Health alert for Discovery

Citi is unimpressed with the darling of the JSE and scoffs at its new banking venture

● Global banking giant Citi rates Discovery, which is due to open the digital doors of its new bank this week, as a high-risk investment and sees most of the company’s businesses as “value-destructive ventures”.

Discovery, a darling among investors and one of the JSE’s 25 biggest companies, has a market capitalisation of nearly R100bn, but at current levels is overvalued by more than 50%, according to a Citi research report.

Among the red flags for Discovery, Citi lists high levels of debt gearing, the regulatory risk associated with health insurance, complex products and cross-selling, and the company’s dependence on its strong retail brand in SA.

“We view SA health as Discovery’s only attractive business out of 10,” stated the report sent to Citi’s institutional clients.

Discovery, whose health business generated a third of the group’s operating profit last year, has been a financial sector success story over the past two decades. It has built one of SA’s best-known medical funds and sprawled into other financial services such as life insurance, wealth management and lending.

But apart from the success of its health business, the rest of the group’s ventures have gobbled up more than R20bn in cash over the past decade — increasing debt and diluting shareholder value, according to the report. Citi is also concerned about Discovery’s diverse businesses that span many jurisdictions — from the US and UK to China — many of which are still in a start-up phase.

Discovery’s largest shareholder, Rand Merchant Investment (RMI) Holdings, told Business Times that it is in it for the long haul.

“As patient investors, we are very pleased with the deliberate and thoughtful way they are doing things,” RMI CEO Herman Bosman told Business Times.

RMI has a 25% stake in Discovery and has been involved since the 1990s.

“They are building a long term and capital-intensive business, and businesses of that nature tend to have quite a bit of capital outlay initially,” said Bosman.

Discovery Life’s book is also still relatively “young”, he said, which means it is not as easily comparable to the likes of Sanlam and Old Mutual. Acquiring clients is the expensive part, but over time the book generates more cash as it matures. “It’s early days and Discovery has the right people, right model and the right trajectory,” Bosman added.

Not fazed by the Citi report, Discovery CEO Adrian Gore said he was feeling pretty good about the business.

“You have a market of many different views and opinions on complicated stuff,” he said; Discovery took note of what analysts said but focused on day-to-day operations.

Citi’s view is a contrarian one. It sets a target price for Discovery of R95, compared with the R140 it was trading at on Friday. This is also much lower than the recommendations by analysts on either Bloomberg or Thomson Reuters’ Eikon.

Banking is Discovery’s latest venture. After a year of testing what it calls the “world’s first behavioural bank” it now enters a highly competitive space where other newcomers TymeBank and Bank Zero will target the thrifty clients that have been flocking to Capitec, while the big four full-service banks and Investec will likely furiously defend their turf.

Discovery firmly believes its shared-value model “would play out strongly in banking”, Gore said in a note to clients this week.

This means incentivising clients to be financially healthier and selling them some of the other financial services in Discovery’s stable.

“It will be a five- to eightyear process of getting to scale,” Gore said.

And time is money. Discovery spent about R1.4bn to build its banking infrastructure — not branches, but systems.

And over the years the company invested billions more to establish and expand its credit card business. These credit card clients will now be migrated to the bank and form the basis of Discovery’s banking clients to start with.

But Citi is also not optimistic about this new venture.

“We believe there is at least an even chance that Discovery will destroy shareholder value in banking,” the report read, pointing to the failure of the company’s experts to generate sufficient returns in its wealth management, insurance, UK health or UK life businesses.

But according to Gore, the better one understands the business, the more enthusiastic one becomes about it.

“We look forward to officially opening our digital doors next week and growing in a well-thought-out way — all to ensure we give you a truly exceptional experience,” he said in an e-mail to clients on Wednesday.

‘There is an even chance Discovery will destroy shareholder value’