Lemonade: A Disruptive Insurance Business Firing On All Cylinders

Oct. 21, 2021 12:17 PM ETLemonade, Inc. (LMND)46 Comments7 Likes
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Jordan Martenstyn
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Summary

  • Lemonade has all the characteristics I look for in a secular compounder: a disruptive business model, exceptional organic growth rates, and a founder-led management team.
  • Lemonade has a large technology advantage over incumbents and benefits from counter-positioning, which makes it difficult for larger and more resourced competitors to replicate their business model.
  • Lemonade has four routes to grow revenues and premiums: adding new customers, existing customers spending more on Lemonade insurance products, adding new insurance products, and expanding into new markets.
  • Lemonade has experienced an 80% multiple compression since January 2021, placing it in an attractive valuation range.
  • Lemonade has a founder-led management team with around 10% inside ownership across the two co-founders.

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Mason jar glasses of homemade lemonade on rustic wood

jenifoto/iStock via Getty Images

Lemonade (NYSE:LMND) has all the characteristics I look for in a secular compounder: a disruptive business model, exceptional organic growth rates, lots of optionality, and a founder-led management team with skin in the game. It has experienced more than an 80% multiple compression since January 2021, placing it an attractive valuation range for patient long-term investors.

What is Lemonade?

Lemonade is an insurance company that uses artificial intelligence (AI) to simplify the process of purchasing insurance and making claims. A lot of companies tout the use of AI to impress customers and investors, but AI truly sits at the core of Lemonade's business.

While most legacy insurance providers (the "incumbents") require prospective customers to endure cumbersome application processes and fill out extensive paperwork, Lemonade allows customers to purchase insurance within minutes from the comfort of their own home by speaking with their AI-powered chatbot named AI Maya. AI Maya asks prospective customers 13 questions via the chat box on the Lemonade website and collects over 1,600 data points throughout this interaction. Lemonade amalgamates all this information into an algorithm to determine the cost of insuring that specific person (i.e., their premium). There is no salesperson involved, no paperwork, and it only takes a few minutes to complete.

Source: AI Maya Chatbot

While AI Maya is involved in the process of purchasing insurance, her male counterpart (AI Jim) handles the claims side of the insurance equation. AI Jim asks customers a series of questions about the claim and then asks them to record themselves explaining the circumstances of the claims request on camera. AI Jim analyses this video recording using facial and audio recognition software to detect inconsistencies from previous submissions, which helps to detect fraudulent claims.

While the process of purchasing insurance through AI Maya is 100% automated (i.e., requires no human interaction), not all claims can be processed by AI Jim alone. According to Lemonade's IPO prospectus, AI Jim is able to process around 33% of claims (generally within seconds), while the remaining 66% of claims require some degree of human involvement.

Source: AI Jim Chatbot

An insurance business focused on delighting their customers … really?

During the founding of Lemonade, Daniel and Shai hired Professor Dan Ariely (Professor of Psychology and Behavioral Economics at Duke University) as their chief behavioral officer to help redesign the insurance process to be seamless, enjoyable, and trustworthy. Rather than make a small incremental improvement over the incumbents, Lemonade sought to upend the traditional insurance business model and one crucial element of this strategy involved aligning the incentives between Lemonade and their customers.

In a radical and highly controversial move, Lemonade registered as a Public Benefit Corporation (PBC) and Certified B Corp., which requires them to balance their social and environmental purpose with the pursuit of maximizing shareholder value. In other words, Lemonade is legally obliged to consider a range of stakeholders (e.g., customers, workers, community) in addition to shareholders when making business decisions, which is very similar to the growing conscious capitalism movement which advocates for a multi-stakeholder orientation. To my knowledge, Lemonade is the only public insurance company in the world registered as both a PBC and Certified B Corp.

Source: The B Corp. Movement

To be clear, a Certified B Corp. is still a for-profit organization and the maximization of shareholder value remains very much at the heart of the business DNA. I would contend that most of the great technology businesses of the 21st century have implicitly adopted a multi-stakeholder orientation, albeit without the official title of being a PBC or Certified B Corp. For example, FAANG companies - Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX), and Google (GOOG) - have, for the most part, adopted an unwavering focus on attracting top talent and improving customer experience. Businesses that do not prioritize providing exceptional value for their customers and hiring/retaining excellent staff are at the whims of business and technological disruption.

I believe that this decision by Lemonade to become a PBC and Certified B Corp. is a brilliant strategic move to (1) build trust with customers, (2) cultivate their "purpose before profits" brand image, and (3) attract top talent. More than ever, Millennials and Gen Z workers are drawn to support companies that value social purpose in addition to financial outcomes. Lemonade is well positioned to attract these smart and ambitious Millennial and Gen Z workers, which could confer a major competitive advantage over the incumbents. Time will tell if this assumption is correct.

A rapidly growing product offering

When Lemonade went public in July 2020, they only offered renters and homeowners insurance. In the past 15 months, Lemonade has expanded their product offering to also include pet insurance and term life insurance, with car insurance expected to be launched before the end of 2021.

The below diagram indicates the percentage of in force premium (IFP; total premiums collected from active policies) generated from each of these product lines as of Q2 2021. Keep in mind that pet insurance was launched in July 2020 and term life insurance was only launched in January 2021, so they haven't had a lot of time to meaningfully contribute to total IFP. While renters insurance still accounts for more than half of IFP, its concentration risk has reduced dramatically since IPO.

Source: Lemonade Q2 2021 shareholder letter

Each of these product lines are showing excellent traction (except possibly term life insurance). In Q2 2021, renters insurance grew at around 50% year over year, while homeowners insurance grew at more than 100% year over year. While growth rates for pet insurance are not reported, Daniel Schreiber noted that pet insurance achieved profitable unit economics within months of launching - a feat which took several years for their more mature homeowners product.

Offering four (soon to be five) products allows Lemonade to (1) offer greater convenience for customers to collate multiple policies into a single platform and (2) offer price discounts for customers who bundle two or more insurance products together (e.g., renters insurance with pet insurance). CEO Daniel Schreiber frequently described Lemonade as operating with "one hand tied behind their back" when renters and homeowners insurance were their sole products, due to the absence of these bundling discounts. I'm excited to see where Lemonade can go with both hands free.

The opportunity in car insurance for Lemonade is massive

The U.S. car insurance market is enormous. Recent estimates from Lemonade value the industry at around 300 billion, which is more than 70x larger than both the renters and pet insurance markets combined. Lemonade's internal estimates suggest that most of their existing customers are already car owners and spend around 1 billion per year on car insurance. Let's conservatively estimate that Lemonade is able to convert 10% of existing customers who have car insurance with another provider through offering price discounts for bundling products.

Such an outcome would equate to around $100m of IFP in 2022 alone (assuming car insurance is launched before the end of 2021). After Lemonade keeps 30% of that IFP (business model to be explained soon), that is approximately a $30 million uptick in revenue in 2022 from a 2021 forecasted revenue base of $123-125 million. Thus, there is enormous opportunity for car insurance to become a meaningful part of Lemonade's business within 12 months of launch solely from their existing customer base.

Targeting a much younger customer demographic than their incumbent competitors

One major differentiator between Lemonade and their larger competitors is their target market, with Lemonade strongly focused on attracting Millennial and Gen Z working professionals. Indeed, 70% of Lemonade's customers are under the age of 35 and an incredible 90% did not switch from another insurance provider (i.e., they purchased their first insurance policy through Lemonade).

Targeting this younger demographic is a bold move that invokes short-term pain for long-term gain. Working professionals in their 20s and 30s generally have less income to spend on insurance policies in the present, but this amount should increase in the future as they become older and gain more personal and professional responsibilities. If Lemonade is able to develop brand loyalty and goodwill with these Millennial and Gen Z customers at the earlier stages of their working life, they will be able to generate decades of recurring and increasing revenue from this existing customer base as they take out additional insurance policies to cover more domains of their life.

Geographical expansion - another element of the growth equation for Lemonade

I won't delve too deep into Lemonade's geographical expansion plans because it doesn't form a fundamental part of my thesis. As of Q2 2021, at least one Lemonade product was available in each of the 50 U.S. states and I expect this to be rolled out for all of their insurance products within 12-24 months, providing a powerful tailwind for growth.

Lemonade's core market is the U.S. and this is where they have focused most of their resources due to more attractive unit economics than Europe. Nonetheless, they have recently expanded some products into Europe to test the waters, including Germany (June 2019), Netherlands (April 2020), and France (December 2020). CEO Daniel Schreiber has noted in recent interviews that Lemonade is seeing increasing conversion rates and declining loss ratios in Europe, so will likely be investing more over the next 12-24 months into expanding their geographical footprint throughout Europe.

Lemonade's technology advantage over incumbent competitors

Lemonade's technology infrastructure (CEO Daniel Schreiber calls this their "digital substrate") powers multiple facets of their business, including loan underwriting, claims processing, fraud detection, and sales and marketing. This digital substrate provides an enormous competitive advantage over less technology-savvy competitors, as Lemonade is able to add new products and expand into new geographies without a proportionate increase in the cost of capital and staffing costs, which affords significant pricing power at scale.

Lemonade also collects a tremendous amount of data (> 1,600 data points) during the loan underwriting process, which is fed into their algorithm to calculate premiums. On a theoretical level, as Lemonade gathers more data over time through more customer interactions, the success of their loan underwriting and claims processing should improve.

Source: Lemonade IPO prospectus

The continuation of this positive feedback loop is crucial to Lemonade's future success and is evident in decreasing loss ratios (a measure of incurred losses divided by collected premiums) from Q1 2019 onward (note: Q1 2021 was temporarily affected by the Texas Freeze).

Source: Lemonade Q2 2021 shareholder letter

While declining loss ratios suggest that Lemonade's algorithm is becoming better at pricing risk over time, it is also helpful to consider other metrics that might indicate whether Lemonade truly has a technology advantage over their incumbent competitors.

Number of customers per employee

Although it is very difficult to find more recent statistics than 2018, it appears that Lemonade has around 5x the number of customers per employee and 2x the number of policies per employee compared to their nearest competitor (State Farm), demonstrating the scalability of their model.

Source: Two Years of Lemonade

Source: Pretty in Pink

Frequency of software upgrades

CEO Daniel Schreiber has noted in numerous interviews that Lemonade averages 20-30 software upgrades per day compared with 4-5 upgrades per year for their incumbent competitors.

Geographical expansion without relocation

Perhaps the most impressive demonstration of Lemonade's technology advantage is that they do not have a single employee based in either of their two largest U.S. markets of California and Texas. Moreover, Lemonade offers contents and liabilities insurance in Germany but does not have a single employee based in Germany (although I assume there must surely be at least one employee in another country who can speak a little German).

Lemonade's disruptive (and controversial) business model: the secret sauce?

Lemonade has an innovative business model that is a stark departure from standard practice in the insurance market. An insurance business typically makes a profit when premiums (inflows) exceed claims (outflows), all other things being equal. Let's ignore other factors, such as investment income and operating costs, to keep things simple. What this means is that an insurance business is incentivized to (1) collect as much in premiums as possible and (2) minimize the amount of claims paid out to customers. The larger this difference, the greater the amount of profit for the insurance business. While this model can be highly profitable, it creates misalignment between the insurer and the customer, who is instead incentivized to (1) pay as little as possible in premiums and (2) receive as much as possible in claims. Sounds like a good old fashioned tug of war. No wonder why you see headlines like these in the media:

Source: Google search

Lemonade flips this model on its head and creates alignment between the customer and insurer (for context, the main slogan on Lemonade's website is "forget everything you know about insurance"). Lemonade collects a fixed fee (currently 30% of premiums) that is used to cover expenses and their proportional share of customer claims, with the surplus theoretically being used to generate a small profit. The remaining 70% of premiums are ceded to reinsurers who cover their proportional share of customer claims. Anything that is left over at the end of the calendar year from this 70% is donated to charities as part of their giveback program, where customers vote on which charities they want their donations to be made to. Thus, incentives are aligned between Lemonade and their customers. Lemonade already keeps a flat fee (30%) and excess dollars that are not claimed from the 70% are paid out to charity, so Lemonade has no incentive to deny customer claims.

Source: Lemonade Website

This giveback program is a critical element of Lemonade's role as a Certified B Corp and in building trust with their customers. And it isn't just a vanity metric; Lemonade donated more than 2.3 million to charities in 2021, which was more than double the amount donated in 2020, and up more than 40-fold from the amount donated in 2017.

Source: Lemonade Website

Insurance is a complex business to forecast; it's inherently very lumpy and insurance businesses can be forced to cover large claims during one-off tail events, such as natural disasters, at short notice. Lemonade reinsures around 70% of their premiums which allows them to boost their capital efficiency and reduce their capital requirements for these one-off tail events. Without their reinsurance model, Lemonade would need to reserve as much as 50c per $1 of collected premium (2:1 ratio). With their reinsurance model, however, most of the surplus capital requirements are shifted to the reinsurer, so that the current capital requirement is more like 14c per $1 of collected premium (7:1 ratio). Thus, because Lemonade does not need to hold as much cash reserves on their balance sheet, they are able to re-invest more capital into the business for growth.

CEO Daniel Schreiber has noted in numerous interviews that Lemonade isn't beholden to their current reinsurance model but deliberately chooses this model because it allows them to invest more capital into their business for growth. Over time, he foresees that Lemonade will reduce the proportion of premiums ceded to reinsurers as the business becomes more diversified across product lines and geographies. This trend has already begun to play out; when I began researching Lemonade in March 2021, they reinsured 75% of their premiums, which was recently reduced to 70% in Q2 2021.

Circumventing the switching costs inbuilt into the insurance industry

Insurance isn't like a Netflix subscription where you can easily cancel and re-activate your subscription depending on their monthly selection of movies or TV shows - it's a complicated, time-consuming, and laborious process that involves filling out lots of paperwork and often speaking to multiple people on the phone. This moat (known as switching costs) is a big reason why large incumbents in the US insurance market have been able to survive (but not necessarily thrive) since 2000 in the midst of massive technological disruption in other markets.

But this is the beauty of Lemonade's strategy. They are not targeting these older customers who have entrenched relationships with existing insurance companies. They are targeting Millennial and Gen Z customers, 90% of whom are purchasing insurance for the first time. Of Lemonade's 1.2 million active customers, almost 1.1 million of them have never purchased insurance before and have chosen to begin their insurance journey with Lemonade. This is a big advantage for Lemonade as it helps them circumvent the switching costs inherent in the insurance industry and reduces their degree of competition with incumbents.

Lemonade's power advantage over incumbents: counter-positioning

Counter-positioning is one of the competitive advantages described in Hamilton Helmer's seminal book 7 Powers: The Foundations of Business Strategy and suggests that upstarts can have an inherent advantage over incumbents when (1) they have a superior and unorthodox business model and (2) incumbents are unable to respond to the competitive threat.

As mentioned earlier, Lemonade has a radically different business model to that of the incumbents. They are a Certified B Corp and digital automation lies at the core of their operations. There is no way that Geico founded in 1936 with tens of billions in revenue will be able to quickly (or efficiently) upend their entire model of selling insurance policies through sales representatives and brokers to compete with Lemonade's D2C AI chatbots (AI Maya and AI Jim). And why would they? Their customer base tends to be much older than that of Lemonade's. What would a 60-year old who has four policies with Geico think if they were asked to submit claims via a chatbot rather than speaking on the phone with their normal client representative who they may have been working with for more than a decade?

Moreover, redesigning their business model to be centered around automation would likely result in thousands of redundant staff, terrible PR, and significant short-term pressure on revenue and margins. There is little incentive for senior executives at an established insurance business to upend their business model, and risk reputational and financial damage to compete with an unproven upstart like Lemonade or Hippo (HIPO). The default option for the management team at an incumbent business is to do nothing, continue receiving their large salaries and stock bonuses, and hope a natural disaster wipes out Lemonade.

How does Lemonade stack up to their modern competitors?

Lemonade is not the only new-age insurance business using technology to disrupt the incumbents like Geico, State Farm, and Progressive (PGR). Below I outline a number of reasons why I think Lemonade will emerge as the leader of these new entrants.

Source: Author generated (as of Oct. 15, 2021)

Customers

Lemonade has the largest customer base, with over 1.2 million customers as of Q2 2021 (note: Hippo did not disclose customer numbers in their most recent shareholder letter).

Products

Lemonade is the only company with at least one product available in all 50 U.S. states and an international presence. Moreover, Lemonade offers the greatest breadth of products with four available products (soon to be five with the upcoming launch of car insurance), which allows them to offer price discounts to customers who bundle multiple products. Root Insurance (ROOT) is the only other modern competitor with multiple products with car, renters, and homeowners insurance.

To remain competitive, Hippo and Metromile (MILE) partnered in May 2021 to offer discounts to customers who bundle Hippo's homeowners insurance with Metromile's car insurance. While this could be a viable solution in the short to medium term, it suggests that Hippo and Metromile do not have the technological capabilities (or willingness) to launch multiple products and decreases their ability to control the customer experience. For example, if a customer signs up for Hippo's homeowners insurance and bundles it with Metromile's car insurance, and then has a poor customer experience with Metromile, Hippo suffers brand damage given their association with Metromile. Lemonade and Root Insurance have instead invested upfront to build out multiple products, which affords them greater control over the customer experience and increased access to customer data.

Growth in premiums and customers

Lemonade is growing customers and premiums faster than their competitors, with a 2-year customer compound annual growth rate (CAGR) of 65% and a 2-year IFP CAGR of 103%. Hippo is a close second with a 2-year IFP CAGR of 94%. Root Insurance's trailing 2-year growth rates are respectable, but their guidance indicates major growing pains ahead. In their Q2 2021 earnings update, Root forecasted year-over-year declines in both premiums/revenue in Q4 2021 and for the whole of 2022. Metromile is the slowest growing of the four with a low single-digit CAGR in customers and IFP over the past two years. Thus, while Lemonade and Hippo are rapidly gaining market share and growing premiums, Metromile and Root Insurance appear to be plateauing, explaining the differential valuations between the four businesses.

Customer experience

In terms of convenience for customers, all four companies are able to offer an initial quote within minutes, but Root Insurance and Metromile extend this duration to weeks for those that want their driving abilities evaluated to receive possible discounts to their premiums. Lemonade is the only business that offers at least a partially automated claims process through AI Jim; the others require speaking with a customer support representative, similar to the incumbents.

Follow the customers - and customers love using Lemonade

It is reassuring to see that Lemonade's obsession with customer experience materializes in their customer reviews. Lemonade receives consistent high scores from more than 60,000 reviews across multiple different websites. If we compare their reviews to that of both their legacy and modern competitors, it is clear that Lemonade is the most consistent performer with a simple average (4.7/5) that blows their competitors out of the water. Even on Trustpilot, which is notorious for attracting the harshest reviews, Lemonade scores 4.4/5 which places them in the "excellent" category.

Source: Author generated (as of Oct. 10, 2021). Note: Data is not available for some businesses (e.g., Hippo) on certain websites.

Explosive organic growth across all key business metrics

Let's now dig into Lemonade's key business metrics and evaluate whether they support the qualitative aspects of this investment thesis.

Customers

Lemonade has experienced phenomenal customer growth since inception. They reached 1 million paying customers in around 1,500 days (4.25 years), which is 4-11 times faster than the incumbents of State Farm, Allstate (ALL), Geico, and USAA.

Source: Lemonade Press Release

Moreover, Lemonade has reported sequential quarter-over-quarter growth in total customers since Q2 2018, adding between 60,000-120,000 customers each quarter (this includes churn from loss of customers). During this period, Lemonade's total customer count grew at a 3-year CAGR of 93%. I expect explosive customer growth to continue for the next 3-5 years (although likely not at a CAGR of 93%) as Lemonade continues to add new products (e.g., car insurance), expand their coverage for all products across all 50 US states, and enter new international markets.

Source: Author generated

In force premiums

As with all insurance businesses, premiums are the oxygen for Lemonade. In force premiums (IFP) represent the total annualized premiums for customers at the end of a given period. IFP has grown at a 3-year CAGR of 135% since Q2 2018 and has accelerated in the past three quarters from 87% year-over-year (Q4 2020) to 91% year over year (Q2 2021).

Source: Author generated

Lemonade also reports very consistent growth in premiums per customer since Q2 2018 resulting from (1) customers upgrading existing policies (e.g., changing from renters to homeowners insurance) and (2) greater opportunities for bundling from the launch of new products. Thus, Lemonade is rapidly growing their customer base at almost 100% year-over-year, and their existing customers are also spending more each quarter (3-year CAGR of 21%), providing a powerful tailwind for growth.

Source: Author generated

Annual dollar retention

Lemonade defines their annual dollar retention (ADR) as the percentage of IFP that it retains over a 12-month period and indicates their ability to (1) retain customers and (2) sell additional or more expensive products to these customers over time. Lemonade reported an ADR rate of 82% as of Q2 2021, which has increased somewhat steadily from 69% in Q2 2019. Although this seemed low at first glance given Lemonade's glowing customer reviews, it is within the average for insurance businesses in developed economies, which has ranged from 79-86% between 2009 and 2019. What is pleasing is the rate of increase in ADR since 2019, which suggests that Lemonade is providing customers with better policies and has the potential to exceed those aforementioned industry retention averages over time.

Source: Author generated

Revenues

Lemonade has grown their revenues at a 3-year CAGR of 92%, which is impressive given that this includes a change in revenue recognition beginning in Q3 2020 where Lemonade decided to increase the proportion of revenues ceded to reinsurers to reduce capital constraints.

As such, year-over-year revenue comparisons for the four quarters from Q3 2020 to Q2 2021 make it seem as though Lemonade's business has plateaued, when in reality the business has gone from strength to strength. For example, revenue dropped more than 40% from 29.9m in Q2 2020 to 17.8m in Q3 2020, despite IFP growing 22% between quarters from 155m to 189m. If we just consider quarter-over-quarter growth rates since Q3 2020, Lemonade grew revenues 15% from Q3 2020 to Q4 2020, 15% from Q4 2020 to Q1 2021, and 20% from Q1 2021 to Q2 2021, which are explosive quarterly growth rates.

From Q3 2021 onwards (next quarter), Lemonade's yearly revenue growth rates should more closely reflect their growth in premiums, making it easier to appraise the strength of the business. It is even possible that revenue growth outpaces growth in IFP over the next 3-5 years as Lemonade benefits from (1) increasing premiums but also (2) reductions in the proportion of premiums ceded to reinsurers (note: this has already decreased in the past 12 months from 75% to 70%).

Source: Author generated

Margins

Gross margins have been temporarily inflated because of the change in revenue recognition from Q3 2020 onwards and have been quite lumpy over the past two years, ranging from 8% (Q1 2021, due to the Texas Freeze) to 41% (Q3 2020). CEO Daniel Schreiber has forecasted long-term gross margins of between 20-30%, which I think is a realistic estimate and consistent with Hippo's long-term gross margin forecasts. Nonetheless, with gross margins in this range, Lemonade is reliant on large volumes to drive profit growth.

Source: Lemonade Q2 2021 shareholder letter

As is the fashion with most early-stage technology companies, Lemonade is not profitable, reporting a whopping net loss of 55.6m on 28.2m of revenue in Q2 2021. Although this is a large net loss, I am not overly worried at this stage of their journey given their strong net cash position. The opportunity for Lemonade is enormous and it makes sense for them to continue to invest aggressively to grow their market share in the US, launch new products, expand into new geographies, and improve their customer experience. Given the potential lifetime value of a customer acquired in their 20s or 30s, it is worth spending up to acquire and retain these customers now. Nonetheless, I will be monitoring these net losses closely over the next few quarters.

Net cash position

As of Q2 2021, Lemonade has a fortress balance sheet with 1.2 billion in cash and no debt after their IPO and a secondary stock offering in January 2021. CEO Daniel Schreiber noted on their Q2 earnings call that their current cash balance should get Lemonade through to becoming cash flow positive, so I would be surprised (and disappointed) to see significant shareholder dilution from here.

Management and corporate culture

Lemonade boasts a strong management team with high levels of inside ownership, including almost 10% combined ownership between the two co-founders. Below I introduce some of the key players:

Daniel Schreiber (co-founder, CEO, and chairman of the board) appears to be an articulate, principled, and visionary leader who thinks in decades over quarters. It is well worth listening to/watching some of his podcast appearances to see what I mean. Prior to Lemonade, he served in senior executive roles at a number of technology companies and co-founded an internet security software business (Alchemedia) which was acquired by Finjan Software in 2003. He owns more 4.4% of outstanding shares and has an excellent 4.5/5 rating on Glassdoor with a 94% approval rating.

Source: Glassdoor

Shai Wininger (co-founder and COO) has previously founded four companies, the most notable of which was the online freelance marketplace, Fiverr (FVRR), which went public in June 2019, has a market cap of 6.5 billion, and is up more than 460% since IPO. He owns 5.5% of outstanding shares.

CFO Tim Bixby previously served as CFO of Shutterstock from 2011-2015 and has an MBA from Harvard. I would highly recommend listening to this interview where he explains Lemonade's business model in a tremendous amount of depth. He owns less than 1% of outstanding shares, so not a lot of skin in the game (at least relative to Daniel and Shai).

Valuation

As of Oct. 10, 2021, Lemonade has suffered a more than an 80% contraction in valuation multiple since January 2021 (see below chart). Even at current levels, Lemonade trades on a forward EV/sales multiple of around 20x, which is well above that of their larger competitors who generally trade on low single-digit EV/sales multiples. Of course, Lemonade demands a higher multiple than incumbents due to their much higher growth rates, their technology advantage, and the fact that they are still very early in their growth curve (for context, most of their legacy competitors were founded before 1950). But can Lemonade can generate attractive returns from the current price?

Source: Sentieo data

Lemonade is an early-stage, unprofitable business with lots of optionality to expand into new products and geographies. So much can change with early-stage technology businesses, so I am wary of overly precise valuation models based on historical data. Instead, I have presented a table presenting returns on initial investment from the current price under a range of 5-year revenue CAGR and exit EV/sales multiple assumptions. As with all my valuation work, I have attempted to be conservative with exit EV/sales multiple assumptions so that any multiple expansion from the current price offers pure upside to these forecasts.

Source: Author generated

Let's conservatively assume that Lemonade grows revenues at a CAGR of 40% over the next 5 years (20 quarters) and trades on an EV/TTM (trailing 12 months) sales multiple of 6x at Q2 2026. This assumes a dramatic deceleration from their prior 3-year revenue CAGR of 92% and significant multiple compression from the current price. Under these assumptions, Lemonade returns a 1.2x return on initial investment, representing an IRR of 4%.

If we assume as a base case that Lemonade grows revenues at a CAGR of 50% and trades on an exit EV/TTM sales multiple of 8x at Q2 2026 (greater than 80% multiple compression from the current valuation), this generates a 2.1x return on initial investment and an IRR of 16%.

If we assume as an aggressive outcome that Lemonade grows revenues at a CAGR of 60% and trades on an exit EV/TTM sales multiple of 12x at Q2 2026 (70% multiple compression from the current valuation), this generates a 4.3x return on initial investment and an IRR of 34%.

Risks

No business is without risk. Here are some of the potential risks that must be considered when evaluating Lemonade as a potential investment:

  • Lemonade is not the only disruptive insurance company in the U.S.; there are a number of other technology-focused competitors founded since 2014, such as Hippo, Metromile, and Root Insurance, which might have an informational advantage over Lemonade for specific insurance products.

  • Possible execution risk from Lemonade expanding too quickly into different product lines.

  • Lemonade's AI and machine learning capabilities are overstated and loss ratios do not continue declining over time.

  • Multiple tail events resulting in catastrophic losses for Lemonade.

  • Lemonade is unable to become cash flow positive in the next 2-3 years and is forced to engage in multiple dilutive capital raises to fund future growth.

  • Either of the co-founders resign from the business or sell down a significant amount of shares near current prices.

Conclusion

Overall, Lemonade is a business firing on all cylinders with an ambitious goal to disrupt the U.S. insurance market. Leveraging the power of technology and a business model informed by collaborations with world-leading behavioral economists, Lemonade reached 1 million paying customers in a fraction of the time of their larger competitors, and have experienced explosive growth in premiums and revenues. They have a long runway for growth ahead of them both within the U.S. and in international markets, and boast a founder-led management team with lots of skin in the game. I'm a buyer at these levels.

This article was written by

Jordan Martenstyn profile picture
273 Followers
Analyst at a VC fund and Masters/PhD student in Clinical Psychology based out of Sydney, Australia. Hunting for a portfolio of 15-20 disruptive growth companies that can generate 15%+ IRRs over the next decade. I publish additional articles on my substack:https://jordanmartenstyn.substack.com/Feel free to reach out on Twitter to collaborate and discuss ideas! @jordanmartenst1
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Disclosure: I/we have a beneficial long position in the shares of 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. I have no business relationship with any company whose stock is mentioned in this article.

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