Unpacking Lemonade’s S-1 Filing

Lemonade, a technology-enabled renters & homeowners insurance company, filed for a $100M IPO last week. The $100M figure is a placeholder and will likely rise in the actual offering. The company plans to trade on the New York Stock Exchange under the ticker “LMND”.

Founded in 2015 by Daniel Schreiber and Shai Wininger, Lemonade has built a full-stack property and casualty insurance carrier in the U.S., Netherlands, and Germany. The company has scaled quickly since launching in late 2016 — premium volume grew from $9M in 2017, to $47M a year later, to $116M in 2019. There are 730K active Lemonade policyholders as of March 2020.

In April 2019, the company raised $300 million of Series D venture funding in a deal led by SoftBank Group, putting the company’s pre-money valuation at a $1.8B (a hefty 27x multiple on revenue). SoftBank also led the company’s $120M Series C financing a year earlier at a pre-money valuation of $450M (meaning a nice 4x self-markup at the Series D).

The S-1 filing comes at an interesting time, both due to the pandemic and resulting macroeconomic environment, as well as the specific stage and scale of the company. While Lemonade’s top-line revenue run-rate recently crossed $100M, the company remains far from profitability having recorded a net loss of $36.5M in Q1 2020.

In this post I’ll dig into the company’s financials, product ambitions and valuation expectations as a public company. I see two key factors in pulling off a “successful” public offering: first, convincing investors that there is a clear path to profitability, and second, demonstrating how its technology platform and growth rate warrant a valuation premium over traditional P&C insurance carriers.

Product Offering

In September 2016, Lemonade launched its renters and homeowners insurance offering in New York to much fanfare. TechCrunch described the product as “pretty freaking cool” (a very rare phrase in the insurance industry). Policies are sold directly to consumers online, a deviation from traditional carriers which typically rely on agents to distribute policies (more than 93% of homeowners insurance policies in the U.S. are sold via agents). As such, the product appeals to younger, more tech-forward customers: approximately 70% of Lemonade’s current customers are under the age of 35.

The company offers competitive pricing (as low as $5 per month for renters insurance) and a mobile chat-based buying experience. Users can also file claims through the Lemonade app in minutes and with zero paperwork. According to Lemonade, it achieved a net promoter score (“NPS”) of above 70, compared to an industry average of 17. Over time, the company plans to launch additional insurance products on its platform, including travel, pet, auto, life & umbrella insurance.

Gross Premiums vs. Gross Profits

When an insurance policy is purchased, Lemonade is on the hook for any claims associated with that policy (for instance, lost or damaged possessions as a result of fire, theft or vandalism). The costs incurred by Lemonade as a result of any claims paid relative to the premiums the company collects is known as its loss ratio. This ratio can vary based on a carrier’s ability to underwrite and price policies correctly. It can also be impacted by unexpected natural disasters or catastrophic events which may lead to a spike in claims.

To help control these fluctuations, Lemonade engages in a practice known as reinsurance in which it transfers most of the premium it collects, along with any claims associated with that premium, to third parties. In return, the reinsurer pays Lemonade a commission (known as a “ceding commission”). This gives Lemonade better control over its gross margins and reduces capital requirements for the business.

The resulting gross margin for Lemonade is about 20% — i.e. for every $100 in premium written, about $20 flows to the company net of reinsurance, loss expenses, and other direct costs (for example, credit card processing fees). While its gross margin are relatively low, the company can improve its margins by a) lowering its loss ratio via enhanced underwriting, b) increasing premiums over time and c) negotiating more favorable reinsurance agreements.

Financial Metrics

Lemonade is growing incredibly quickly — since launching in New York in late 2016, the company has grown to capture approximately 7% of the in-state renters insurance market, and continues to scale quickly both in New York and across the geographies in which it operates. In Q1 2020 the company reported $26.2M in total revenue (including earned premium and investment income), up 141% from Q1 2019. Its in-force premium (the aggregate annualized premium for active customers) is $133M, up 133% from the prior year. There are 729K active customers as of Q1, the majority of whom have renters insurance policies (the company reports only 12K condo insurance policies in its S-1).

While the hyper-growth is impressive, the company is generating a relatively small amount of gross profit. In 2019, Lemonade reported only $13.1M in adjusted gross profit — its total operating expenses over the same period of time was $119.8M. As such, the company is generating a large net loss, coming in at -$108.5M in 20 19. The silver lining is that losses are shrinking relative to revenue — adjusted EBITDA margin improved from -141% to -73% between 2019 and Q1 2020.

Operating expenses relative to revenue are very high, but improving (see chart below, and note that Q1 2020 G&A excludes a one-time donation the Lemonade Foundation). Most notably, sales and marketing expense clocked in at 73% of total revenue in Q1 2020; this is potentially troubling given the company’s low gross margin (20%). Without a gross margin improvement or better operating leverage, the company would need to more than 5x its premium volume to get to breakeven.

Marketing, Retention & Customer Lifetime Value

Lemonade has been a prodigious spender of marketing dollars since launching. The company spent $131M on sales and marketing in 2018 and 2019 (combined) to drive $163M in gross written premium over the same period. Of course, marketing efficiency has improved over the last several quarters, and according to the S-1, the company “currently spends $1 in marketing to generate more than $2 of in-force premium.”

Outside of direct-response advertising, much of Lemonade’s marketing investment should be attributed to brand building. The company has developed strong brand recognition, particularly amongst younger consumers. While the S-1 does not breakout paid vs. organic customer acquisition, I would expect that the volume of organic and word-of-mouth traffic will grow nicely over the next several quarters.

Ultimately, the company will need to demonstrate that it can sustainably acquire users and retain them as active policyholders. Unfortunately, Lemonade’s customer churn (both voluntary and involuntary) is relatively high compared to its peers. Annual customer churn is about 33% (blended rate based on year 1 and year 2 churn), compared to an industry average of 16%. Lemonade customers who do renew their policies tend to spend more — about 16% more per year, on average. This means that net dollar retention (a metric more common in the SaaS world) is about 77%.

Using this data along with other metrics shared in the S-1, we can triangulate both customer acquisition cost (CAC) and lifetime value (LTV) in the most recent quarter. To do so, we first infer the volume of new gross written premiums (GWP) in Q1 2020, as we are only focused on new business generated by customer acquisition spend in the quarter. In Q1, Lemonade spent $19.2M in sales & marketing to generate $25.4M in new GWP (or $0.76 for every $1 of GWP). From there, we can use the metrics around retention and gross margin provided in the S-1 to estimate customer lifetime value. As you’ll see in the graphic below, $0.76 in marketing expense yields $0.85 in lifetime gross profit, for an LTV/CAC of 1.13.

This ratio is low when compared to both insurance carriers (we ran a similar for analysis for Allstate, which has an LTV/CAC > 7) and SaaS comps (typical LTV/CAC benchmark is 3 or greater). As a public company, Lemonade must demonstrate that it can meaningfully improve the underlying metrics that drive this acquisition cost, customer lifetime value and ultimately profitability. Over the next several quarters, the company can pull the following levers to get to closer to profitability:

• Increase gross margins by improving loss ratio: Lemonade touts its technology platform as a key differentiator in evaluating risk. According to the company, it “generates close to 1,700 data points” before quoting a home insurance policy, vs. 20–50 data points at traditional carriers. The company must prove that it can use this data to its advantage — i.e. a better loss ratio relative to incumbents. Doing so will allow the company to capture more gross profit per policy and improve customer lifetime value. The challenge ultimately will be be in balancing aggressive top-line growth with the more conservative underwriting approach required to drive down its loss ratio.
• More efficient customer acquisition: As mentioned in the marketing section, the company has invested meaningfully into its brand building and customer acquisition efforts. It will need to demonstrate continued marketing efficiency improvements over the next several quarters. For reference, Allstate spends about $0.26 to acquire $1 of new GWP whereas Lemonade currently spends $0.76.
• Improved customer retention: Key to building a sustainable business is Lemonade’s ability to retain customers for several years in order to pay back the marketing expense required to attract those customers. This is an important lever for the company — for example, increasing annual customer retention from 66% to 76% doubles LTV/CAC from 1.1 to 2.2. There are a few encouraging signs here: first, retained customers tend to spend more with the company (resulting in higher net dollar retention), and second, as the company introduces more insurance products it may be able to better retain customers by bundling these products.
• New products with an attractive attach rate: Core to the Lemonade strategy is its ability to successfully launch new insurance products to compliment its core renters product, as discussed in the S-1: “Our regulatory framework, technology stack, and brand are all extensible to new lines of insurance, and we anticipate that these will contribute to our growth in the future.” The strategy makes sense given the size of the renters insurance market ($3.8B) relative to other categories like homeowners ($105.7B), auto ($288.4B), life ($868.5B) and pet ($19B). One could argue, however, that going after new insurance lines is analogous to starting a new companies within Lemonade — the approach to underwriting, policy creation and claims management can vary greatly. The bet here is that the Lemonade team and technology platform is extensible enough scale into new product lines, and that selling into its large base of existing customers (730K and counting) will yield marketing efficiency advantages.

Valuation Expectations

Lemonade’s last funding round in Q1 2019 valued the company at more than $2B on a post-money basis. At the time of this financing, the company’s gross written premium run rate was about $77m — meaning the round valued Lemonade at a 26x multiple (which is rich even for fast-growing SaaS businesses). Applying this same multiple to the company’s Q1 2020 GWP run rate ($152M) would value the company at just shy of $4B.

It will obviously be difficult for the company to justify such a valuation without a strong belief in the long-term growth story around improved loss ratios, better retention and successful cross-sell / up-sell of new insurance products. Lemonade will also need to convince investors that it should not be valued as a traditional insurance carrier (which typically trade on a multiple of net income or book value). Fortunately the company has an impressive growth profile (see chart above) and is early enough in its journey to get a “pass” on its lack of profitability. In the insurance industry especially, companies tend to see profits only after several years of operations.

The company would clearly like to steer investors towards SaaS-like multiples (the S-1 includes more mentions of “digital platform” than it does “insurance carrier”). But the gross margin profile and customer retention issues may scare investors off, at least until Lemonade demonstrates sustained improvement across those metrics.

The table above shows some valuation scenarios across different comp sets, including the company’s last private round valuation multiple. As you can see, there is a broad range of outcomes depending on the company’s 2020 growth rate, as well as the set of peers public investors decide to benchmark Lemonade against. Also included on the table is Palomar Holdings (PLMR), which is another fast-growing property insurance carrier that is trading at a healthy multiple as compared to other carriers.

Lemonade is strong example of how technology and digital customer acquisition can lead to outsized growth within industries usually dominated by large, slow moving incumbents. It will be interesting to see if the company can transition from market share acquisition to profit generation over the next several years. Regardless, their IPO is a nice win for the broader insuretech community.

Thanks to Eddie Ackerman and Moriya Blumenfeld for assistance on this post.