It was supposed to be the time for balloons, hot dogs, clowns and cannon fire.

Discovery had planned to launch its new bank this quarter. But the Reserve Bank was a party pooper. It never made sense for FirstRand to be a sleeping partner in the new Discovery Bank. And much as SA’s most successful bank would have been happy to hold 25% of the newcomer, the regulator gave the businesses up to five years to unwind the shareholding.

"But as we will be competing it makes much more sense to make a clean break and to buy FirstRand out," says Discovery CEO Adrian Gore.

It will raise R1.8bn in equity capital, R700m for the remaining share in the credit-card operation and R1.1bn for its share in Discovery Bank. "We could just about manage to cover this through internal resources but we would then be touching our self-imposed gearing limit."

The Discovery card has a cost-to-income ratio of 40% — well below the average of SA banks, which is closer to 56%.

But Gore says that this is its ratio in the belly of FirstRand and should not be seen as an indicator of Discovery Bank’s expected efficiency ratio. Some analysts believe Discovery will soon "drop the pilot" and put the current CEO of the bank, Barry Hore, out to pasture — much as it did to former Santam CEO Steffen Gilbert when he had built up Discovery Insure.

The bank probably needs a more client-friendly, marketing-savvy face to replace Hore, a technology geek who was never one of the Discovery insiders.

Warwick Bam, head of research at Avior Capital, expects the bank to grow well beyond the credit-card client base as it can sell into the captive health and life customers, but does not expect it "to offer vehicle finance and mortgages from their launch date, to allow the bank time to gain scale and become self-sustaining."

Discovery might soon look like a universal financial services business but the original Discovery Health business remains the dominant cash generator, and effectively the funder of most other business. It spews out a huge R2.83bn in cash. The next biggest contributor is Vitality Health Insurance in the UK, with R475m. Discovery Life in SA is the dominant producer of paper profits in the group — R3.8bn out of the group’s R8.2bn, but just R434m in hard cash.

Rahima Cassim, a portfolio manager at Ashburton Investments, says Discovery still doesn’t exhibit strong free cash flow generation.

"We want to see the business reinvesting in their operations," says Kevin Cousins, head of research at PSG Asset Management. "In fact we would prefer it if we weren’t paid a dividend at all and capital was continuously reinvested."

As it is, the dividend is quite meagre, covered more than eight times by earnings.

Gore says that while many commentators have focused on the bank, the group has many other irons in the fire. It has rolled out its Vitality rewards programme, partnering leading local life insurers in Japan, Korea, Pakistan and Ecuador, as well as business insurance locally, which also offers bells and whistles such as links to sources of capital and help with business software. It has also set aside R200m for its umbrella (retirement) fund business, which will leverage off many of the products and systems developed by Discovery Invest. The group’s most ambitious project other than the bank is the launch of Vitality Invest in the UK, a very similar offering to its Discovery namesake. It will focus on the retail market for now, offering brokers a whole party pack of algorithms to facilitate financial planning.

Stanlib portfolio manager Louis Chetty says that the group’s 25% holding in China’s Ping An Health gives a new growth vector, with scope for new business to double every year for the next five years at least.

But don’t write off some of the more mundane parts of the group such as Discovery Insure. It came late to the new-generation short-term insurance market but its growth trajectory has been steady and it made a R68m operating profit in the year to June.

There was disappointment in the investment community that the bank launch has been postponed, but Discovery remains highly innovative. It’s not cheap with a p:e ratio over 20, but has strong long-term prospects.

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