Funds manager says Medibank float attracting strong interest

With the Federal Government's announcement of the Medibank float, all eyes are looking towards the details.

Fund Manager Peter Esho from 100 Doors says there are several things that potential investors should watch out for when the prospectus for the initial public offering (IPO) comes out, which the Government has said will happen during October and Mr Esho says he has heard may be this week.

Mr Esho says the first key financial metric will be the return-on-equity (ROE) - a key measure of profitability that looks at the return company's deliver relative to how much money shareholders have invested.

He says his estimate, based on publicly available data, is that Medibank's ROE was 15 per cent for the 2013 financial year.

"A 15 per cent return on equity estimate is basically where most industrial companies listed on the ASX200 should be returning," he wrote in a note on the IPO.

However, Mr Esho says Medibank has an opportunity to boost its profitability if it can match the lower costs of already ASX-listed rival NIB.

"We estimate Medibank's net margin to be around 3.5 per cent compared with publically listed NIB's margin at 5.0 per cent," he noted.

"By focusing on costs, the business can hope to reduce its management expense ratio from around 9.2 per cent, where it currently stands, towards 8 per cent which is close to NIB.

"The mere 1 per cent fall over the next few years, if achieved, will become a significant earnings driver."

Mr Esho observes that Medibank's revenue growth has been in line with its main rival Bupa over the past five years, but slightly lagged NIB.

He notes that premium increases are regulated, and there is also a risk equalisation fund that compensates funds with a preponderance of older members from those who have younger, healthier members.

However, Mr Esho warns that heavily regulated industries also carry the risk of policy shifts.

"As regulation is changed or removed, there can be a profound impact on the status quo into the future," he added.

Mr Esho says his view on the health insurance industry is positive, as the population ages and people spend more money on trying to maintain their quality of life, but a final view on whether Medibank is a good value investment is not possible until the float pricing and prospectus details are released.