Although its shares have retreated over the last month or so, retail investors who bought into Medibank Private Ltd's (ASX: MPL) initial public offering (IPO) in November are still sitting pretty.
With the stock now hovering around $2.38, those investors have recorded a 19% paper profit, given that the shares were capped at $2 per unit. That's an outstanding return in just over four months and compares to the S&P/ASX 200 Index's (Index: ^AXJO) (ASX: XJO) 10.7% gain.
However, given that I was concerned about the stock's valuation prior to its listing, I have become even more concerned now that it has jumped even higher. At $2.38, the company boasts a market capitalisation of nearly $6.6 billion, while it is trading on a price-earnings ratio of more than 25 times projected earnings. That is considerably higher than the average P/E across the ASX 200, while it is also high considering Medibank's size and limited ability to expand.
It seems that an enormous amount of hype has been priced into the shares, based around the insurer's ability to reduce management costs and improve efficiencies. Unfortuantely, those issues will be no overnight fix and when the market realises this, a heavy sell-off of the stock could be in order.
Meanwhile, product cannibalisation is another key issue that many investors appear to be ignoring. While Medibank is Australia's largest health insurer, ahead of BUPA, HCF and NIB Holdings Limited (ASX: NHF), it also owns the much cheaper insurer ahm, which is experiencing far stronger growth than Medibank Private branded policies.
In its most recent half, ahm recorded growth of 19.6%, compared to a 1.5% decline in Medibank-branded policies.
Although there is no doubting the quality of Medibank as a company, it is trading at a lofty premium – especially when you consider these key risks. While the issues facing the business will be no overnight fix, investors may want to consider looking for other, more compelling investment opportunities.
