The story behind the founding of Trupanion (NASDAQ: TRUP) is almost too good -- and sad -- to be true: Teenage boy loves his dog. Dog has twisted stomach -- an easy operation would save its life. The family doesn't have thousands of dollars to pay for the surgery. Dog has to be put down long before it reaches old age. Boy is heart-broken.
That's the origin story of one of the world's fastest growing insurance companies, one that insures cats and dogs. That boy was Darryl Rawlings, and he not only went on to found Trupanion, but he still runs the company as CEO. He also owns just over 4% of the company -- worth roughly $41 million at today's prices.
Image source: Getty Images
The company is also one of the fastest growing in its industry. Between the end of 2013 and September 2018, the company almost tripled its base of "clients" (insured cats and dogs) to nearly 500,000. Over that same time frame, revenue has increased by 30% per year over the last five years.
Data source: SEC filings. Note that 2018 results are for the trailing twelve months ending September 30, 2018.
That's impressive growth, and it's helped the company's stock quintuple since its post-IPO lows of December 2014. But that doesn't necessarily mean you should back up the truck on the company. Investors need to take a close look at three salient risks before buying shares.
1) When regulators come calling
In late 2018, short-sellers came out with accusations of illegal relationships between Trupanion, its legion of Territory Partners, and the veterinary offices they visit. Typically, these Territory Partners -- who are independent contractors -- will visit all of the vet offices they can in their area. They make vets familiar with Trupanion, and offer access to the company's proprietary software -- Trupanion Express -- as well. The vets, the thinking goes, will refer more clients to Trupanion with this face-to-face contact.
Short-sellers saw two big problems with this. First, the Territory Partners were often not licensed insurance salespeople. And second, the short-sellers argued that vets were being compensated for their leads -- which is against the law in most states, for fairly obvious reasons.
Trupanion admits their Territory Partners aren't required to be licensed on their own website, saying, "their role is to create meaningful, long-term relationships with veterinarians and to educate those veterinarians about the benefits of high-quality medical insurance." Some partners, the company notes, do decide to obtain licensure and can sell direct to consumers -- but they appear to be small in number.
The company also cancelled one of the programs alleged to have been compensating vets in November 2018. It was careful to point out, however, that, "The termination of the program was unrelated to any regulatory inquiries. To the contrary, the determination was made because the test program was not having the desired results."
It's clear that some state agencies are kicking the tires on Trupanion's practices. It remains to be seen if any regulatory action will be taken, but even if there aren't changes in the marketing channel, this could slow growth in signing up new customers. The company admits on its web page that its Territory Partners represent a significant competitive advantage, or moat. Any change in that program will have consequences.
2) Stock priced for perfection
The second risk to be aware of is more run-of-the-mill. After quintupling in less than five years, the stock isn't cheap.
Over the past twelve months, Trupanion has not been profitable. And even when we back out the $55 million the company recently spent on a new Seattle office building, it still only brought in $10 million in free cash flow. That gives it a price-to-free-cash-flow ratio of almost 90 -- a very expensive sticker price.
This isn't to say that you should stay away from the stock just because it's high priced. Rather, it's to realize that your margin for error is slim. If the company experiences a slowdown in growth or a speedup in regulatory action, it could dive in short order.
3) Low culture marks
I generally like investing in founder-led companies. Such founders often view their companies as extensions of their beings, and work toward creating something that will benefit society long after they are gone. They are, in short, focused on the long run.
Darryl Rawlings is no exception, but there's much to give me pause. Most of that comes from Glassdoor.com, where the company and Rawlings get very low marks. Overall, employees give the company 3.3 stars out of 5, and Rawlings sports a 65% approval rating.
The problems with the company appear to be two-fold (you can check them out yourself): Salaries are apparently very low, especially for the Seattle area. One employee said that was because savings were being passed on to policy holders -- which admittedly isn't the worst thing in the world.
The second -- and more serious -- indictment is that the company's leadership leaves much to be desired. Rawlings and his counterparts -- many reviewers claim -- are doing a poor job of following through on the public promises they make. It's worth pointing out the exact details of these communication and follow-through problems aren't readily available. In the end, if just one or two employees commented on this, I would ignore it. But this theme comes up again and again in the reviews -- sometimes in great detail.
Over the long run, culture matters. Long-term investors would do well to investigate the culture of the companies they are investing in before clicking the "Buy" button.
Takeaway for investors
No company is without its risks. That risk, in fact, is what helps to make the stock market a, well, market. Different people have different timelines, goals, and appetites for risk.
None of the points above mean you should avoid Trupanion entirely. Instead, I believe investors would be well served to weigh these concerns carefully before making up their own minds.
Personally, I don't feel confident enough to buy the stock or give it an out-perform rating on my CAPS profile. But it's an interesting business that I'll be following closely over the years to come -- with an open mind toward starting a position if it makes sense based on results.
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