There is nothing remotely unique about the growth stories we keep hearing about today. Most have been powered by the same weak logic of running losses with the hope of becoming large enough to someday make money. Of course, every story is unique in a way and surely there will probably be 5-10 stocks out of hundreds of the current crop that will justify the hype. Is Lemonade, Inc. (LMND) one of them? Let’s find out.
An Industry Set For Disruption?
Lemonade is an insurance company that uses artificial intelligence or AI, to simplify the insurance business. This starts from the first interaction with the person where a few questions allow the chatbot to collect enough data points to start pricing the policy. The same process is also applied to clients when processing claims. Not all claims are processed via AI alone. But it is designed to simplify and in the long run give customers a better deal on pricing. This makes sense in theory as humans are a very expensive and time-consuming part of the equation. Especially, with inflation surging and wages going up, having an in-house software can perhaps help with pricing in these times. That said, AI is not all that is cracked up to be. For starters, the larger players in this business, armed with tons of cash they make every year, have always been on the lookout for efficiency. The Allstate Corporation (ALL), for example, has been deploying AI for a long time.
Enter ABIe (shorthand for the Allstate Business Insurance Expert), which my firm helped develop. Employing a rigorous approach to the words and phrases at the heart of the company’s products, ABIe’s avatar-driven interface offers accurate answers to policy questions while streamlining the quote process. From just a few thousand queries a month in 2013, ABIe now handles 100,000 – from all of the company’s employees, and not just from agents. A new version of ABIe will soon be taking queries directly from the customers. Best of all, ABIe paid for itself the first year, so almost all of the ongoing savings now drop to the bottom line.
In case you missed it, that was from 2016. Countless examples exist from within the industry, but we want to show one more to demonstrate how quickly companies figured out where the maximum usage point was for this.
From a recent Q&A from Capgemini Consulting on AI and business: “We don’t want to replace our [human] advisers — they are a really important route to market for us. But we want to augment them and add to their capabilities,” says Dr. Michael Natusch, Prudential’s Global Head of AI in the Group Digital team. “We want our human advisers to become prime users of our robo adviser, so they can tune in even better to the actual needs of their customers.”
Prudential could easily replace its human staff with robo advisers — and might save money if they did. But Prudential believes that would be a business mistake. As Natusch demonstrates, Prudential knows how to use AI to achieve its business aims, but is very selective about why they use it.
Source: Gallup (emphasis ours)
That was from 2018. Tell us again how this is all new?
Perhaps the argument here is that Lemonade’s software is more artificial or more intelligent (probably the latter). That is certainly possible and we will entertain that. Let’s see how the numbers are playing out to support that.
Q3-2021
Lemonade’s losses increased faster than its revenues for the three months ended September 30, 2021.
Source: 10-Q, highlights from author
Some of this can be attributed to growing pains as technology expenses are still extremely high and increased even faster than revenues. But investors should focus on that, as it shows how the human cost is buried elsewhere. After all, we are certain that the AI is not charging Lemonade to improve its performance. Lemonade also spent a stunning 120% of total revenues on sales and marketing. That is another key question that must be asked. Can Lemonade grow its customer base without spending such outlandish amounts on sales and marketing? The losses also bring forth an important question. How long will anyone finance this experiment? Thanks to the timely secondary offering, Lemonade is loaded with cash. Net assets were over $1.0 billion as of September 30, 2021.
Source: 10-Q
Lemonade is running a quarter billion loss rate per year though. If somehow Lemonade manages to double its revenues again, in 2022, without improving its loss ratios, we are looking at a half a billion annual burn rate. This is all assuming there is no extraordinary event that spikes claims even beyond that. Either way, we see lots of new stock being issued to finance this growth and investors may not like the dilution they get.
Valuation & Verdict
If you want to run crazy assumptions about growth in 10 years and rationalize that LMND can command any valuation, you have come to the wrong article on Seeking Alpha. Here, the base assumption is that growth investors are confusing brains with a (now dead) bull market. Even optimistically speaking, revenues will not hit $1 billion all the way into 2026.
Source: Seeking Alpha
This will also be a heavy loss-making journey according to the lone ranger ready to forecast that far out.
Source: Seeking Alpha
If we somehow ignore the stock dilution that will likely come to fund this (including the amounts for Metromile (MILE)), and use today’s share counts as a base, we can reach an idea of a fair value. ALL’s peak market capitalization this year, came rather close to its current set of revenues.
Again, giving Lemonade the benefit of 2026 revenues, we can assign a $1 billion market capitalization as achievable.
That would create a sub $20 price, in 2026. That is the upper-end best-case scenario for us. Five years is a long time and we would not be surprised to see the share count double from here (sub $10 stock price), revenues fail to meet the optimistic growth rate or large one-off events that make losses worse. The good news for investors? This.
Short interest is incredibly high (40%) and a lemon squeeze may send this ripping higher. Ideally, the company should use that to issue more shares. That short interest though keeps us neutral and not bearish.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.