After the high of a “successful” IPO, the company has quickly been introduced to the less fun sides of being a public company: increased investor scrutiny, short attacks and the ability to watch the market judge your earnings and conference call performance in real time.
Indeed, every company being pitched right now by investment bankers to follow in Root and Lemonade’s footsteps should be told one simple fact in conjunction with any analysis showing potential trading multiples: Being a public company Sucks with a capital S.
Of course, the honeymoon period for the latest stock market darling tends to last a little longer than the few hours Root enjoyed above its IPO price of $27. Since its intra-day peak of $29.37 the stock is down 49%, and is 22% below the post-money valuation from its pre-IPO capital raise (plus the proceeds from the IPO).
One of the fundamental laws of nature is that every action has an equal opposite reaction. Root is beginning to experience that now as the offset to the euphoria and hype, including the first public signs of interest from the short community.
For example, Edwin Dorsey at the Bear Cave launched a negative note on Root on December 3, highlighting doubts over the company’s comments on its conference call that it had cut base rates in Texas. The note also included content from customer complaints filed with insurance departments obtained via a FOIA request accusing the company of a bait and switch strategy on pricing, and highlight the company was facing market conduct examinations in two states. (Per rate filings, base rates in Texas did go up +4.1% in April, with a range of +99.7% to -33%, with an indicate need of +11%).
If that’s a small taste of what is likely to come in the future, I want to pivot our focus backwards for a moment. As I was busy with Metromile over the past week or so, I haven’t had a chance to comment on two major milestones for Root as a public company: the launch of coverage from sell-side equity analysts, and the company’s first earnings and conference call. Let’s take them each in turn.
First, the company was able to achieve positive coverage from sell-side equity analysts. The result seems to have been negligible at best.
For example, on November 20, seven analysts launched coverage with a largely neutral to positive skew (4 buys, 3 holds, 0 sells). The fact that these largely positive reports led to a stock movement on the day of -10% is suggestive of the net contribution of this research to the market’s understanding of the company.
A few points are worth making.
First, I really struggle with analysts trying to execute the sell-side two-step of having (a) a neutral position on the business, and (b) a neutral position on the company’s stock.
Let’s be clear that when a stock is priced for perfection and mass disruption, a neutral view on its business prospects should lead to a sell recommendation. And as we pointed out in our analysis of Metromile, at some point the fact that a company is “yet to prove” any competitive advantages should be sufficient to begin to discount their “disruption” narrative – at the very least.
Second, I simply struggle to understand the logic of the valuation approaches used by some on the street to justify their price targets and ratings. Multiple analysts relied on the trading comparables of internet businesses like Netflix and Peloton. I must say I have heard about the new insurance “cycle” many times, but never one that involved taking spin classes from the comfort of home.
One fun detail. With the stock now at $15, and the most heavily weighted trading comparable Lemonade up 43% since the Root coverage launched, if analysts believe their valuation approach rather than just solving for +/- the stock price, surely we should see a spate of upgrades and price target increases now? Indeed, one analyst’s valuation approach relied 50% on Lemonade’s trading multiple, a fact alone that would justify a 22% increase in their price target since initiation.
Let me be very brave and make a highly controversial prediction. At scale, full-stack InsurTechs with balance sheets will earn comparable economics to “traditional” insurance companies, however hard they try to financially engineer their early growth stages. The variable is growth, not margins. Comping insurance companies to infinitely scalable internet business without comparable capital requirements is not credible.
I have some sympathy for the Street. The business model has evolved to devalue research and genuine insight in preference of corporate access. If all goes well, Root is likely to be an active customer of investment banks. And institutional money has a long bias that generally means you’ll upset more clients than you make happy by pounding the table on a short.
Perhaps more importantly, in a bull market driven by tech-fever, it is simply hard to generate interest in your work on “old-economy” companies among generalist investors. The temptation to seize on any “tech story” to join the party must be high.
That said, some of these analysts are going to be walking a very fine line trying to triangulate between their price targets, investment recommendations and content of their analysis. In particular, any gap between their published research and private communications will open them up to similar charges that got analysts into trouble during the tech bubble years.
Second Root’s management was introduced to one of the chief joys of being a public company: reporting earnings, facing investor scrutiny on conference calls, and watching the market react in real time.
With Root’s stock price off 45% from its recent highs, its first earnings and conference call with investors represented the first test of management’s ability to confront their critics and regain control of its narrative. And indeed, it was hard not to be impressed by a management team willing to take on the key controversies like “just how authentic is Bubba Wallace” in response to questions about their CAC efficiency.
In general, the company’s approach to its earnings release and conference call was to try and re-focus investors on its long term “narrative” and away from the near term (horrible) growth numbers. And their strategy to deal with critics of their business model and customer mix (first outlined by us here) simply seemed to be to ignore them out of existence.
Given the earnings were pre-announced, I don’t intend to go through them in detail. However, there were two “new” data points generated from earnings that are worth commenting on.
The first was the high prominence it gave to the below chart showing the supposed loss ratio improvement by state from 2019 to 2020.
This is simply another attempt by the company to find a different way of showing the same data and pretending it shows fundamental improvement at the company rather than being a direct consequence of the frequency benefit due to Covid-19 restrictions that have led to similar YoY improvements at every major insurance company. Recall, we de-bunked the last version of the chart here. This is simply the same chart, broken down by state instead of underwriting vintage.
The irony here is that another way of saying this is a significant portion – perhaps even the majority – of its states remain below sustainable loss ratio levels even with the tailwinds of a once in a hundred-year benefit from lower frequency.
We should note that management explicitly tried to attribute this to the “predictive power” of its telematics program improving rather than due to the pandemic.
Rosenthal went on to say the company decided to share the data because “we thought it was very compelling” and that “what you’re seeing [in the chart] is a function of time more than anything else”.
I beg to differ. The only compelling part of the chart is the fact that the company would make such a big deal out of such an easily disprovable data point.
The second useful data point we took from the company was public acknowledgement of our work showing the company is re-engineering its sales funnel to apply tiering to its acquisition cost factors.
We have argued this is tacit acknowledgement that its customer acquisition strategy has resulted in over-paying for non-standard customers with too short expected policy lifetimes to justify the CAC spend. Root’s management seems to want to sell it as further confirmation of their brilliance.
My research team has studied Root as a business in immense detail, and have found little evidence that management is stupid. To borrow a phrase, when you have eliminated the impossible, whatever remains, however improbable, must be the truth. The only inference left to us is that, if management is not stupid, they simply think capital markets are. We do not think this is a viable long-term strategy.
With the stock down 13.5% the day after earnings and the call, it does not even seem to be a viable short-term tactic. We think the company’s credibility with investors would benefit from some hard-truth telling, some admission of missteps, and a simple plan to get the company back on track.
Right now the company’s predilection for treating every data point (even negative ones) and every action (even remediation) as further evidence of their brilliance carries all the PR savvy of Prince Andrew chalking up his relationship to Jeffrey Epstein as due to his “tendency to be too honorable”.
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