Thursday Deep Dive: Lemonade
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This week for our Deep Dive, Ian, Ryan, and I discussed Lemonade. The company is attempting to disrupt the insurance industry with a product that is digitally-native, AI-powered, and fixed-fee focused instead of the traditional insurance companies who have many offices and human reps selling the product. Right now Lemonade offers home, rental, and pet insurance and onboard customers with “Maya,” their intake chatbot. “Jim” (to be clear, just a chatbot) processes customer claims.
Lemonade was founded in 2015 and is barely five years old. The co-founders were Dan Schreiber (former president of Powermat) and Shai Winninger (co-founder of Fiverr). According to company history, the founders weren’t necessarily interested in insurance but wanted to find a legacy industry that was ripe for disruption. This is classic, eye-roll-inducing Silicon Valley-Esque lore, but I think we can all agree the entire insurance industry has been behind the eight ball.
Lemonade got $13 million in seed funding in 2015 and it was off to the races from there. The company IPOe’d this July and gained almost 140% on its first day of trading. Suffice to say there has been a lot of excitement around the stock.
Industry and Competition
The insurance industry has many entrenched players. You’ve likely seen their commercials on TV, as that is where they spend a bunch of advertising dollars. These companies include State Farm, Allstate, Geico, Travelers, and Nationwide but there are many others. On the whole, these companies are decades old and have entrenched ways of doing business. Lemonade’s goal is to create a competitive advantage by being online-first and offering a value proposition that is the opposite of these players.
It is estimated that 37% of renters get insurance and that 50% of people who rent are under 30. On average, people spend about $150 a year on renters insurance. Homeowners spend a lot more on insurance, averaging around $1200 a year in the United States. Lemonade’s goal is to land a customer with renters or pet insurance because they are more likely to want a cheaper online-only option and then grow with them once they transition into becoming a homeowner.
It should be noted that 11% of U.S. GDP is spent on insurance and that a typical mature insurance company will have 10-15% operating margins.
“Perhaps the costliest problem in insurance is distrust” – Daniel Schreiber
Schreiber was the President of Powermat Technologies from 2011 to 2015, which was founded by the current Nano-x CEO. Nano-x is currently embroiled in a nasty short-selling dispute, which I think is not necessarily a red flag for Schreiber but something to keep in mind. Wininger was co-founder and CTO over at Fiverr, which coincidentally was the company we discussed last week. This gave Lemonade some street cred when getting funding and was probably why they were able to close a $13 million SEED round.
Lemonade has 11% insider ownership (a plus, according to us) and is a certified B corporation. What is a “B Corporation,” you may ask?
“Certified B Corporations are businesses that meet the highest standards of verified social and environmental performance, public transparency, and legal accountability to balance profit and purpose”
Valuation, Earnings, and Balance Sheet
Valuation (as of recording):
EV of $3.99 billion
EV/sales of 40.5
EV/GP of 125
MA EV/sales of 119.7
Latest Earnings (FY 2019):
$67.3 million in sales, up 199% YoY
Adjusted gross margin of 17%
Net loss of $108 million
729,000 customers, up 96% YoY
Premium per customer of $183
Gross loss ratio at 72% in the most recent quarter
Cash balance of $295 million
Large preferred stock balance that is being converted to common stock
Reserves of about $86 million
Trading at 13x book value when adjusting pref shares (Allstate at 1.2x)
Does Lemonade Have any Competitive Advantages?
We did not have trouble finding any competitive advantages for Lemonade. Here were each of ours:
Ryan: Pricing. Since they are digitally native, their overhead/operating expenses should be lower, which means they can charge less than Allstate and achieve similar profit margins.
Ian: The AI platform. Compared to other insurers they have a big start in modernizing the writing of policies and using these new machine learning tools to write smarter contracts and better policies.
Me: Younger target market. Traditional insurers go after older customers who will pay more in premiums. Lemonade wants to start with customers who are under 30 even if they don’t contribute much in revenue. The plan is to keep these customers on and hope they can grow “ARPU” as they mature financially.
What are Lemonade’s Future Growth Opportunities?
Here are the three future growth opportunities we chose for Lemonade:
Ryan: Partnering with rental companies. This is an intuitive next step for Lemonade (they do this already with WeWork, but who knows how long that will last) if they want to reach more renters. Most people don’t think about rental insurance until they are signing a lease, so having property managers bundle them together could accelerate growth.
Ian: Auto insurance. Everyone pays for car insurance, and people love to bundle home and auto with traditional insurers, so this would level the playing field for Lemonade. One thing we did discuss and could be a reason why Lemonade hasn’t launched an auto product is that it is typically a complicated claims process that an AI would have trouble with currently. Or, maybe they are just waiting for the right time to launch.
Me: Growth of customer base. This is a simple one, but one many people are underestimating with Lemonade. With less than 1 million customers, Lemonade has a gigantic market to go after. Insurance companies also scale well.
What We Liked About Lemonade
There was a lot to like about Lemonade. Ryan had the point that an online-only, AI-focused insurance company had a long-time coming, which we all agreed on. We also liked how 75% of their liabilities are passed off to Loyd’s of London, their reinsurer. Their giveback program for part of their earned premiums is a great idea because it shows the consumer Lemonade is not out to screw them and write high-priced insurance policies for no reason. This aligns with the interest of all stakeholders in the Lemonade business.
What we Didn’t Like About Lemonade
The main concerns with Lemonade started with the valuation. 40-times sales is a large number, especially when you consider the gross margin number. Yes, they are growing like a weed, but that doesn’t guarantee they will continue to in the future.
We also were cautious regarding how aggressive Lemonade is with its growth. They had $18.9 million in unearned premiums in the 1H of 2020, and since they are in “move fast and break things” mode, if something goes wrong it could be devastating for their float. They do have reinsurance to offset this, but it is concerning having a company try to “growth-hack” the insurance industry.
Lastly, insurance is a sticky product, so once Lemonade hits saturation on their target demographic, we were concerned they might slow down their growth and/or have to spend more on advertising. Not saying they will but something to consider.
Links to Further Reading/Learning
Thread on Lemonade (a dumb amount of emojis, but good info here)
Disclosure: The author is not a financial advisor, and may have an interest in the companies discussed.