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Is Lemonade a buy after it dropped 60% from peak? - YouTube
Channel: Mr.Alpaca
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Mr. Alpaca, fundamentals in ten minutes
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Lemonade went public on NYSE as of July 2020.
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Share price climbed to over $180
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before it trended down to around $60/share today
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only a third of its peak price.
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So is Lemonade a good investment?
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Established in 2015 and headquartered in New York City,
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Lemonade offers renters, homeowners, pet,
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life insurance and soon car insurance.
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The company has made it its core strategy
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to deliver customer satisfaction.
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Traditional Insurance companies tend to
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deny the claims of customers.
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Companies pay 100 dollars to customers,
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When Lemonade receives premium,
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it keeps 25% flat fee
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and reserves the remaining 75% to pay claims and reinsurance.
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Any money left-over will be paid to non-profits
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chosen by customers.
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This removes the conflict of interest and distrust
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between the insurer and customers.
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Lemonade has powered its business with machine learning.
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More than one third of the inquires and claims are handled by AI.
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AI Maya helps you with new insurance contracts
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and AI Jim assists you with claims.
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Here is a video showing how fast and how
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they communicate with customers.
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As shown in the video,
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massive amount of data are generated in the process
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and enhance the artificial Intelligence
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to provide competitive pricing and better service.
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This helps improve overall customer satisfaction
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and attract more customers.
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The flywheel turns and creates a virtuous cycle.
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You may notice from the video that
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the communication is very straight forward,
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there are no insurance jargons
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hidden fine prints or long waiting time on the phone.
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The company’s strategy appeals
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especially to customers under 35 years old.
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Millennial quickly adapts to the digital way of
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insurance subscription.
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It’s easy, fast and cuts the cost of brokers.
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They typically start with renter insurance
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and later add more coverage
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the premium per customer increases as their assets grow.
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For example, 10% of condo insurance holders
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were graduated from renters.
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Our core plan of strategy is to acquire customers at a time,
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when we have a massive advantage
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delight them so that they never leave.
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And then as they go through naturally recurring
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highly predictable life cycle events,
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we grow with them.
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Over the past years,
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both the number of customers
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and premium per customer increase steadily,
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which lead to higher in force premium or IFP.
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IFP, defined as the aggregate annualized premium
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for customers as of the period end date.
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It shows the company’s ability to generate revenue in near future.
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As of Q2 2021,
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renter insurance contributes to 56% of IFP,
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Homeowner 30%, Pet 13%,
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Term Life insurance 1%.
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This shows a trend of Lemonade customers
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shifting to higher premium products.
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As Lemonade introduces car insurance
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we will see more growth
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as bundle discounts will be even more attractive to customers.
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Now let’s talk about market opportunity.
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The insurance industry takes about 11% of US GDP
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and is about 5 Trillion world-wide.
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Some of the largest insurance companies
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are doing over 100 billion a year.
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yet none of them takes more than 4% of market share.
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The industry hasn’t changed for the last century.
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It is due for a disruptor.
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With AI technology,
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Lemonade has expanded its business in every US state and
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now a few countries in Europe including
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Germany, the Netherlands, and France.
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Not all products are launched in each location.
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In US for example, as of Q2 2021,
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at least one Lemonade product
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is available for purchase in each state.
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The revenue is expected to grow at fast pace
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once more products are introduced.
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The company is also increasing its investment in Europe.
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So far it has won a number of awards,
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including 5-stars for Best Product Quality
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on MoneyView Research
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Best Product from Consumentenbond
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Best Score for a digital service offering by Focus Money
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showing a great market feedback.
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Future opportunity for Lemonade is presence in more markets
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more products in each market
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and more market share for each product.
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Now let’s talk about financials.
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Since Q2 2020,
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the company has transitioned to a new reinsurance structure.
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Lemonade agrees to cede 75% of premium received
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and retain 25% on their book.
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For example, if premium received is $100,
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Lemonade gives $75 to reinsurer and keeps only $25.
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The reinsurer will pay $18.75 to Lemonade as commission.
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In case of customer claim,
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Lemonade pays 25% of the claim
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while the reinsurer takes care of the rest.
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Before the program, all $100 would be recognised as revenue.
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But now only $43.75 is recognised as revenue.
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That explains the revenue drop as of Q2 2020.
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Why did management decide to take the reinsurance?
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In short, it is about capital efficiency,
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risk control and market expansion.
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Under US and EU regulation,
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insurance companies are required to set aside capital surplus
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in case they need to pay claims to their customers.
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Without reinsurance,
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younger companies like Lemonade would have to reserve
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as much as 50 cents for every dollar of premium received,
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known as 2:1 ratio.
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The reinsurance arrangement shifts
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most of that surplus requirement to reinsurer,
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so that the surplus ratio for the company is only 7:1.
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This strategy limits its volatility exposure
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and enables financial model to be capital light.
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Unlocked capital could then be deployed in market expansion.
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We are now looking at customer count
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and in force premium for the last 4 quarters.
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As we can see, both numbers are increasing.
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However, the losses are getting larger
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as a percentage of revenue.
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For example, by Q2 2021,
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for every dollar of revenue generated,
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Lemonade losses about two dollars.
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This company is bleeding, what is happening here?
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If we dig deeper into the expenses breakdown,
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We may find a clue.
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Loss and loss adjustment expense is basically
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claim approved and paid to customers.
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Think of it as cost of revenue.
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It is usually around 45%.
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The surge in Q1 2021 was due to Texas Freeze.
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This item can’t be improved in near term.
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Sales and marketing is around 120% of revenue.
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As a young insurance player,
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Lemonade has to spend huge amount of money
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to establish reputation and trust
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among existing and potential customers.
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For every dollar spent to acquire a customer,
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it takes 2 years’ gross profit from the customer
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customer to just make even.
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As Lemonade gains more brand recognition,
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this item is expected to drop considerably.
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Technology development is around 30% on average,
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Q2 2021 surge was largely due to car insurance related development.
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General and administrative stables around 60%.
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Currently, profitability is not the top concern for Lemonade.
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The priority is to expand its market share,
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and then reduce these expenses as a percentage of revenue.
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Overall, I believe the company has a good business model
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and market potential.
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If we look at its P/S ratio since IPO,
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it ranges between 25 to 107.
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Today it stands at around 44.
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It is good time to start an initial position,
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if you have long term vision about the company.
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