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Privatising Medibank: will an IPO deliver for taxpayers?

The planned sale of Medibank Private by IPO continues a trend of privatisation that commenced with the Commonwealth Bank in 1991. While the debate about the merits of privatisation continues, it’s also…

The government has decided to privatise Medibank Private. Now they have to ensure taxpayers get maximum value from the sale. AAP/Mick Tsikas

The planned sale of Medibank Private by IPO continues a trend of privatisation that commenced with the Commonwealth Bank in 1991.

While the debate about the merits of privatisation continues, it’s also important to consider how governments can maximise the price they get for the businesses they choose to sell.

Will an initial public offering (IPO) achieve the best possible outcome for Australian taxpayers and result in a price that represents fair value for the sale? That’s uncertain, but it seems it’s the best of a number of options.

Privatisation has been on the agenda for more than two decades, but governments don’t have the best record in maximising value. Sydney Morning Herald

The possibilities

There are three possible ways the government could sell Medibank Private: a sale to a private equity fund, a trade sale to one of Medibank’s competitors or an IPO.

It is unlikely the government would be in favour of selling Medibank to a private equity fund. Private equity funds only hold their investments for an average of five years, so even if the government did sell Medibank in this way, the company would be likely to be back on the market in the not too distant future.

Private equity funds also tend to attempt to maximise their return on investment by increasing efficiencies and cutting costs during the short period they control a company.

Cost cutting could result in politically unfavourable staff cuts and a reduction in the services and benefits provided to Medibank’s 3.8 million members, particularly in less profitable rural branches.

A trade sale would likely involve selling Medibank to one of its competitors – BUPA, NIB Health Funds or HCF. The government commissioned scoping study, carried out by Ernst and Young, HerbertSmithFreehills and Lazard Pty Ltd, recommended this option on the basis that it was likely to provide the government with the best financial return.

But given the concentration in the Australian health insurance market and Medibank’s 30% market share, it might well be that the ACCC would block such a sale as it would result in a substantial lessening of competition unless the acquiring firms did not currently have a significant Australian presence.

A research study published in 2013 showed that Australian government trade sales have historically sold assets for less than fair value.

For example, using equity returns data, it was inferred that NSW taxpayers were short-changed by approximately A$3 billion in the trade sale of NSW government electricity assets to Origin Energy and TRUenergy.

For what it’s worth

Eliminating trade sales and private equity sales leaves open the option of an IPO. An IPO would provide all Australians with the opportunity to apply to buy shares in the newly privatised company.

But the challenging issue in any IPO is setting a price to ensure the seller can achieve maximum value while ensuring the offering is fully sold.

Unlike selling a car, where you can obtain a reasonable estimate of value through comparison with vehicles of similar make and model, company valuations are often as much of an art as a science. A rule of thumb often applied when valuing a company is to take a multiple of earnings from the most recent year.

Medibank generated a profit before tax of A$315 million in the last financial year. Given Medibank’s competitors are currently trading with price-to-earnings multiples of between 12 and 16, Medibank’s value could be estimated to be between $3.8 billion and $5 billion.

If anything, the value of Medibank should be at the upper end of this range, given its dominant position in the market and the potential for improved efficiencies as the business moves from public to private hands.

This valuation range indicates that the $4 billion figure recently reported by the media is the minimum price that must be achieved for Medibank to ensure Australian taxpayers get something close to a fair deal.

But there is no guarantee the IPO will realise the full value of Medibank. Counterbalancing the broader interests of taxpayers, the government may have political incentives for selling shares at below market price to domestic shareholders, who are also voters.

Let’s hope the current government is able to look beyond the political cycle for the greater good.

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11 Comments sorted by

  1. David Stein

    Businessman

    This article illustrates exactly why any promises are made by the government to assuage the public's concerns about this sale won't be worth a cracker. We will hear about robust regulation, charters of patient rights, soothing words about premiums and the like.
    But, once in private hands, the corporation's interest will be profit. Gone are the days that private insurers were not-for-profits whose incentive was the interests of patients - they had a prudential obligations, to be sure, but of a…

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    1. Daniel Gardiner

      Trader

      In reply to David Stein

      Well said.
      I also struggle with for profit health funds. How can a company maximise profits for shareholders and at the same time maximise benefits for members? They are mutually exclusive and I reckon I can guess who gets the sh*t end of the stick

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  2. David Stein

    Businessman

    "Counterbalancing the broader interests of taxpayers, the government may have political incentives for selling shares at below market price to domestic shareholders, who are also voters."
    Can I quickly make a comment on this suggestion - that those 'voters' who have the available funds should potentially be given a politically driven discount on their purchase of shares.
    This would be nothing less than a criminal offence if the Board of a private company conspired to IPO at less than market thereby delivering the pre IPO shareholders less-than-market returns in exchange for some 'favors'. In this case, the Board is the executive government, the pre IPO shareholders are voters and the 'favors' are votes.
    Whenever suggestions like this are floated, I also want to see them forcefully rejected. The idea that a Liberal government hands over private assets for less than a market price to the already privileged is repugnant.

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  3. Gary Murphy

    Independent Thinker

    A profit of $300 million a year. That means it is worth at least $6 Billion dollars to the government (because government borrowing costs are less than 4%).

    Would the private sector pay $6 Billion for it? Of course not - because they are not interested in assets that pay only 5%.

    Privatisation never has been and never will be a good deal for taxpayers. It is only a good deal for the new private operators when they get to buy assets dirt cheap from politicians not acting in the public interest (who coincidentally get well paid positions with these companies when they leave office).

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  4. Paul Docherty

    Senior Lecturer, Newcastle Business School at University of Newcastle

    Thanks for your comments David and Gary. If we are debating the efficacy of privatisations, we also need to consider whether it is appropriate for governments to hold significant interests in companies within competitive markets. There is also the obvious potential for conflicts of interest where the government is simultaneously enacting legislation that pertains to the health insurance industry while also owning the company with the largest market share in that industry.

    Regardless of the merits…

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    1. Gary Murphy

      Independent Thinker

      In reply to Paul Docherty

      Good point - I should have used the after-tax profit figure.

      But would the private sector pay $4-4.5 Billion? It is only a return of around 7% and not without risk as you point out.

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    2. David Stein

      Businessman

      In reply to Gary Murphy

      Gary, I'm not as close to the Australian rates, but US corporate bond rates are around L+4, or, say 4.5% (given 1 year Libor has been around .5%).
      If it was a corporate deal, and your gross EBIT is $300m, your unlevered free cash (assuming 30% tax) is, say $210m, you need to pay 4.5% on $4 billion, or $180m, it's leaving a pretty skinny free cash flow after interest costs.
      Substituting borrowing cost for the 4% approximation of the risk free rate Paul is referring to, there's really not all that much incentive for people to buy into the IPO rather than leaving it in the bank.

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    3. David Stein

      Businessman

      In reply to Paul Docherty

      Paul,
      Based on Gary's observations and my own shaky math, it's pretty clear you would only get $4 billion on the assumption by investors that there would be significantly greater returns once Medibank Private was privatized. The free cashflows really aren't that much more than the risk free rate you identified at $300 million EBIT.
      I'm sure there are some overhead and other SG&A cost savings that would be available, but the real savings would be in cost savings from scope of service. That is…

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  5. Fred Smith

    Electrical Engineer

    And selling the Commonwealth Bank was such a resounding success. Instead of having a direct mechanism to adjust the economy, let the market sort it out. The reserve bank does some voodoo and the big 4 do whatever they hell they like, with them taking turns in being the bad guy in not passing on the rate cuts/etc. Its not as if the Commonwealth Bank in government hands would not make a profit (arguably not as much as in private hands). Considering the politicians on both sides begging and pleading for the banks to play nice in recent years, having a government bank would sort the others out.

    Flogging off another profitable business and leaving another industry to look after itself on its quest for profit will do nothing good for either the average taxpayer or members of Medibank in the long term.

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  6. John Kelmar

    Small Business Consultant

    Medibank Private is a "cash cow" for the Government, and selling it for a short-term gain just indicates how ill-informed and uneducated our politicians have become in this "Third Wave" (Alvin Toffler) economy.

    A smart businessman would hold and acquire income producing assets, not divest to pay irresponsible debt.

    No Government should ever incur any debt to fund their services, as this implies gross mismanagement and incompetence on their part.

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