen for Medibank.
Here's what I'm doing
Medibank is clearly a quality company, and one with sustainable competitive advantages and fantastic potential. But, as is the case with any investment, you need to pay a reasonable price to make it worth your while in the long run.
While the shares will likely open up at the higher end of the indicative price range (or even higher), they do not present as good value for long-term investors. As such, I will not be taking part in the IPO and will instead add the stock to my watchlist and wait for a more attractive opportunity to present itself.
