Overpaying for hope and the Medibank IPO

Everyone loves to make a quick buck and investors in Medibank Private (ASX: MPL) got their chance yesterday. The company ended its first day of trading on the ASX at $2.14 per share – a 7% premium to the $2.00 paid by the stampede of retail investors who subscribed to the offer, raising $5.7bn for the Government in the biggest privitisation since Telstra (ASX: TLS).

Stag profits look easy, especially in hindsight. But as with any over-hyped IPO of a well-known brand, the profits to be had are based more on hope than valuation. That's no way to invest for the long term: let's not forget that Telstra's share price is still below its Tranche 2 listing price of $7.40 some 15 years later.

Nonetheless, with happy investors, happy taxpayers, and champagne flowing at a few investment banks, there's only one thing left for Medibank to do: deliver on its operational promises.

Medibank was trumpeted as a cost-cutting story. If its efficiency can be improved to a similar level to its competitors, such as BUPA and NIB (ASX: NHF), today's price looks cheap.

The story isn't without merit: an ageing population and ever rising healthcare costs provide a revenue tailwind and, with a 29% share of the private health insurance market, Medibank possesses significant negotiating power with healthcare providers as well as economies of scale in claims and marketing.

However, management have been in place for more than a decade so, one has to wonder, if a striking turnaround in efficiency is so easy, why didn't they do it sooner?

Then there's the nagging question of where regulation is headed. Health insurers require ministerial approval before increasing their premiums. Approval hasn't been hard to get historically, with the company frequently being permitted to increase its prices well above inflation.

However, the Government no longer has any commercial interest in allowing the cost of insurance to rise year-on-year and may decide it's time to put a little more pressure back on the insurers – squeezing their margins in the process – to encourage people to move away from the overburdened public health system. Not to mention that standing up for mums and dads against the health insurance oligopoly will win some brownie points at election time.

An operational transformation is no certain thing. However, there is one clear way for investors to profit from the Medibank IPO: value the business conservatively, don't speculate on short-term price movements, and patiently wait until the market offers you the company at a sensible price with sufficient margin of safety.

Medibank is trading on a multiple of 24 times forecast earnings for 2015 and has a dividend yield of 3.4%. That's a rich valuation for a company growing in the mid-single digits, even a high-quality one. You'll find us in the waiting room.

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