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04 October 2014
by Jonathan J. Ariel

Bad medicine: the sale of Medibank Private

Christmas has come early for the battalion of brokers, advisors, consultants and assorted carpetbaggers with the announcement of the forthcoming IPO of Medibank Private (ASX code presumably "MPL").
The looming privatisation by Commonwealth Finance Minister Mathias Cormann raises many, many issues.
Topping the list are:

  1. What is the prime objective of the sale?
  2. Is it in the taxpayers' interest for the health insurer to be sold?
  3. Assuming it is in the taxpayers' interest, is the Commonwealth government's choice of an IPO the best way to go about it?
  4. How much are the advisors (financial, legal and marketing/communication) engaged being paid? What incentives were thrown their way? Is their role solely to complete the transaction? To maximise proceeds of sale? To maximise the widest distribution of stockholders?
  5. Will the government guaranty that insurance premiums will not skyrocket?

Let's focus on (3) for the moment.
Earlier this year, both the Government and the Opposition muddied the waters with their partisan and less than comprehensive comments.

The ABC in March 2014 reported, "the Opposition believes the insurer should stay in public hands and has raised concerns about premium increases and the future of Medibank Private employees".

The Opposition Leader is indeed on strong ground querying, if not forecasting, premium hikes once Medibank is sold. He is however whistling Dixie when he wonders out loud about the fate of Medibank's employees. Does he really think it is the job of the Australian taxpaying public to keep public servants employed performing a task when less of them could (quite possibly) perform those very same functions?

The ABC also reported that Sen. Cormann stated that the Government wanted to sell Medibank Private at the "right time" to maximise the sale price.

Heads-up Senator. Maximising proceeds is not a function of the "right time", but of the "right time" and the "right means". Just ask any real estate agent.

On Monday, the Senator while spruiking the IPO claimed on the Seven Network's Sunriseprogram that the value of Medibank would be "set by the market" and that "in 2014 there is no reason for the Federal Government to still be running a private health insurance business".

The facts the Senator omitted could fill Sydney Olympic Park's ANZ Stadium:

  1. In an IPO, the value set by the market, evidenced by the share price at the end of the first day of trading minus the listing price is synonymous with a loss to taxpayers. That gap, be it minimal or yawning, will expose just how mispriced the share offer was, and by inference, how many millions of dollars were gifted shareholders and advisors (at the direct expense of all Australians, the current owners of Medibank);
  2. The Senator crooned that "the government is out to achieve the best possible net return" to taxpayers. He said this as though there is compelling evidence that an IPO is the best means to do so; and
  3. The Senator dismissed the role of government in the healthcare space, as though we have perfect competition amongst healthcare insurance providers. On the contrary Senator, there is indeed a role for government involvement in owing a player that commands 30% of the market. For one thing, the government's ability to temper premium rises for a dominant player (itself) sends a powerful message to other market participants.

If we assume the Commonwealth's argument that Medibank must be sold, why are alternatives to IPO not publically canvassed? Alternatives include:

  • a) Sale to a private equity group;
  • b) Trade sale, say to a US HMO (Health Maintenance Organisation) or an Asian equivalent;
  • c) Sale to a foreign pension fund;
  • d) Sale to a foreign sovereign wealth fund (Singapore? UAE? Norway?); or
  • e) Sale to our very own sovereign wealth fund: the Commonwealth Government's Future Fund.

A critical flaw with the IPO process is that the seller sets a price range based on its understanding of the value of the asset being sold, and the alleged demand in the market. The Government's understanding is often a function of the documentation prepared for it by its advisors. The advisors are intimately involved in the sale and may well be investors to boot. Conflict of interest, anyone?

When the seller sets the range of prices, there is restricted competition between potential buyers so it is difficult for the seller to accurately gauge the full level of demand in an open market. Once book-building starts - the process by which the share price and the allocations to bidders is made – interested parties compete to buy shares and at this point may have incentives to reveal higher levels of demand. But by announcing a specific price range, the seller has effectively capped the price.

So how have IPOs fared around the world?
Lazard, an investment bank, was Her Majesty's Government principal advisor on the sale of Royal Mail. Lazard was paid £1.5m for its advice. It also invested in Royal Mail shares.

On the first day of trading, 11 October 2013, the shares listed at 330 pence and opened at 448 pence: 36 per cent above the IPO price. At the close of trading, Royal Mail's share price closed at 455 pence, up 38 per cent on the day.

The benefit of the share price rise on that day, a whopping £750 million was funnelled to the new shareholders: the deep pocketed and the well connected, at the expense of ordinary Britons.

Lazard, the savvy financial advisor waited until the day after listing to unwind its holding of 6 million shares, offloading them at 470p, making a sweet £8.4m profit.

That stellar mispricing robbed the Exchequer and by inference, the public. Put another way, this amount is close to what the government spent in the same year on pre-primary and primary education (£800 million).

Guess who's advising the Commonwealth Government on Medibank?
Notwithstanding the electoral appeal of offloading a state owned asset at a deep discount to Mum 'n Dad investors (who double up as voters), most IPOs have very serious flaws and result in massive transfers of wealth that can – if so wished - be easily be avoided.

In contrast to a one-off listing via an IPO, selling in tranches is an improvement. Say initially only 25% of the equity of Medibank was sold. Once the first tranche is allocated, listed and traded, a well-established market will exist into which the Commonwealth could offload the balance of shares at a more accurate price. That way any mispricing in an earlier tranche would be rectified in subsequent tranches.

Other means to privatise include selling an organisation in whole or in part or to another entity.Such a trade sale would have to address one major issue: that competitive tension inherent in the industry will be maintained or heightened. This can most easily be secured by forbidding the sale to rival domestic insurers. Selling the organisation to say an American HMO (Health Maintenance Organisation) or for that matter a Japanese, Korean, Singaporean or Chinese HMO would serve to maintain or even increase competition in the industry. Market forces could be used to a far greater extent in the setting of Medibank's price, as tender offers (for a trade sale) lead to more accurate pricing. In the United States it is common for parties keen to own a piece of the freshly baked pie to make firm bids stating both the prices they are offering and quantities of shares they are prepared to buy in advance. If this method were aped in Canberra, it would enable the Commonwealth Government to exploit the information it learns from foreign healthcare providers.

This contrasts markedly with the insular approach often used in Australia and the United Kingdom, which involves focusing on the domestic investor market and sounding out a handful of financial institutions close to the seats of power to indicate the 'appropriate" price.

Another simple and inexpensive option is to hawk Medibank (lock, stock and barrel) to say private equity groups or sovereign wealth funds. A transparent, public auction for the entire company, taking bids from all corners of the world will maximize the sale proceeds. And this is surely the best result for all Australians.

After all, aren't transparent, open auctions the most popular method of selling the family home when Australian Mum 'n Dads want to maximize the price?

IPOs for state owned assets, as commonly conducted, serve little purpose other than to enrich so few at the expense of so many.Just ask the Brits.