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Lemonade: A Call Option On Digital Insurance

Oct. 04, 2021 1:47 PM ETLemonade, Inc. (LMND)71 Comments
Rogue Trader profile picture
Rogue Trader


  • Lemonade is a cheap, zero-theta call option. It could potentially deliver >100x returns.
  • Auto insurance presents a huge opportunity and will be a preview of things to come. The opportunity isn’t in analyst expectations. European entry is another potential catalyst.
  • Technical factors present favorable risk-reward with a price floor, low investor sentiment, and high short interest.

Sürahi ve bardaktaze limonata

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Investment Thesis

Lemonade (NYSE:LMND) is a very early stage disruptor looking at a massive opportunity. It is a highly scalable company that benefits exponentially both on the revenue and cost front as it scales. It could

This article was written by

Rogue Trader profile picture
Ex HF portfolio manager, Ex management consultant. Now I manage my own money and focus on anything that can create alpha. I will write on any idea I have and lay out my thesis and analysis openly to get feedback from and discuss with the SA community.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of AMZN, LMND either through stock ownership, options, or other derivatives. 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.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (71)

This one is a mystery to me. If renters and home insurance in the US are massive markets ripe for disruption and you have just begun doing that..why do you take a company with 570 employees and go international and into a totally different area of insurance which is labor intensive , It cant be because you need to offer bundling discount. Hippo does it with metromile.
Rogue Trader profile picture
@jguy2 Interesting point. Perhaps to do it before someone else does it?
@jguy2 perhaps to promote the stock?
@jguy2 It's because it sounds good to the Fanboi crowd, which is the company's only interest.
They have no life insurance product they area an agent for one company. I can go to policygenius and get quotes from a dozen companies in a couple of minutes
It may be "zero theta" but the gamma is likely to be massive when they release their loss ratio from Idna with ny as their largest rental insurance market. Spinmeister CEO Shreiber is giving advance warning with his blog post aboout how loss ratios dont matter. I see they are still flogging that "we take a fixed fee pay out the claims and payout the rest to charities stuff" sooner or later the sec or insurance regulators will make them take it down..it's nonsense ..try to find it on their financials.
They have barely moved the envelope in homeowners insurance as you can see by the average premium of $249 (homeowners insurance averages $1200+) yet they are going to take on the massive task of creating an auto insurance company from scratch. Their rationale is the customers' preference to bundle and get a discount. Hippo has partnered with metromile to offer auto in a bundle..no doubt earning a bit of commission without taking on any risk or adding the massive staff needed to properly run an auto company. At least in CA it is impossible to settle an auto claim "digitally" certainly if it involved another vehicle: a claims rep needs to contact the other party's insurer determine who is at fault, arrange for a rental car, examine the car for damage,set up an authorized repair shop and then authorize the claim. Multiply this by the amount need in each state Just providing service to CA would mean close to doubling their staff....and they have to be trained etc.. And insurance is licensed state by state...your guess on the legal fees for that?
If you're looking for a "call option on digital insurance" you're better off looking a hipo. The stock is selling at half the spac/ipo price. The CEO/Founder Wand has been buying stock lately....at least you would be buying alongside him...not from him. I blogged on hippo here www.israelstockinvestor.com/...
You can scroll through all the negative comments from me and others on previous articles on LMND. But I think enough info comes from the insider sales of ceo/founder Shreiber who has sold of $87 mln of his holdings ($47 mln worth at the secondary offering at 3x the current price) leaving him with $3 mln. If that's not a good enough forecast I dont know what is. Cofounder Winniger has been a huge seller as well, The director of the board sold $82 million on the secondary leaving him with 11,000 shares. Insiders now own around 5% of the company. It it's an option on digital insurance..then you're buying it from the founders and cfo. As they say if you dont know who is the sucker in the trade...it's probably you. www.marketbeat.com/...
kthor profile picture
got a home quote from Lemon and it was 300+ more expensive than my geico home insurance ..pretty sure car insurance would be more expensive once they start selling it! Life Insurance, lol, I'll stick with NY life
Rogue Trader profile picture
@kthor Thanks for the on the ground info. Where are you located? With auto the expectation seems to be that it'll be 13% less expensive than the average (Tennessee state objection letter) and second cheapest to Progressive.
kthor profile picture
@Rogue Trader

Northern California, I do quotes yearly just to see if I can lower my life, home, car etc Insurance
Man that Kool Aid must be good. Another person drinking it double fisted. What competitive advantage? This article is so divorced from reality, so blindly bullish, so ridiculously naive, I really have to wonder..........
Rogue Trader profile picture
@MrFafman So blindly bullish? I thought I presented a balanced view skewed towards bullish honestly :)
@Rogue Trader Ok, I'll accept that was your goal, but the idea that this company has the chance to be "100's of billions" is blindly bullish given that is has not demonstrated the ability to make a profit, acquire customers at a reasonable cost, expand into auto, or manage its loss ratio. You have accepted as a given that it has a "competitive advantage" when in fact there is no evidence of that whatsoever. Your article basically says that if a company can take over the insurance business it will be worth a gazillion and this one is rumored to be doing it, but you offer no justification for that whatsoever despite tremendous evidence to the contrary.
Rogue Trader profile picture
@MrFafman I see what you're saying but by no means am I implying that it will achieve such result with certainty. I'm just saying that it is in a position that it can. And that the equity investment presents an opportunity of buying that outcome at a relatively reasonable price like a call option. I'm betting that this is what Allianz and AXA thought when they bought in.

I hate to lead investors with my biases. I especially added parts citing to highlight that this investment could go to zero. I also wrote about the very high expectations and the very lofty multiple.

Don't think of Lemonade like your typical $30 bn+ IPO company with proven unit economics and solid traction. This is different. Think of this like a venture round at a $4 bn valuation. Venture investments rarely go to surety, but to bear risk. Acquisition costs are almost always very high in these stages as is new products/markets. Lemonade's indeed unproven and can all go belly up, but if management executes, we're looking at very many bagger returns.

Amazon was public at a similar stage in its cycle and was trading very expensive. Tesla was the same, despite my bearishness towards the company for the past three years it went on to compound amazing returns. Not saying that Lemonade is the same, it isn't, but investing at this stage could have very high payback and bears extraordinary risk.
Jeremy Blum profile picture
Another absurd article about LMND that completely ignores the huge amount of issues. Not the least of which there is no viable business model here. Revenues are only increasing because of massive advertising. Here are 29, yes 29 reasons you should avoid LMND.

1. Losses are massive - Losses have actually exceed revenues in every time period to date. This is unusually high for a growth company of this size. In the most recent quarter, revenues totaled $28.2 million and losses totaled $55.6 million. Losses are increasing faster than revenues are growing. Most money losing growth companies are at least narrowing their losses.

2. There is no clear pathway to earnings - It is unclear how the company will become profitable based on the current business model. The company is currently paying more in sales and marketing expense than it is receiving in revenues. In the most recent quarter, sales and marketing was $33.1 million which exceeded revenues of $28.2 million. If this expense is reduced, growth is likely to be reduced significantly or even reversed. Every dollar spent on sales and marketing is currently resulting in more than $1 of losses.

3. Growth is slowing fast– Growth of the customer base was 48% in the first six months of 2021 down from 56% in 2020 and 108% in 2019.

4. The churn rate (customers leaving) is very high. This is primarily due to renters insurance being their largest segment. That means more customer acquisition cost is needed.

5. Very high stock price - Lemonade is in fact a traditional insurance company trading at an astronomical level. Most insurers trade at 1 to 2x book value and 1 to 2x revenues. Lemonade is currently trading at 44x last quarter’s revenues annualized.

6. Ceding to reinsurers significantly reduces earnings - By ceding most insurance risk to reinsurers Lemonade significantly reduces potential profit. If you remember only one thing on this list let it be this. Most insurance companies derive the vast majority of their profits from insurance underwriting in the form of premiums. Investment income is a distant second and becoming even less so due to low interest rates. Lemonade has effectively ceded 75% of its premiums to reinsurers. That means it has given away the industry’s traditional profit center. It has little to replace that with. The 25% they keep needs to cover costs. Currently sales and marketing alone are well above the 25% of premiums they are getting. The company is inching away from reinsurance and is lowering the ceded portion to 70%.

7. The ESG claim of giving to charity only adds to losses. This is egregious to investors when the company is losing a lot of money.

8. Larger competitors offer online applications too - The three largest competitors for rental insurance are Allstate, State Farm and Liberty Mutual. All are much larger. All have internet applications for renters and homeowners insurance.

9. Automated underwriting is also done by their peers – Most of their peers have automated underwriting augmented by human interaction when needed. It is less effective overall than using a human component in reducing claims losses. Even Lemonade brings in a human for more complex applications. The move to more complex insurance like homeowners will require more human touch.

10. Limited underwriting data versus competitors - The company states the following on page 96 of its S-1 “ our extensive use of data and technology enables us to be increasingly precise at risk selection, risk pricing, and claims handling”. The reality is most competitors have decades of data to plug their algorithms into for underwriting insurance. Lemonade has barely two years worth of its own usable data. Lemonade does appear to pay for third party data to add to their own. That adds cost. Their competitors with much larger underwriting budgets almost certainly have better algorithms developed over decades. This is more of a disadvantage than advantage for Lemonade.

11. Reinsurers will call the shots - If you believe that underwriting doesn’t matter because the reinsurers are taking most of the risk think again. The reinsurers will eventually call the shots once the claims data is sufficient to model. If there are too many claims, they will increase their take from Lemonade. This will force Lemonade to either lose more money or increase the premiums. Lemonade may have been forced into reducing the amount of reinsurance to 70%.

12. Hurricane and storm risk - Texas and Florida are two of three largest markets for Lemonade. Both are hurricane and storm prone. In fact, homeowners and renters insurers in those states suffered heavy losses in 2020 and 2019. The February 2021 Texas storm caused huge losses for Lemonade. Their losses to revenues was much higher than any other insurer I am aware of.

13. Insider selling has been massive since the IPO.

14. The AI bot can be duplicated - The only apparent secret sauce Lemonade appears to have is its Al Maya online bot. However, that can be easily knocked off by its larger competitors if they see it as a threat.

15. More costs are coming - The large operating losses are before all the new claims adjusters the company will need to hire to handle the increasing insurance. Lemonade not the reinsurers handles the claims.

16. Competition coming from tech companies - The S-1 on page 26 states “There are various technology companies that have recently started operating in adjacent insurance categories that may in the future offer renters and homeowners insurance products.”

17. Regulatory risk - Lemonade has not been examined by its regulator (the New York Department of Insurance) since 2018, a year when it wasn’t very active. A regulatory exam is due and its large losses will need to be considered. As a former bank regulator my experience is new financial companies trying new things often leads to errors and omissions that need to be cleaned up.

18. AI will likely have limited help with claims processing - The company claims that AI is being used for claims processing in addition to underwriting. I personally have an experience going through a large real estate insurance claim. The process took 9 months, with constant back and forth, and the eventual claim was three times the original estimate. The point is claims are much more complex than underwriting an individual customer. There are literally hundreds of potential variables. No program is going to able to handle all of them, at least yet. In the S-1 the company claims its bot, AI Jim, can handle a claim start to finish about 1/3 the time.

19. California law on bots - From the S-1 “A California law, effective as of July 2019, makes it unlawful for any person to use a bot to communicate with a person in California online with the intent to mislead the other person about its artificial identity for the purpose of knowingly deceiving the person about the content of the communication in order to incentivize a purchase of goods or services in a commercial transaction. Although we have taken steps to mitigate our liability for violations of this and other laws restricting the use of electronic communication tools, no assurance can be given that we will not be exposed to civil litigation or regulatory enforcement”

20. Human touch - The power of human interaction cannot be brushed aside. Humans can have empathy which is something robots or bots are nowhere close to. Humans can tell much by your tone or changes in your voice that bots cannot. The bot experience may be interesting or fun. But once things get serious it can and often will be annoying and frustrating.

21. No insider insurance background - BIG ONE. None of the directors or officers of Lemonade have an insurance background as shown by their backgrounds mentioned on the S-1. This one is very concerning. Lemonade is a technology company entering a financial segment. It doesn’t have the experience underwriting the incumbents have.

22. Little investment income - Lemonade’s competitors get a significant portion of their earnings from investment income. Lemonade currently has few investments held as assets. The two largest sources of income for insurance companies (premiums and investments) provide little for Lemonade.

23. Little traction in homeowners insurance - Based on its average premium size, Lemonade does not appear to be getting much traction in homeowners insurance. It does not provide a breakout between the two. The average annual premium per customer was $201 as of September 30, 2020 which is much closer to a renters premium than a homeowners.

24. The loss ratio is way understated due to LMND's rapid growth.

25. This to a large degree has been the GEICO or Progressive approach. Direct selling has existed for decades, well before the internet. How much of a higher loss ratio will LMND accept? To date they have not put forth an equation that works.

26. Adverse selection is a major concern. LMND, right now, is likely getting business the large incumbents are indifferent about. These are very small niche markets. Renters insurance is a throwaway for them.

27. How claims management is handled matters. Most claims are fractional, there are few total losses. To manage this right you need a lot of data and knowledge and experience as to how to use it. It usually takes more than a bot.

28. Lemonade made a grand announcement it was entering the car insurance business in April, 2021. But in its second quarter 2021 earnings release it pushed back any scale expectations in this business due to how long it will take to get various state regulatory approvals. It no longer expects any meaningful revenues in 2021. Meanwhile it is racking up expenses by hiring people for this business.

29. Fast growth in car insurance means big losses down the road, especially for newer entrants that don't have the brand identity and consumer trust to pull the most profitable customers away from GEICO, SF, TVR and ALL. Specifically, Lemonade’s younger customer base is not very profitable if at all. They do pay much higher premiums so higher revenues may look like things are going well. But more unprofitable growth.
Rogue Trader profile picture
@Jeremy Blum thanks for the detailed comment, really shows the value of the SA platform. There are things I agree with like the lack of insurance experience of management (despite their innovativeness), high churn rate, and especially the very high multiple.

But I think you're underestimating the value of the UI and the lovebrand here. Similar things have been said about Amazon and Tesla and many others in the past that didn't hold water. This is not to say that Lemonade is the same, it isn't. But you can't just say that a competitor can easily copy it. If that were the case industry insiders, AXA and Allianz would build their own offering instead of investing in the company.

When it comes to the renters niche and economics of the business: renters insurance is a throwaway yes, but you can't begin to transform an industry from the most competitive niche. Think again, Amazon started from just books. Many said then that selling books wasn't innovative and that it was very expensive. Once Lemonade gets users on its platform, it'll be able to grow surprisingly fast. And, yes, it needs to address the churn rate.

Economics of a business this young are almost always bad. We just don't see them in the public markets as they're usually funded by venture capital. Lemonade is a unique opportunity in that we can invest much earlier in its growth cycle, albeit with more risk. You don't see many disruptors at $4bn valuation. Not for everybody's risk appetite, but the upside is huge if it goes right from this stage.

You mentioned selling costs. They are high. They will be for a while for market share. It's very difficult to scale a business rapidly with profitability. For example Salesforce, the pioneering trailblazer of the SaaS model, still has SG&A above 50% of sales. I see your point with the gray road to profitability in the near term but not in the long term. Clearly the path is to onboard as many customers as possible and then sell them bundles to get them on the platform then leverage the convenience factor and raise prices. This will result in a lot of cash burn, of course. But the upside could be the making of an insurance behemoth.
Jeremy Blum profile picture
@Rogue Trader there is only one reason LMND is getting the growth it is. It is old fashioned throwing a bankload of money into marketing.

You did not provide a pathway to profits other than to say the vague reaching scale will do it. No writer on SA has. Reality is losses get bigger as they scale. If they back off on the marketing, the sales growth will slow and the stock will get hit as growth investors move on.

There is nothing else here other than a friendly bot that can be duplicated. All of the majors have their own automated applications already.

The investors in this stock just don't understand the insurance business. It's very complicated requiring math whizzes and has all kinds of variables. You can't out underwrite companies that have been doing this for decades. It already was disrupted online by GEICO and Progressive. LMND adds nothing to that, again other than a freindly bot.
Rogue Trader profile picture
@Jeremy Blum I see your point and it definitely is the bear thesis. But again, very very few startup investments attacking similarly sized markets at this point in their growth cycle and around these valuations have what you're looking for in terms of profitability. You're buying the risk along with the potential return. A zero theta call is quite an apt way of putting it I think.

You could be right about the data portion, as you say I am not an industry insider and don't know for certain. If they absolutely zero competitive advantage in terms leanness born out of less headcount due to automation and also zero actuarial competitive advantage in underwriting, then yes this investment is likely worth near zero. From what I read both in equity research, company reports, and from what I see in the investor base, two insurance behemoths AXA and Allianz both investors, I have reasonable amount to believe.

Despite absolute widening losses, like I write and present a chart of in the article, are widening but losses, in terms of a percentage of revenues seem to be at an inflection point. As I wrote above, any company at this stage needs to burn cash to grow fast. Early profitability isn't worth much when you're behind the market.

I see and respect your opinion. It is a risky investment and leaves the investor a lot to think about at night. But the upside intrigues me. If you have concrete data that shows that Lemonade won't in fact be more profitable at scale due to digital native platform and uses data worse than peers, then I go and downright short this stock. If not, I treat it like a call option and keep in my portfolio.
aktien-boersen profile picture
Lemonade is a cheap, zero-theta call option. It could potentially deliver >100x returns.

lmnd is cheap?

Revenue 90M

Net Income Avi to Common -169.4M

Market Cap 3.81B

is this cheap?
Rogue Trader profile picture
@aktien-boersen As a call option its cheap. You're buying a call with near infinite maturity. As a stock it's clearly very expensive as stated in the article. Sorry for the confusion.
@Rogue Trader "As a call option its cheap. You're buying a call with near infinite maturity" I totally dont understand...the way I look at it a share in googl is a much better "call option" at 30 p/e to buy a money and profit machine with basically no competition in many of its businesses. Just the you tube part alone is an amazing money machine, they pay nothing for content sell advertising and pay the content creator pretty much whatever they want since they dont disclose the algorithm It's like netflix with no cost of content...and you can have it with commericials for free or pay a subscription to skip the ads.....genius.
Rogue Trader profile picture
@jguy2 Upside of google is less limited, the payout is more certain and the price is higher for GOOGL. Its a regular stock bet whereas Lemonade more similarly reflects the dynamics of an out of the money call.
D Lombardo profile picture
@Rogue Trader I agree on many of your points and think that management is quite impressive. My management opinion is based on several interviews I heard (CEO, CFO) and high marks from Glassdoor.

However, the results are not there!. Revenues for such an Early-Stage company should be growing much quicker and losses should be lower given the company's optimization of revenue product mix.

Also, I would add that their biggest risk is Operation & Execution.

They're going into new regions and end market products at the same time. I'm not talking about expanding from NY to NJ. But expanding overseas into different markets with different loss ratios and different regulatory regimes. Seems like a Herculean task in my view.

Def a big risk !

Again, I like this company but we need to stay objective.
Rogue Trader profile picture
@D Lombardo I completely agree and thanks for highlighting the management.
@D Lombardo For me a company with tiny revenue, massive losses, lack of execution, a risky business plan, fierce competitors, highly regulated and big mistakes "objective" means run for your life.
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