Greenhaven Road Capital - Hagerty: Very Profitable Car Insurance Business With A Very Long Runway For Growth
Summary
- Hagerty is a SPAC trading at over 200X forward earnings.
- Two sophisticated insurance companies, State Farm and Markel have already invested in HGTY.
- Hagerty is a very profitable car insurance business with excellent unit economics and a very long runway for growth.
Domepitipat
The following segment was excerpted from this fund letter.
Hagerty, Inc. (NYSE:HGTY)
A SPAC trading at over 200X forward earnings run by a man who almost became a priest should be either the set-up to a bad joke or a pitch for a short investment. However, out of the rubble of SPAC-ageddon emerges a very interesting company: Hagerty, Inc.
Earlier this month, we held an Annual Meeting for LPs that included a “Fireside Chat” with Hagerty’s CEO. The interview is worth watching as it covers much of the ground of this write-up and provides additional details.
Hagerty stood out to us when they disclosed their historical and prospective investors during their “de-SPAC” process. State Farm, the largest auto insurance company in the U.S., invested $500M in the SPAC deal at $10 per share, and specialty insurance company Markel (MKL) not only owned 25% of Hagerty prior to the de-SPAC, but also invested an additional $30M in the deal at $10 per share.
Two sophisticated insurance companies investing in another insurance company… It was unlikely the trailing P/E ratio that convinced State Farm to part with half a billion dollars and have their CEO join Hagerty’s Board, so we decided to do some digging.
Today, 92% of Hagerty’s revenues are insurance related. I will describe the other pieces of the business shortly, but the economic engine that powers the company is automobile insurance. More specifically, the company specializes in a particularly niche insurance category: classic and collectible cars. Hagerty insures everything from 100-year-old cars requiring a crank to start to Mazda Miatas from the 1980s and modern “Super Cars” (McLarens, Bugattis, Lamborghinis, etc.) that are currently in production.
What differentiates a Hagerty policy from the traditional policy you have on your Ford / Toyota / etc.? Hagerty policies aren’t for “daily drivers.” Instead, they are insuring people’s prized possessions like the old convertible that the owner only drives on sunny Sundays to a farmers’ market. People treat their “toys” well, and this shows up in Hagerty’s numbers with their loss ratio (amount paid out for claims) coming in around 41% vs. 70%+ for a typical auto insurer.
In capitalism, profit pools typically get competed away, but Hagerty has not seen this happen to date despite being in existence since the mid-80s. The low loss ratio is not a new phenomenon – it has consistently been nearly half the industry average. Can that persist going forward?
Pricing and servicing a policy for a collector car has its pitfalls. To cite one of the company’s simple examples, take the Chevrolet Camaro from 1969, considered the finest year for classic Camaros. Over 240k Camaros were produced in 1969; however, they were made in 147 different variants. The least valuable version is worth approximately $11,000 while the most valuable version is worth over $1M. An insurance underwriter better understand which version they are insuring.
In addition, unlike most automobiles, the value of classic/collector cars tends to appreciate each year. Both the insurance company and the customer need to understand the rate of appreciation for the model in order to avoid a situation where the insurance proceeds are insufficient to replace a beloved car. Classic cars also face service challenges. If one needs to replace the windshield on a 1915 Model T Ford, trying to file (let alone complete) a claim with the 800-number of a mega insurer will likely be a frustrating experience.
Hagerty has a whole team dedicated to helping its members source specialty parts, a service of extremely high value to customers. Large insurers are not equipped to service this niche market well – they have neither the data nor the operational support for this niche product that ultimately equates to a small percentage of their overall insurance book.
The typical owner of classic/collector cars loves their cars but also has many other items needing insurance (homes, boats, daily drivers, etc.). Consequently, nine of the top ten insurers (not Geico) partner with Hagerty to price and service insurance to their policyholders with classic and collectible cars. Why would they partner with a company some would see as a competitor?
Hagerty provides more accurate pricing and better service and reduces the likelihood of losing excellent customers by mishandling a classic/collector car policy that is only a small, but emotionally charged portion of the overall relationship. By not offering homeowners, umbrella, and other insurance products, Hagerty avoids channel conflict, meaning that those that would otherwise be Hagerty’s competitors are instead their partners, creating a favorable competitive dynamic within the industry that provides at least a partial explanation for the persistence of the company’s low loss ratio.
For more than a decade, Hagerty has grown at three times the rate of the overall auto insurance industry, fueled by high retention rates (90%+), effective marketing (more on that later), and the partnerships described above. What is not obvious when first studying the company is that existing partnerships tend to be a source of ongoing growth. Many auto insurance agents are independent, meaning, for example, that they may represent Allstate (ALL) as well as other companies.
Hagerty has a partnership with Allstate, but agents do not have to use Hagerty or switch their customers off an inferior Allstate classic car policy on to an Allstate/Hagerty policy. That means that the book of business on classic cars not with Hagerty has continued to grow at the same time as the mutual policies have.
This semi-captive audience is a source of value because Hagerty has a “hunting license” within that population and slowly converts over agents and policies. The fact that nine of the top ten insurance companies are partners does not mean that future growth is stunted – Hagerty is still early in the penetration of those customer bases.
The market size for classic and collectible cars is larger than I would have thought. Hagerty estimates that there are over 43M registered classic and collectible cars. That number grows each year as new collector cars (McClaren, Ferrari, etc.) are produced and other cars “age into” the category (25 years old or more). Hagerty currently has ~2M cars insured, so there is a long runway for growth.
In addition to acquiring customers through the partnership model, Hagerty also acquires customers directly. Unlike many large insurers that blanket the NFL television broadcasts with commercials every fifteen minutes, Hagerty focuses on content and events that tap into classic car lovers’ passion for cars. They now own several of the largest classic car shows in the United States in addition to the second largest (by circulation) automobile magazine, a YouTube channel focused on classic cars with over 2M subscribers, and an automobile valuation tool that is widely used.
Hagerty also operates a “Drivers Club,” which provides roadside assistance and weekly emails to over 2M members. This diverse set of assets is intended to fuel peoples’ passion for cars – insurance is rarely, if ever mentioned directly. However, these offerings serve as very effective customer acquisition tools. By our math, Hagerty’s customer acquisition costs are less than half the industry average.
To further monetize their core insurance business more effectively, Hagerty entered the reinsurance business in 2017-18 with the creation of HagertyRe. Since its acquisition of Essentia in 2013, Markel was Hagerty’s captive reinsurance partner whose primary function was to provide their balance sheet and credit rating to support the underlying growth of Hagerty’s insurance book. The reinsurance business is very attractive for both Hagerty and Markel due to the low loss ratios experienced in the underlying book of business.
To illustrate this point, let’s see how $100 of premium flows through the reinsurance business. First, Hagerty gets to keep ~$42 as a commission for servicing the policy. $32 of that is a base commission and $10 is a contingent commission that is earned if loss ratios stay within a pre-determined range. The next ~$41 will be paid out to policyholders because of accidents incurred. (We are now up to ~$83 out of the $100 premium.)
Next, ~$6 will be used on operating expenses and reinsurance costs. The net result is that, for every $100 in premium received, HagertyRe earns ~$11 in operating profit. That sounds great by itself, but there is more: for every dollar retained in HagertyRe’s business, it can write $3-4 in premiums. In other words, the return on every incremental dollar retained in the reinsurance business is 30-40%.
For the past two decades, Hagerty has been led by CEO McKeel Hagerty. His parents started the company in their Michigan home in the 1980s, initially focusing on insuring wooden boats on the Great Lakes. Recognizing that people love their toys and, if done properly, insuring the toys was a good business, they added collector cars and began to expand beyond Michigan.
On paper, their son is not a person you would select for the job. On paper, he is a tenth-round draft choice. He was an English and Philosophy major in college and then then decided to enter seminary, studying to be a Russian Orthodox priest and pursuing higher education.
However, since it came under the leadership of McKeel and his sister Kim (who held various roles before retiring in 2014), Hagerty has grown the company from 30 employees to over 1,700 today while launching the partnership model, entering the media business, beginning the Driver’s Club, creating their specialty valuation tool, and buying up classic car shows.
McKeel has a very folksy demeanor, but this is no simple small-town boy. In 2016, he was elected to serve as the global chairman for YPO (Young Presidents Organization, the world’s largest CEO organization) and has traveled the world interacting with business leaders. The company has a strong culture and has been voted among Fortune’s Best Places to Work for the past four years. If one peels back the layers, this business has been assembled methodically and is about to enter its next phase of growth.
Insuring cars with low loss ratios, low customer acquisition costs, and low churn is an excellent business. Creating and supporting a marketplace for classic and collectible cars might be an even better business. For a marketplace business, there are three important components – the supply side (goods), the demand side (customers), and a trusted intermediary. Hagerty has these pieces. They can feed the demand side through their media properties and leverage email relationships with over 2M Hagerty Drivers Club members.
They also have a top-of-funnel position controlling the valuation tool that is used across the industry. On the supply side, Hagerty owns the software used by over 200 leading classic car dealers to manage their inventory and also owns several car shows that have traditionally hosted in-person auctions as part of their programming.
Through their recent acquisition of Broad Arrow Group, Hagerty also acquired the management team that led the automobile auction and financing business at Sotheby’s. As an insurance company and the name behind the valuation tool most widely used in the classic car space, Hagerty is starting from a position of trust.
While Hagerty has been laying the groundwork to enter the auction business for several years, they only completed their acquisition of Broad Arrow Group last quarter and have since held two auctions selling a total of $70M+ of classic cars. They also began to offer classified ads, but the real volume will come over time, as an alternative to Bring-A-Trailer (a popular auction platform for classic and enthusiast vehicles) was recently announced and will debut next month.
The company’s data suggests that, of the cars that Hagerty insures, $12B in market value traded hands in a combination of auctions and private transactions over the last 12 months. In addition to monetizing a passionate car-loving community that Hagerty has assembled, the marketplace provides an opportunity to both improve retention and acquire new customers since the moment of purchase is an ideal time to attach a new insurance policy.
Given that a Hagerty member selling their single classic/collector vehicle is the largest cause of churn, Hagerty is simply better positioned to monetize and execute such transactions than traditional auction houses or marketplaces.
Short-term financing is yet another ancillary business that will emerge from the marketplace business. Hagerty, which has the industry leading valuation tool, insurance relationships with millions of owners, and a strong balance sheet, is in prime position to provide short-term loans to facilitate transactions (typically at 50% loan to value).
Frequently, these loans are essentially bridge financing until a collector can sell another car, a transaction which Hagerty again is well-positioned to capture vs. competitors. The flywheel at Hagerty is spinning – what would once have been a simple car insurance policy can now turn into a buyer’s commission, a seller’s commission, listing fees, and financing fees.
While the marketplace business has the potential to be quite large, it is in its infancy and will likely not be a source of large profits in 2023 or 2024 as Hagerty invests in growing the business. Fortunately, Hagerty has two contractual events that will occur in 2023. The first is that State Farm will onboard 470,000+ policies to Hagerty. This is part of their 10-year contractual relationship and $500M PIPE investment.
The State Farm opportunity has not contributed any revenue for the past two years, instead actually only contributing costs as massive systems integrations and upgrades have been undertaken. Those costs are now dropping off as the partnership becomes revenue-generating next year. The second contractual event will be the change in reinsurance revenue share between Markel and Hagerty, increasing Hagerty’s share of revenue from 70% up to 80%.
One would think that the upcoming contractual events and burgeoning marketplace opportunity would be well understood and reflected in the HGTY share price, but to us that seems to not be the case. One more casual indication of investor apathy is that, on the website Seeking Alpha, fewer than 500 people “follow” Hagerty vs. more than 42 million for Apple (AAPL) and hundreds of thousands for many companies you know.
It was a SPAC, screens expensive (in part because State Farm has been all expense no revenue) and has a small free float (less than $3M trades daily). Until last week, Hagerty had only one sell side analyst who, in their initiation report, did not even give financial projections beyond 2022 for 2023. Last week, a new analyst initiated coverage and did include 2023 projections, but these somehow appear to ignore the State Farm policies and the marketplace revenue, which are both 2023 events.
Hagerty has grown at 3X the overall insurance industry and, with increased penetration of their partnerships, the realization of contractual events, and launching of the marketplace, I believe the topline growth rate will inflect to over 30% per year for the next few years.
Loss ratios should hold steady at ~40% lower than the industry average, and customer acquisition costs will likely decline further to less than half that of the industry average. Because of the statutory nature of the product (you need insurance if you want to drive your car), the contractual events in 2023 (State Farm and Markel/reinsurance), and a growing marketplace, Hagerty is well-positioned to withstand a recession should one occur in 2023.
Hagerty will continue to screen expensive on an earnings basis for the next few years as they invest in their marketplace and international insurance businesses. However, at the core of Hagerty is a very profitable car insurance business with excellent unit economics and a very long runway for growth as they continue developing the ecosystem to support, sustain, and monetize peoples’ passion for cars.
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