Metromile: GEICO 2.0 With SaaS Option Value

Summary

• Metromile is an innovative pay-for-usage full-stack car insurance company. Premiums are correlated to how much a person drives.
• The decade old promise of telematics and data revolutionizing the car insurance industry has stalled. Metromile could be the company that helps bring the industry into the 21st century.
• Metromile was part of the 'SPAC-craze', including backing by prominent entrepreneurs Chamath Palihapitiya, Mark Cuban and Uber's Ryan Graves.
• Fundamentally, this is a good company with differentiated products, including a overlooked SaaS offering. Its ability to create a proprietary underwriting model (i.e., better actuary) could be very disruptive.
• Metromile stock has sold off ~50% from highs. If not acquired, returns should compound, as it expands into more states and establishes its brand as new alternative to large incumbent players, such as State Farm/GEICO and smaller players in a fragmented industry.

What is Metromile?

Metromile was founded in 2011 by tech entrepreneur (and All-In Podcast member) David Friedberg, who continues on as Chairman. The idea behind Metromile is simple: all drivers shouldn't be paying the same car insurance premiums based on static factors that don't incorporate usage. Why should the person who lives in San Francisco who drives 100 miles per month pay the same car insurance premium as someone who lives in Sacramento driving 1,000 miles per month. You don't have to be an actuary to understand the logic, the less someone drives the less probability of an insurance event.

Before we go into this deeper, I want to make a distinction between pay-for-usage (i.e., miles driven) insurance and insurance discounts based on how you drive. Pay-per mile insurance is structured as a base rate plus a per mile rate (see below). Insurance companies, like GEICO or State Farm, giving people a discount on how they drive is a separate and distinct product although both use telematics. The interesting thing about Metromile is it's really tracking both and therefore creating a fundamentally more dynamic underwriting model that only gets smarter as it grows its customer base. The fact that its primary telematics selling point relates to tracking miles is also an easier sell, I believe, for most consumers vs. 'how you drive' assessment purposes. In addition, it is a digitally-native insurer so is attempting to automate as much of the claims process as possible (i.e., taking pictures, getting an estimate, etc.) with the goal of driving more efficiency, which should drive a structural margin advantage vs. incumbents (i.e., physical offices, adjustors).

Metromile is currently offered in 8 states and claims the average customer saves 47% on car insurance. It also has a division called Metromile Enterprise that licenses its technology platform to other insurance companies.

Business Model, KPIs & Financials

Metromile generates/distributes* its revenue in three primary ways:

1. Selling car insurance
2. Reinsurance arrangements*
3. Selling software & services to other insurance companies

Given most people conceptually understand #1 and #3, we briefly overview what reinsurance is below, as it's an important concept to understand before investing in any insurance company.

What is Reinsurance?

Reinsurance is a contract where an insurer (let's say Metromile) makes a deal with a reinsurer (let's say PartnerRe) to take on part of the claim risk in return for a share of the premium revenue. For example, if Metromile underwrites $10 million of car insurance premiums it may make a deal with PartnerRe, the reinsurer, where PartnerRe is paid $4 million of the $10 million in premium, but is responsible for a percentage of the claim that may arise from Metromile policies. Essentially, reinsurance is a way insurance companies manage risk by redistributing potential claim payouts in exchange for giving up some premium revenue. These structures can get very complex, but you don't need to go into the minutiae, as the financials will reflect how well the structures are doing.

KPIs

Understanding Metromile's KPIs is the best place to start as reinsurance arrangements may confuse many investors if they go directly to the Company's Income Statement

Source: Metromile S-1 (Feb 2021)

Let's quickly define some KPIs to further our discussion of Company performance.

• Policies in Force: # of current active Metromile insurance policies
• Direct Written Premium: Total insurance policy premiums bound. Excludes mileage-based premiums and premiums ceded to reinsurers
• Direct Earned Premium: Total insurance policy premiums that were earned during the period. Excludes premiums ceded to reinsurers (Direct Earned Premium per Policy gives sense of the avg. annual premium a Metromile customer pays)
• Gross Profit/(Loss): Total Revenue - Total Losses & Servicing Expense. Includes the impact of reinsurance arrangements
• Contribution Profit/(Loss): Adjusted Revenue - Total Losses & Servicing Expense. Excludes the impact of reinsurance arrangements. Adjusted revenue also excludes revenue from the enterprise software business, interest income generated outside insurance company & bad debt expense
• Direct Loss Ratio: Direct Losses / Direct Earned Premium. Higher percentage indicates worse performance (note: excludes reinsurance)
• Direct LAE Ratio: Direct Loss Adjustment Expenses (LAE)/Direct Earned Premium. Higher percentage indicates worse performance (note: excludes reinsurance). Basically, this is the expense associated with investigating and settling an insurance claim (i.e., opex expense ratio)

Now that we've defined the KPIs, we have a better sense of how the underlying Company is performing and how the financials may look.

The main takeaways from the KPIs for me are:

• Policy growth continues, but at a slower pace (4% YTD '20 vs. 8% in '19)
• Premiums collected decreased although # of policies increased*
• Dramatic increase in Gross Loss, but much improved underlying performance Contribution Margin (14.7%) & Direct Loss Ratio (59.1%)

*Explanation given by company in Metromile's S-1:

Financials

Source: Metromile S-1 (Feb 2021)

Analyzing the financials of an insurance company can be confusing, but since we have some background on the underlying KPIs, we can make more sense of these figures.

Revenue

At first glance, revenue being down 47% YTD '20 vs. '19 seems very concerning. However, we know that Metromile continued to grow its overall policies. So, what explains the large decrease?

~90% of the total decrease relates to reinsurance arrangements. Remember, reinsurance arrangements should also decrease expenses so this revenue decline should be substantially offset in opex. It was also positive to see Metromile increase business from its Enterprise division that functions essentially like a SaaS business.

Operating Expenses (Opex)

Layering on operating expenses we see that the Company actually improved its YTD 'Loss from operations' by $5m to -$32m.

Of note are the decreases in 'loss and loss adjustments' and 'sales & marketing' expense by 51% and 80% (!), respectively. Given policy holders drove less miles due to stay-at-home orders, this drastically decreased claims.

Digging into the note on 'sales & marketing' expenses, more than half of the decrease doesn't relate to reinsurance. Going forward, if Metromile can keep a similar sales & marketing expense ratio and continue to grow policies it would clearly signal they have become much more efficient at customer acquisition. This also likely explains why policy growth slowed from 8% in FY2019 to 4% YTD 2020.

It's hard to understand (outside-in) the exact mechanics of the reinsurance program, but bottom line is that the Company was able to reduce its 'loss from operations' and grow policies. Increased policy growth, on less marketing spend (i.e., CPA), and better financial performance continued into Q4, as highlighted in the Company's Q3 supplemental presentation.

That's impressive.

Source: Metromile Q3 Supplemental Investor Presentation (Dec 2020)

TAM (Total Addressable Market)

I think the below slides sum up how large a market opportunity exists for Metromile, which currently operates in 8 states only. The TAM is believable given ~15 million new cars and ~36 million used cars sold in the US in 2020. In addition, there are ~287 million registered cars in America, the market is huge. Given Metromile's growth trajectory and regional expansion I would expect total policies and earned premiums to accelerate. I also assume it's one of the more sophisticated players in the industry from both an underwriting, operational and marketing perspective, outside of the largest players, and that should accrue advantages in terms of share gains and pricing policies.

Source: Metromile Investor Presentation (Nov 2020)

Competition

I think what the Market may be overly concerned about is Metromile's ability to take market share from the giant incumbents, like State Farm or GEICO, that spend billions on ads, can bundle insurance (i.e., Home & Auto) and are very well known by the average American. That is the wrong way to look at Metromile's prospects though as the industry, as mentioned, has a highly fragmented 'tail' (i.e., 16 insurers account for 80% of the auto insurance market according to Progressive, implying the 20% 'tail' is highly fragmented). Therefore, the top players all could continue to grow or maintain their share, but it wouldn't prevent Metromile from expanding via 'tail' penetration. That being said, I still expect the Company to take share away from large incumbent auto insurers as the pay-per mile product is more appealing to many consumers conceptually, including the recently enabled cost conscious, car buying Millennial population.

Another competitive threat that some maybe worried about is Auto OEMs offering insurance themselves, especially companies like Tesla (TSLA) who have proprietary data that could drive a better underwriting model. However, this is actually more an opportunity than a threat given the Auto OEMs, including Tesla, are not actually taking on balance sheet risk, but are acting like brokers essentially. Metromile, given its a full stack insurer (i.e., takes on balance sheet risk) with an Enterprise offering, could be a perfect partner (see next paragraph).

The enterprise software business also provides investors with great option value and sets up another revenue stream for the Company. The Company already has an active deployment with Tokio Marine (OTCPK:TKOMY), a top 10 US carrier, and expects to have 22 total deployments by 2022. In addition, Metromile's investor presentation mentions that it was set to launch its first Automotive OEM partnerships in Q4 20 with 8 OEMs expected to be connected by 2022, which may have also have some Enterprise upside.

Source: Metromile Investor Presentation (Nov 2020)

Valuation & SPAC Transaction

I am not an insurance industry valuation expert, but I don't think you need to be to take a view on what Metromile could be worth. I will though derive a valuation based on a direct comp, but wanted to make a few comments before I do that.

Metromile has growth investment characteristics, while most players in the auto insurance industry are defined by their dividend. You are taking a view on Metromile's ability to:

1. Grow policies and market share
2. Use technology and data to create a leading proprietary auto insurance sales & marketing, underwriting and claim management model
3. Create structural superior margins due to #2
4. Have supportive investors willing to promote it & provide capital

I think Metromile's story may ultimately be comparable to Uber's (UBER). Uber came into a traditional, entrenched industry that was ripe for disruption. GEICO, State Farm, Allstate (ALL) and Progressive (PGR) are definitely not Yellow Taxi garages in this example, but they have not innovated as quickly as they should have. Case in point is the fact that only Allstate and Nationwide offer a competing pay-per mile product. Metromile basically created an insurance product category that many consumers find attractive given it's tied to usage. The argument that the other companies can quickly adopt to offer the same pay-per mile product probably gives the incumbents a bit too much credit regarding how quickly they move (not mention the other smaller insurance players). In addition, Metromile Enterprise provides interesting option value as it may convert Metromile margins to look more similar to an embedded higher margin SaaS company that helps insurers (plus potentially Auto OEMs) improve their underwriting and operating models. Finally, Metromile has grown to its current size by operating in only 8 states, which means they haven't really even ramped up yet.

SPAC Transaction & Valuation Comp

Source: Metromile Investor Presentation (Nov 2020)

When announced, the initial SPAC transaction with INSU Acquisition Corp. II valued Metromile at $956 million or $1.253 billion, including pro forma cash (i.e., Market Cap). The transaction completed on February 9th, 2021.

Progressive Insurance

Progressive, the third largest US auto insurer behind unlisted State Farm and GEICO, is the best large comp to compare Metromile to. 94% of Progressive's Personal Lines net premiums, which represented more than 80% of its total premiums, relate to personal auto insurance (Note: Progressive also has a large commercial auto insurance business). In comparison, ~70% of Allstate's net premiums relate to auto insurance.

Although Progressive has ~200x (i.e., 16.5 million personal auto insurance policies) the number of policies as Metromile, let's compare some key ratios and metrics.

Source; Progressive 2020 10-K, Metromile Investor Pres. (Nov 2020)

It's worth mentioning that COVID and the associated stay-at-home orders, skewed Direct Loss Ratios lower for both companies. However, the figures are still comparable and telling.

• Growth: Metromile has historically and is projected to outgrow Progressive (exception being 2020, which I believe is explained away by the pandemic and the fact that Metromile had to take certain opex actions given its size). Obviously, Metromile's growth is from a much smaller base, but it still should factor into valuation.
• Direct Loss Ratio: Metromile's direct loss ratio is estimated to be ~300bps better in 2020 than the much larger Progressive (note COVID was unique year for both companies). As Metromile scales it's reasonable to assume this ratio gets better. By FY 2023, only 3 years from now, Metromile expects to have a direct loss ratio of 64.4%, which would 700bps better than Progressive's 2018 and 2019 ratio of 71.4%. This would be a structural superior margin likely driven by their proprietary underwriting model.

Progressive, which pays a dividend, currently trades at the following valuation. It also should be noted Progressive generated over $1.6 billion in investment income in 2020.

• Market Cap: $52 billion (~10% off 2020 highs)
• Dividend Yield: 5.47%
• P/E: 9.2x

Metromile, which obviously doesn't pay a dividend and will likely not in the near future, should be compared to Progressive's valuation to an extent. However, given its projected growth rate, structural direct loss ratio advantage and the option value of its Enterprise business I believe a premium is warranted that values its blended earnings between 20x to 25x. For an investor with a 3- to 5-year time horizon, I expect Metromile to compound at between 11% to 17% based on my assumptions (see below), which I think is an attractive base case risk-adjusted return.

Source: HFW Analysis, Metromile Estimates in Investor Pres. (Nov 2020)

The investment in Metromile is filled with a lot long-term option value. As mentioned, its Enterprise business, which sells a SaaS product to other insurance companies on its own could be a multi-billion-dollar enterprise in a bull case scenario. In addition, similar to GEICO and State Farm, Metromile could start bundling other insurance products, such as home insurance, with its auto offering.

As I said before, valuing Metromile is imperfect right now as it is still a young company that has many growth company characteristics. I believe entrepreneurs/investors like Chamath Palihapitiya, Mark Cuban and Ryan Graves view the investment as a way to replicate what Warren Buffett did with GEICO. Essentially, a vehicle that compounds cash flow (i.e., own capital). In fact, Chamath Palihapitiya and Ryan Graves make this exact point.

Ryan Graves interview about investing in Metromile.

I also wanted to note that both Mark Cuban and Ryan Graves are not strangers to the auto insurance industry. As employee #1 at Uber, Ryan Graves will know first-hand about auto insurance dynamics given how important it is to rideshare economics, as I have written about previously. Mark Cuban, is an investor in The Zebra, which is a leading US car insurance search engine.

Conclusion

I expect Metromile to be a compounder that is genuinely innovating and making a better insurance product for consumers. I think ubiquitous autonomous driving is some years away, so for the next decade a better "human driver" insurance product is needed. Metromile is not going to take out GEICO or Progressive, but with time it is likely to be a serious competitor and a name most will consider when purchasing car insurance, especially those that own a car but don't drive a lot. Its structural margin advantage driven by its ability to use machine learning and data to not only lower premiums, but make the claims process more efficient should also increase its ability to take share. Finally, the option value of the Enterprise division, which looks more like a SaaS business, provides exciting upside. This is a 5 to 10+ year investment for us that I expect to compound at around 20%, if it doesn't get acquired.

The stock is trading off ~50% from highs and is back near its initial SPAC entry point. I think this was a legitimate SPAC and company that may have gotten thrown out with the "bathwater" during last week's market sell-off. We are bullish on Metromile's long-term prospects and have invested in the company.

Analyst’s Disclosure: I am/we are long MILE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.