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Destiny Health triggers its stop loss

04 September 2007 Gareth Stokes

Discovery presented their audited year end results to 30 June 2007 at a function in Johannesburg yesterday. Group performance was in line with expectation and South African operations Discovery Life, Discovery Health and Discovery Vitality contributed the bulk of the 34% increase in net after tax profit. Before adjustments for BEE transactions Discovery posted a net profit of R1.1 billion for the year.

This profit was achieved despite difficulties in the group's offshore operations. PruHealth in the UK and Destiny Health in the US posted significant losses for the full year. But that is where the similarities end.

PruHealth (a joint venture between Discovery and Prudential) is showing tremendous potential and already covers approximately 130, 000 lives in the UK. New business (annualised premium income) surged from R282 million in 2006 to R743 million in 2007. Future plans include the restructure of the joint partnership between Discovery and Prudential to accommodate the launch of PruProtection. Once start-up expenses are out of the way, this business will contribute strongly to group turnover and income.

In stark contrast, the US operation is fighting for survival. At the interim result presentation earlier this year, the Discovery board set two criteria which Destiny Health had to achieve to remain in the Discovery stable. The first criteria required that Destiny's operating losses not exceed 5% of group operating profit, and the second criteria required that each successive six-month period should be better than the last. Unfortunately Destiny Health posted an operating loss of R102 million for the full year 2007. At 5.9% of group operating profit this loss failed the first criteria and dismal second half earnings failed the second.

The US is a tough market to crack

Despite a number of management and operational changes, Destiny Health continues to lose ground in the US. Membership fell from 62,250 at the end of the last year to a disappointing 48, 793 at the end of 2007. "The performance at Destiny Health was in a sense quite strange. The operational performance I believe is excellent, but the financial performance was disappointing," said Discovery chief executive Adrian Gore.

Management performed admirably in restructuring existing partnerships with Tufts and Guardian and also negotiated a partnership with Aegon, one of the world's largest insurers. Notable successes had also been achieved in marketing "Vitality as a stand-alone, non-risk product to large companies." Gore says, "I think we've made it clear that the company has gone through 24 months of difficult times and we've been scrambling hard to work out how to address them."

In the introduction to the financial results, Discovery states: "At the interim stage, Destiny's financial performance was in line with [the criteria] and this favourable performance continued from January through to April of this year. Unfortunately the financial performance in May and June was disappointing" Operational efficiencies aside, the group could not improve the bottom line.

A downside to talking tough

Perhaps Gore and the Discovery board are regretting their decision to set such stringent criteria for evaluating Destiny Health. They are on record saying that the struggling group would be canned if it failed the criteria, and this intention constrains their decision making process where the future of the US operation is concerned. Can a decision on millions of rand in investment be sensibly based on a 0.9% breach of pre-determined target? Something as simple as a weaker rand to pound exchange rate at year end could have pushed the loss into an acceptable bracket.

A decision will have to be taken. Gore states: "We are going to act decisively. We are looking at a number of important strategies and different approaches to the market place, all of them aimed at reducing those losses rapidly and substantially." Gore urged stakeholders to be patient and allow the Discovery board adequate time to consider all options before making a decision.

And the heat is already on. A member of the audience asked Gore if given the performance at Destiny Health and the board's criteria it was not time for Discovery to exit the US businesses. Had the board not set the criteria earlier in the year, this question would probably not have been asked.

Counting the days

There is an old expression that advises: "Never flog a dead horse." The logic here is that no matter how much you try, a dead horse is not going to take you anywhere. If Destiny Health were dead, this expression could guide the Discovery board in reaching a final decision on the future of Destiny Health. The problem is that Destiny Health is not dead! And it becomes more difficult to walk away as the investment in time and money increases.

Whatever decision the board takes, shareholders and analysts do not have long to wait before they learn of Destiny Health's fate. Over the last quarter, Discovery has been investigating strategic options for the operation going forward. They will consider the various options before making a public decision public on 15 October 2007.

Editor's thoughts:
Discovery chief executive Adrian Gore was quick to admit that the group's foray into the US had run into hard times. However, we got the feeling that he still has hopes for Destiny Health. Pride aside, it might be time to take a hard look at what Discovery is likely to achieve in a difficult US market. What hope is there of the group cornering a significant US market share. In light of this is we wonder whether Discovery should pursue the US medical aid market further. Send your thoughts to
gareth@fanews.co.za

 

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