Banking isn’t cheap for Discovery
All eyes are on Discovery’s new bank, which aims to challenge the big four. But don’t expect miracles
Discovery’s steady march towards building the most substantial banking and insurance business in SA since FirstRand unbundled MMI in 2010 continues apace, even if this week’s half-year results didn’t exactly shoot out the lights.
At the results presentation this week, Discovery CEO Adrian Gore revealed an 11% drop in net income to R24.4bn — but all eyes were on how much money the company is ploughing into its much-awaited new bank.
Of course, starting a new bank was never going to be cheap, even if Discovery is going the less capital-intensive route by not setting up branches. Already, Gore’s company has spent R1.8bn to get full control of the Discovery Card (it was a venture with FNB) and invested R2.6bn in various systems and infrastructure for the bank — R200m ahead of budget.
It is significantly more than the other newcomers, TymeBank and Bank Zero, have spent as they’ve made use of cheaper options such as cloud computing and mainframes about the size of a bar fridge.
But Gore says it makes sense for his bank to be constructed around the big bank architecture, which uses SAP software, as it will do more than simply facilitate transactions. For example, Discovery’s bank will be able to load enough information to assess the rate at which each client will be charged (and paid) interest based on a dynamic interest rate model. The bank will also have to interact closely with Discovery’s other arms — such as the life and investment businesses, the medical aid and the short-term insurer.
Clearly this will be one way it will try to lure bank clients. Discovery Life, for example, has already launched a "Bank Integrator" product which will offer discounts on premiums of up to 15% based on the Vitality Money status of clients of the bank.
Warwick Bam, head of research at Avior Capital, says: "The bank looks more promising than I had expected. Assuming the service levels are high, the functionality of the banking platform is an attractive proposition and it will gain meaningful market share, though over three years, not a few months."
Chris Steward, head of financials at Investec Asset Management, says Discovery should build a credible banking brand over the next three to five years, "but to suggest it will have a serious impact on the profitability of competitors such as FirstRand would be an exaggeration".
The bank should offset the more cyclical returns of the largest contributor to the group’s bottom line — Discovery Life.
One of the low points of the half-year results to December was the 13% fall in Discovery Life’s operating profit, which still amounted to R1.5bn. Part of the reason was an unusual number of high death claims, as just 4.5% of claims accounted for 38% of the payouts. With hindsight, Discovery’s reinsurance should have been smarter. But Gore says he is confident that premiums are correctly priced to reflect risk — those with higher status in the Vitality programme still lived longer, for example.
Discovery Insure made only a modest profit of R51m after more than six years of trading. This was dwarfed, however, by the R780m it made from selling half of its 20% holding in Cambridge Mobile Telematics (CMT, and no relation of Cambridge Analytica) to the Japanese tech investor SoftBank, which will come into the books only in the second half of the year. CMT provides telematics, a method of monitoring how well customers drive, through a mobile app. Previously Discovery Insure used to fit clunky black boxes into the boots of clients’ cars.
The group is also rolling out its business insurance, looking mainly at small to midsized businesses, at a cost of R92m. Gore says the group has no ambitions to move into the large corporate market, or into specialist lines of insurance, such as marine and liability.
A more substantial R140m is being invested into the umbrella fund business, which is intended to be an attractive home for corporate pension funds that want to avoid the hassles of running funds in-house.
It was certainly a good period for Discovery’s UK arm. Both its units there did well: Vitality Health increased operating profit by 26%, and Discovery Life by 15%, even though low interest rates make profitability tricky.
Denker Capital portfolio manager Jan Meintjes says he expects all the business units in SA to be duplicated in the UK eventually.
The group is building its VitalityInvest platform for £33.5m to complement the other UK business. (Vitality Health and Discovery Life in the UK already account for 23% of the Discovery group’s equity value.)
Meintjes says he will not be surprised to see Discovery set up a short-term insurer in the UK, though this is a notoriously low-margin business, dominated by price comparison websites. But he says more work could be done to improve the existing businesses, as there is just a 1.6% overlap of the clients of Health and Life.
China is also soaring. Though Discovery’s Chinese arm, Ping An Health, will probably never be as important to Discovery as Tencent is to Naspers, its growth is extraordinary by the standards of its other markets. New business grew 117% to R4.3bn in the half-year, while its app already has 8-million users. The main Ping An life insurer has 27-million clients just in the affluent sector. Discovery’s share of operating profit in China looks modest right now — at R61.5m — but expect this to alter as the group builds scale.
In the rest of the world, Discovery works with various large insurers which offer the Vitality programme alongside their products. In the US John Hancock now only sells products with Vitality built in. But it is not cheap to offer a global Vitality chassis — the bill for a state-of-the-art model is R552m.
Discovery’s health business — the original backbone of Gore’s group — also saw its operating profit rise 10% to R1.46bn, thanks to the 3.5-million medical aid members to which it provides administration services. But Bam says growth in its health arm will slow, as its market share of 40% means there’s diminished opportunity to manage more medical aid schemes.
And there’s also the spectre of national health insurance (NHI), which presents a number of unquantifiable risks to Discovery Health’s model — even if it seems unlikely that the private sector will be excluded from health funding altogether. Still, the SA medical aid still accounts for about a third of Discovery’s earnings, which some of Discovery’s more exuberant supporters tend to gloss over.
Investors have always been enthusiastic about Discovery. At about R150 a share, it has pulled back from its 12-month high of R193. But seen over a longer term, like three years, Discovery’s gain of 27% is still double that of the wider JSE all share’s 13%.
Bam argues it offers value, but be aware of the possible impact of NHI in SA and of Brexit on the UK business, The bank isn’t a guaranteed success either.
But Discovery is one of the few genuine quality growth businesses in SA, especially in financial services.