Lemonade Inc.'s (NYSE:LMND) stock gained 139% after its initial public offering on Thursday, July 2. The stock opened from the primary market at a price of $29 and ended the day at $69.41. Investors are interested in the stock for several reasons. The company uses an innovative artificial intelligence system to process claims at speeds of potentially three seconds. The company is also part of a new wave of emerging technology in the insurance industry, offering customers a much faster, fully online experience.
Benefit Corporation Status
Lemonade is one of few companies now holding the Benefit Corporation status. Benefit Corporations, or B-Corps for short, proclaim to offer some public benefit to the economy at large. In Lemonade's case, it donates some of the company's premiums and unclaimed funds to charity. This status does not generally affect the company's financials or provide any particular tax advantages. In essence, it is more of a commitment to environmental, social and governance activities, which falls within the realm of corporate sustainability. Lemonade has obtained a B-Corp certification through B Labs, which accounts for its credibility and requires periodic checks for consistent adherence.
Lemonade reported $63.8 million in total revenue in 2019, up from $21.2 million in 2018. Its gross revenue in 2019 was $67.3 million for a gross profit margin of 105%. Despite the astounding gross profit margin level, the company has spent exorbitantly in the operating expense category. Operating expenses were up 133% in 2019 to $175.2 million, for an earnings before interest and tax level of -$107.9 million. This leaves it with an operating profit margin of -169%. Most of its expenses in 2019 came from sales and marketing, which could easily be reduced as the company gains more public attention from its IPO. On the bottom line, the company paid no interest payments in 2019 and only reported a tax obligation of approximately $600,000. This left it with a net loss of $108.4 million in 2019.
From the initial public offering, the company sold 11 million shares at a price of $29 in the primary market for total capital raised of $319 million. The IPO also includes an optional 1.65 million shares available for the underwriters within the next 30 days at the offering price, which could lead to an additional $47.85 million. The paid in capital from the IPO could take the company from a negative shareholders' equity position to a positive one. In 2019, the company's shareholders' equity totaled -$182.5 million, primarily from an accumulating deficit of $198 million. In 2020, with capital infusion of $319 million alone, the company's equity position could be improved to around $136.5 million.
In terms of cash flow, Lemonade ended 2019 with $270 million in cash and equivalents. It brought in $300 million from financing activities, while paying out $78 million for operating activities and $54 million for investing activities.
IPO listing and beyond
Lemonade has an interesting platform. In the insurance industry, its ability to potentially payout claims within three seconds should certainly give it some advantages over other business models, which have yet to fully automate and promise fast payouts. The company has tremendous gross profit opportunities, with gross profit exceeding total sales. It will need to find a way to reduce operating expenses over the longer term in order to at least show some operating profit. Reducing capital expenditures will also be important, since capex has been a big drag on free cash flow. On the bottom line of the income statement, the company has been capitalized with very little debt, which leads to hardly any interest expenses. When it can generate a net profit, its taxes will however increase.
On the balance sheet, the IPO capital will be a huge boost. The $319 million improves its solvency position. The potential for an additional $38 million from the optional underwriting share purchases would also be a big help.
Currently, the company does only focus on homeowners' and renters' insurance. Whether it expands in the future could be tricky and also would affect its position among insurance competitors.
With forecasting for negative Ebit and such high capex, it is challenging to arrive at a reasonable target estimate for the stock. Currently no major sell-side firms have released their target estimate opinions yet. When looking at some comparables, namely Progressive (NYSE:PGR) and Aflac (NYSE:AFL), the company is trading far beyond established industry multiples. Progressive currently shows a price-earnings multiple of 17 and Aflac 11.
With a somewhat expected industry comparable enterprise value to sales multiple of 2, the company's shares would be priced at $12. With the high demand for the share pre-IPO, $29 seems reasonable. However, after the IPO, the company's enterprise to sales multiple jumped to 57 with the assumption of 11 million shares outstanding. The market clearly sees the shares worth a range between $29 to $69. However, it is not likely that the shares should reasonably move much above $69. Until the company provides its most recent earnings details, anything above $69 looks to present a high risk for buyers.
Disclosure: I own shares of Lemonade.
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This article first appeared on GuruFocus.