Demand for the Lemonade (LMND) IPO has been very strong. The company increased the price range from $23-26 to $26-28 but experienced IPO investors know they will be leaving money on the table and the shares are likely to open up sharply higher from the IPO price.

Lemonade also fits into a broad theme of FinTech and InsurTech companies that are aiming at the needs of younger, more modern consumers for which old models of human agents and financial planners is a non-starter.

Their lofty mission is to “harness technology and social impact to be the world’s most loved insurance company.”

Insurance is a huge business so investors are paying attention. The property, casualty and direct business in the US is ~$650B.

Here’s the lemonade story in brief:

  1. They target first time insurance needs like renters and convert them to customers with a fully digital model that makes the purchase fast and easy. They company has invested heavily in the design and implementation which is a differentiating factor.
  2. Lemonade is a “full stack” insurer with a lower cost operating structure that gives them a pricing advantage, particularly in smaller policies like renters or homeowners insurance. Their plan is to continue to capture a large share of this first-time buyer market and to grow with these younger customers as they require more insurance over time.
  3. Their business model is different than traditional insurers in that they take a fixed 25% of premiums and offload excess claims to reinsurers. Excess premiums are usually donated to nonprofits selected by their customers. Lemonade is a B Corp which will appeal to the ESG investors.
  4. The company believes that this “cocktail” of great prices, buying experience, claims handling and aligned values has broad enduring appeal – especially in a market as poorly served as insurance. There are some firms like Geico and Progressive that do a better job than average but their strategy is more around cherry picking the best customers.
  5. There’s lots of technology candy in the story to appeal to investors as well. This includes machine learning and a reliance on “bots” like “Maya” for onboarding customers and “Jim” for claims processing. These technology investments allow the company to automate more of the business – further reducing costs and giving them better control and management of the business on a day-to-day basis.

The P/S ratio is ~20x. Assuming the deal prices at the top of the range at $28 that will value the company at ~$1.7B on 60M shares outstanding. (I’m assuming the shoe and including the existing options pool which has an average strike price of $14.40.)

The Information reported that this is actually below the valuation received in their last private round of financing which was $2.1B.

What could go wrong?

Rather than pile on the bandwagon let’s take a look at some of the reasons we might not want to own this stock.

Management doesn’t have much (any?) experience in the insurance business. They have hired a Chief Insurance Officer, John Peters, who does have real experience from Liberty Mutual but the rest of the management team hails from different technology businesses. Don’t get me wrong their background in technology is solid and includes experience from Spotify (SPOT), Fiverr (FVRR), and Shutterstock. The CEO has a more mixed technology background – before Lemonade he served as the President of a wireless charging company, Powermat Technologies.

Right now the company offers primarily renters insurance but they have moved upstream to homeowners policies. As they grow and expand their offerings it may take some time for them to learn more about these areas and new customers. Next up are categories like pet, travel, auto, life and ultimately umbrella insurance. Each of these may require some learning curve.

Trupanion (TRUP) has done fairly well in pet insurance but it took them a couple of years to figure it out and begin to see real stock appreciation. In some ways getting new customers is the easy part – making downstream adjustments based on claims and expectations can be trickier.

There is a presumption that the company has done the “hard part” which is technology and automation and an unspoken “how hard can insurance be?” It may turn out that handling claims, adjusting policies and managing reinsurance levels and costs could be a challenge they are not fully prepared to meet. These challenges can expand by product, by geography and via the regulated nature of the industry.

Considering the size and scale of competition from companies like Geico you can expect some meaningful response in the market if Lemonade continues to be successful. At $83M the company is a tiny player but the IPO is likely to draw attention to their success.

One question to ask is would you still want to own this stock at a $2B+ valuation if they were only able to participate in the lower end of the P&C space in the US with renters and basic homeowners insurance?

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