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Lemonade IPO | S-1 Breakdown

By 

Max Motschwiller

|

Jun 12, 2020

Company Overview

Lemonade, a digital consumer insurance provider, filed for a $100M IPO. That $100M figure is a placeholder and is likely to rise by the time the company prices their IPO. Goldman Sachs is leading the IPO and Lemonade plans to trade on the New York Stock Exchange (NYSE) under the ticker “LMND.”  Lemonade’s mission is to “harness technology and social impact to be the world's most loved insurance company” and it operates in one of the largest and least digitized industries in the world. Most of the industry remains offline, with more than 93% of homeowners insurance policies in the United States still sold via agents. Daniel Schreiber, co-founder and CEO of Lemonade, started the company in 2015, with a view that the existing parts of the insurance value chain are dated. Lemonade’s core product today is renters insurance. They have added condo/homeowner insurance and plan to add additional product lines (e.g. travel, pet, life) to grow their relationship with customers over time. 


Source: Company S-1

While Lemonade has only been around for 5 years, it has grown its revenue to $67.3M in 2019, up 199% YoY with 643,118 active customers up 108% YoY. Lemonade ended the Mar-20 quarter with $26.2M of revenue, up 138% YoY. Lemonade is headquartered in New York City with a large presence in Israel and has 329 employees across the company. The company was incorporated as Lemonade Group, Inc. in June 2015 and later changed their name to Lemonde, Inc.

Product & Technology

Lemonade currently offers insurance products to renters and homeowners in the United States and liability insurance in Germany and the Netherlands. The insurance in the United States covers stolen or damaged property, and also covers personal liability, which protects the consumer if they are responsible for an accident or damage to another person or their property.

Source: Company S-1

Lemonade’s core product offering is mobile-first and leverages artificial intelligent (AI) chat bots to create an end to end digital insurance experience. To receive insurance, consumers can chat with AI Maya (customer experience bot) and by answering an average of 13 questions receive a bindable renters insurance quote in a median time of under two minutes, and under three minutes for a homeowner quote. 96% of claims filed are started by chatting with AI Jim (claims experience bot), which pays claims in as little as three seconds. The CX.AI bot offers efficiency in customer support service inquiries, like change of address or transfer of coverage. As of Dec-17, 6% of support requests were resolved by CX.AI, that percentage has increased to 32% in just over 2 years.

Source: Company S-1

Lemonade also offers customers a unique “Giveback” feature. After customers purchase a policy, the company asks them to select, from a pre-screened list, a charitable cause to support with residual premiums from their policy. As part of the annual Giveback program Lemonade donated over $600,000 to 26 nonprofit organizations in 2019.

Lemonade claims to have a customer net promoter score (NPS) of 70, which is high, especially in the insurance market.

On the backoffice side, Lemonade has developed a technology and data platform that informs their efforts around many business elements including marketing, underwriting, fraud detection, and servicing. This fully integrated technology combined with data is key to enabling Lemonade’s strategy, business model and consumer experience. They highlight this in the flywheel below:

Source: Company S-1

Lemonade is licensed in 40 states and currently operates in 28 of those states, including Washington, D.C., which are home to approximately 75% of the U.S. Population. They hold a pan-European license, which allows them to sell in 31 countries across Europe.

Business Model Summary

Insurance companies often have predictable and highly recurring top-line revenue, but risk of bottom-line volatility due to losses. Lemonade has taken the approach of using reinsurance, a financial instrument under which one insurer, the reinsurer, agrees to cover a portion of the claims of another insurer, the primary insurer, in return for a portion of their premium. The implementation of reinsurance can come in different structures around things like size, terms and duration. Using these reinsurance structures, Lemonade transfers risk, lowers its cost of capital and maintains more control of its gross margin while sharing premium with reinsurance partners in return. 

The chart below shows “ceded” earned premium as a percentage of gross premium. The historical numbers have been consistent at ~15-16%.

Source: Company S-1

On July 1, 2020, Lemonade will have proportional reinsurance protecting 75% of their business. Under these contracts Lemonade transfers, or "cedes," 75% of their premiums to reinsurers. In exchange, these reinsurers pay Lemonade a "ceding commission" of 25% for every dollar ceded, in addition to funding all of the corresponding claims, i.e. 75% of all claims. This arrangement shifts Lemonade’s future P&L, which is a surprising change in the midst of an IPO. The changes should correspond to increasing ceded earned premium, lowering net earned premium, increasing commission income, lowering loss and loss adjustment expense and limiting gross margin volatility. It also increases capital efficiency by offloading regulatory capital requirements to the reinsurer. Under this new structure Lemonade has seven proportional reinsurance partners and eight non-proportional reinsurance partners with term lengths of both one and three years.

The continued availability and terms of reinsurance protection has an important impact on Lemonade’s business model and is dependent on variance from the level of losses anticipated at underwriting. If Lemonade is unable to maintain adequate reinsurance at reasonable rates they would have to increase their risk exposure or reduce the level of underwriting commitments, each of which could negatively impact volume and profitability. 

Summary Metrics and GTM (Go-to-Market)

Lemonade’s primary marketing channel is the internet, where they pay for ads through various media and social media platforms like Facebook, Instagram and Google. Lemonade’s products attract a younger demographic of first time insurance buyers. Approximately 70% of customers are under the age of 35 years old and 90% claim they did not switch from another carrier when joining Lemonade.

  • Currently spends $1 in marketing to generate $2 of in force premium (IFP), which is approximately equal to annualized gross written premium.
  • Lemonade states that “Applying a roughly 20% gross margin, we would earn back the cost of acquiring our customers in just over two years."
  • California, Texas and New York represented 61% of Lemonade’s gross written premium in the quarter ended Mar-20.
Source: Company S-1

Market Opportunity

Insurance is one of the world's largest industries with approximately $5 trillion spent globally on property, casualty and life insurance premiums per year. The market remains fragmented with no single company owning more than 4% market share. Furthermore, the ecosystem has not yet experienced the same digital transformation as compared to other large global markets, like transportation.

The largest insurance companies offer multiple lines of insurance products to the same user (e.g. auto and home). As customers accumulate wealth and have changing life events their insurance needs also grow. Lemonade has the opportunity to continue to expand its product offering and coverage to retain consumers and increase their lifetime value without having to spend incremental marketing dollars. For example, in February 2020, the Company announced its plan to launch pet insurance this year.

  • Larger premiums paid per year coincide with higher median ages.
Source: Company S-1
  • Lemonade has demonstrated the ability to consistently increase the number of graduates, defined as a customer upgrading their policy from renters to a condo or homeowner policy, as a percentage of active condo policies. Condo policies account for 12,445 or 1.7% of the customer policies but have significantly higher premiums.
Source: Company S-1

Competition

The renters and homeowners insurance market is well established and competitive. There are large traditional providers like Allstate, Farmers, Liberty Mutual, State Farm and Travelers and some of these players have started new digital first brands like Farmers with its Toggle brand. The large incumbents have competitive advantages including brand recognition, access to capital, multiple product lines that can be “bundled” and more types of coverage. Lemonade also faces competition from technology upstarts like Jetty, Hippo and Kin. There are also other technology startups that are operating in adjacent lines of insurance that may offer renters and homeowners insurance products in the future.

Investors and Ownership

As of Dec-2019, Lemonade has $480.2M convertible preferred stock, which matches closely with the $478.8M of total capital raised according to Pitchbook. 5%+ pre-offering institutional investor shareholders include Softbank (27.30%), Sequoia Capital Israel (10.30%), Aleph (10.30%), General Catalyst (7.30%) and XL Innovate Fund (5.20%). The two co-founders and Daniel Schreiber (CEO) and Shai Wininger (President, COO), own 8.05% and 8.93%, respectively. According to Pitchbook, the Series D was a $300M total round at a $2.1B post-money valuation in April-2019.

% Ownership, Pre-Offering

Source: Company S-1

Preferred Stock Prices by Series

Source: Company S-1

Financials and Other Metrics Output

Lemonade reports on different premium metrics defined below:

  • Gross written premium is the amount received, or to be received, for insurance policies written by using Lemonade during a specific period of time without reduction premiums ceded to reinsurance. This includes new written business, renewals of existing policies and size of premium rate of bound policies.
  • Gross earned premium represents the earned portion of Lemonade’s gross written premium. Their insurance policies generally have a term of one year and premium is earned pro rata over the term of the policy.
  • Ceded earned premium is the amount of gross earned premium ceded to reinsurers.
  • Net earned premium represents the earned portion of gross written premium or gross earned premium, less the earned portion that is ceded to third-party reinsurers. Premium is earned pro rata over the term of the policy, which is generally one year.

Today, Lemonade’s revenue is primarily net earned premium, 95% of 2019 revenue, and net investment income, 5% of 2019 revenue. Consumers usually are up for renewal on an annual basis. 

Lemonade did not disclose a quarterly P&L except for Mar-19 and Mar-20 quarters. They did choose to disclose a select group of metrics reported on below.

Historical P&L & Metrics ($M)

Source: Company S-1

Annualized Operating Revenue ($M)

“Operating Revenue” is a non-GAAP financial measure that helps normalize revenue by subtracting both earned premium ceded to reinsurers and commission revenue. It multiples quarterly revenue by four.

Source: Company S-1

Annualized Net New Operating Revenue ($M)

Net new operating revenue has been declining slightly over the past two quarters.

Source: Company S-1

Adjusted Gross Profit ($M)

Source: Company S-1

After falling in Dec-2018 through June-2019, quarterly adjusted gross margins have increased to 18-20%

Source: Company S-1

Sales & Marketing and Research and Development Expenses ($M)

S&M has continued to come down as a percentage of revenue, but still remains high at over 73% in Mar-20. R&D spend has been consistently lower than S&M, at 13% of revenue in Mar-20.

Source: Company S-1

Quarterly Adjusted EBITDA ($M)

Adjusted EBITDA losses are large and were accelerating through 2019, but started to shrink and become a smaller percentage of revenue in Mar-20.

Source: Company S-1

Customers

Lemonade ended Q1-20 with 729,325 customers, up 96% YoY and 13% QoQ.

Source: Company S-1

Net New Customers

Over the last four quarters net new customers additions have ranged from 71,181 to 119,499 with the last two quarters below the peak of Sept-19 peak.

Source: Company S-1

Premium Per Customer

Premium per customer has increased steadily by quarter over time and is currently at $183, up 19% YoY and 3% QoQ.

Source: Company S-1

Customer Retention

As of the quarter ended Mar-20, year one customer retention rate (% of starting purchasing customers remaining at year one) and year two customer retention rate (% of year one customer remaining at year two) were 75% and 76%, respectively. However, these reported retention rates exclude company-initiated cancellations, rescissions and non-renewals based on underwriting risk assessment. Taking this additional churn into account, year one customer retention rate is 62% and year two customer retention rate is 71% for an implied year two customer retention as a percentage of starting a starting purchasing customer of 44%.

Company S-1

Loss Ratios

Loss ratios are important for understanding Lemonade’s historical underwriting performance.

  • Gross loss ratio, expressed as a percentage, is the ratio of losses and loss adjustment expense to gross earned premium.
  • Net loss ratio, expressed as a percentage, is the ratio of losses and loss adjustment expense, less amounts ceded to reinsurers, to net earned premium.
Source: Company S-1

Valuation

Public property & casualty (P&C) insurers and reinsurers today are, generally speaking, mature businesses with low revenue growth and are profitable on a net income and free cash flow basis. These businesses (a select group of which are shown in the comps table below) typically trade on multiples of earnings (e.g., price / NTM EPS) or book value (price / book value per share).

Because Lemonade has negative net income today, imputing its value based on these insurance comps would require a “discounted future value” analysis. In this analysis, one would forecast Lemonade’s net income to a point in the future when net income is positive. This would ultimately require forecasting the entire business (gross premiums, net earned premiums, loss ratios, sales & marketing expense, etc.), or at the very least, assuming a “steady state” net income margin (say, 10% for example) based on the public comps. Then a range of multiples would be applied to that net income to calculate a range of future value of the business. These multiples could be higher or lower than the public company peers based on factors including top line growth, margin profile and scale. At this point, you would then discount that future value to the present using an assumed discount rate.

The investment banks advising Lemonade on its IPO likely frame its valuation based on a combination of methodologies, including discounted future value and discounted cash flow (DCF).

Source: Capital IQ
Source: Capital IQ

In its updated S-1/A on June 25, 2020, Lemonade included an expected price range of $23-$26 per share. At the mid-point of the range ($24.50), this implies an equity value of $1.402B. Notably, this is a down-round from the $42.21 per share price of the Softbank led Series D in 2019. Given the multiple layers of assumptions required to perform a discounted future value analysis, we’ve opted to include a simpler valuation approach here for reference. We show an analysis at various prices (AVP) model along with implied revenue multiples based on assumed NTM revenue growth growth rates.


Source: Company S-1/A. Note: Growth rates are illustrative

Pinpointing Lemonade’s intrinsic value, as with any business, is challenging and in reality, many factors will affect how Lemonade trades. Lemonade’s perceived “scarcity value” as a digital-first insurance provider and its brand recognition among millennials who will continue to expand spend and adopt its add-on products might warrant a premium. It’s smaller relative scale and negative margins may warrant a discount, which could be offset by a premium for its significantly higher growth. At the end of the day, each of these factors contribute to Lemonade’s ability to generate future free cash flow, which ultimately determines its value. 

Lemonade is significantly smaller than many of the recent technology IPOs, but is growing quickly and believes the market-size and ability to continue to innovate on the consumer experience and grow LTV offers great opportunity. As one of the first next-generation digital insurance providers to file for an IPO, the industry of insuretech players and investors are watching closely to see how the public markets respond to the offering.


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