The truth behind the Medibank hype

Don't believe the hype surrounding the float of Medibank. Demand for the IPO, which breathless reports have said could be several times the shares on offer, will be artificially inflated.

The banks running the offer will say that strong demand far exceeds the 2.7 billion shares available, and thus justify a price towards the top end of the indicated price range.

But a lot of that apparent demand will not be real, and it is worth keeping this in mind as the retail offer opens to investors today, just as the retail broker firm offer closes. Some brokers, including CommSec, closed off their offers early.

This is because individual investors believe that demand will be high, and are therefore applying for allocations well in excess of what they actually expect to receive. They know they are going to be scaled back. 

Anecdotally, high-net worth clients of some retail brokers have also been putting in for more stock than they expect. 

There is a huge amount of cash to tap. It has been 17 years since the sale of the T1 slice of Telstra, the last large-scale government privatisation of a household brand name. Estimates from APRA show that SMSFs hold about $183 billion in cash, for a start, at record low interest rates.

Mum and dad investors think they understand the business of Medibank, the nation's largest private health insurer with 1.8 million policyholders. That may not have been the case with the $4.6bn privatisation of rail haulage business QR National in 2010, the last major government privatisation (an definitely not a household brand name).

The Medibank retail offer, which opens today, is due to close on November 14 but could close earlier depending on demand. Investors apply for a dollar figure, rather than a number of shares, because the price hasn't been set yet. It will be set via an institutional bookbuild on November 18-20, with final pricing and allocation due on November 25. The IPO will raise up to $5.5bn.

The bankers backing the float say there are past precedents of IPOs with investors bidding for oversized allocations. One of their tasks will be in assessing and judging underlying demand versus how much “order inflation” is involved.

Potentially adding to the pressure on domestic demand will be interest from foreign investors. The float's bankers will be taking the roadshow to Asia tonight to tempt international fund managers, and the bankers will actually be paid double on overseas applications.

Most large-scale IPOs, including recent private equity floats such as Spotless and the New Zealand government's Meridian Energy, are marketed internationally to ensure a broad investor base.

Bankers also have memories of the Queensland Rail IPO, when domestic funds steered clear of the float and only demand from foreign investors helped to push the float over the line. They say it would be irresponsible not to structure an offer that offered such a backstop, although the businesses, the sectors and probably demand are completely different.

There are other risks for investors to keep in mind. The dividend yield that Medibank appears to offer is 4.2 per cent, but that payout rate is under jeopardy in the long term, as Robert Gottliebsen points out.

The private health insurer also comes to market with its own investment portfolio of $2.2 billion, with twice the equities exposure of rival NIB and plans to increase its allocation further, possibly contributing to earnings volatility, as Miranda Maxwell has explained.

The mood of financial markets is fickle and the government has been lucky that the past two weeks have reversed the nerve-wracking slide of the prior fortnight. The apparent departure of volatility, however temporary, has added to the positive momentum surrounding the IPO market.

With the US Federal Reserve about to reveal whether it has truly pulled the plug on its costly bond-buying experiment, the recent willingness of investors to increase their exposure to equities may not last.