Summary:
- Root, Inc. provides auto insurance through a direct-to-customer model and uses telematics to determine safe drivers, offering more affordable rates
- The company acquires customers through direct and partnership channels, with a focus on profitable growth and underwriting discipline
- Root's utilization of telematics has led to industry-leading loss ratios, demonstrating the effectiveness of its underwriting capabilities using data and machine learning
- Float is ~14.92M shares, of which only a fraction of that is currently being traded (~4.3m shares are in the market). Of the available float,1.3m are currently short (short interest ~31%)
- Market makers are likely finding difficulty in hedging their short call option positions and have net short exposure because of the sheer volume of call options they are selling, coupled with a low float underlying stock that makes it extremely difficult to accumulate shares
- The Company delivered turnaround quarters with explosive revenue growth and profitability (Operating Income & Adj. EBITDA). GAAP profitability is imminent, yet ROOT remains ~70% undervalued and unnoticed, trading far below 1.0x EV/FY24E S while comps with far less growth trade at a median 2.79x EV/FY24E S
Overview of the Company:
Root, Inc. ("ROOT" or the "Company") provides auto insurance products and services in the United States. ROOT operates a direct-to-customer model and serves customers primarily through mobile applications, as well as through its website. The ROOT app uses technology in smartphones to measure driving behavior—such as braking, speed of turns, driving times, and route consistency—and determines who is a safe driver and who isn’t, using telematics. By only insuring safe drivers, ROOT can offer more affordable rates to good drivers, while maintaining higher profitability than traditional auto-insurers. The App also enables users to customize and purchase policy, find their insurance card, make changes to a policy, and file a claim. ROOT is currently available in 34 states in the US, with plans to expand across the entire US. The Company does not insure all drivers, as it believes that ~30% of drivers cause ~45% of all accident costs. On its website, the Company mentions: "We don’t think good drivers should have to pay for other people’s bad driving, so we don’t insure bad drivers. That means good drivers save."
ROOT believes that by insuring low risk "good drivers", it can price low risk drivers more efficiently than a traditional insurance company would. This means that good drivers end up paying less than they would with traditional insurers, and ROOT would get claimed against less, leading to superior gross accident loss ratios. Over time, low risk "good" drivers would migrate towards ROOT's lower pricing, leaving traditional insurance companies with risky non-profitable drivers.
Key Events & Timeline:
- In October 2020, ROOT IPO'ed at a price of $27 (pre-reverse split of 18:1 discussed below) per share (~$6.7b market cap). The Company has taken longer than expected to ramp up its revenues vis-a-vis its fixed and variable operating costs. Accordingly, the Company was burning cash (arguably headed towards bankruptcy) and its shares slid to all time lows
- In August 2021, Carvana (Ticker: CVNA) invested approximately $126 million as preferred equity in leading insuretech Root, Inc. Under the terms of the investment agreement, Carvana invested approximately $126 million of primary capital in ROOT via convertible preferred security, convertible at $9.00 per share (pre-reverse split of 18:1 discussed below), into approximately 14 million Class A shares in Root (pre-reverse split of 18:1 discussed below). The investment agreement also provided Carvana with warrants for Class A shares in Root, Inc. that are linked to the performance of the commercial partnership between the two companies
- In August 2022, in order to remain listed on the NYSE, ROOT effected a one-for-eighteen (1:18) reverse stock split of its Class A Common Stock to increase its share price
- As of date, the Company's shares outstanding stood at 14.92 million shares, a considerably low float for a publicly traded company, as a result of the reverse stock split
- On May 1, 2024 Carvana reported a quarterly GAAP net profit of $28m- a large contributor to the $28m net income beat was Carvana's unrealized gain on ROOT warrants of $75m. CVNA's shares have surged more than 134% to date (and most recently a 50% rise in share price from ~$80 to $120 per share due to the earnings beat) and currently trade at $23.1b
Q1 2024 Earnings Highlights:
- In Q1 2024, ROOT achieved revenue of $254.9m, positive GAAP operating income of $5.5m, and GAAP net loss of $6.2 million, delivering its third consecutive quarter of positive operating cash flow. On a non-GAAP basis, the Company generated $15 million of adjusted EBITDA
- The Company nearly quadrupled total new writings and grew policies-in-force 101% to 401,255 compared to Q1 2023. Gross premiums written increased 146% to $331 million. Premiums in force stood at a healthy $1,189.3m, Gross accident period loss ratio, which measures insurance claims against premia earned by the insurance company, improved 4-points to 61%, driven by pricing and underwriting advancements
- See Page 7 (Net Income and EBITDA evolution) and 19 (Operating Metrics) of ROOT's Q1 2024 shareholder letter for reference: https://ir.joinroot.com/static-files/49b07d14-3b03-4fcd-ad03-91a049989d08
- LTM March-24 revenue $640 million has more than doubled since LTM March-23 $296 million
- Q1 2024 was an inflection point in the Company's growth and profitability trajectory. Their revenue scale is now sufficiently large enough to generate gross profits to cover S&M, G&A, and Tech costs (which are largely fixed in nature) – this is evidenced by the company's long awaited positive operating income in Q1 2024 (+$5.5m)
Industry Leading Loss Ratios Proves Pricing Based On Telematics Data Works:
ROOT's utilization of telematics and driver behavior based underwriting, using machine learning, has been consistently producing industry leading gross accident loss ratio for the past 4 quarters. Most recently, the Company was able to achieve a 61% loss ratio, with accident loss ratios for renewing customers even lower at 57%. This industry leading and consistently improving loss ratio is a strong indicator of the power of telematics and ROOT's underwriting capabilities – consistently low loss ratios cannot be a fluke (See page 6 of Q124 shareholder letter). To put things into perspective, State Farm had 82% loss ratio, All State 71%, and USAA 73%
ROOT'S Sales Channels:
Root acquires its customers through both direct-to-consumer channel and partnership channels. In Q1 2024, ~88% of new writings were through direct channel, while ~12% came through partnership channels. So far, ROOT has relied mainly on direct-to-consumer channel for its revenue growth. Accordingly, ramping up revenues and growing policies in force requires ROOT to invest in direct marketing. Since the Company relies primarily on a direct-to-consumer approach to fuel its growth, its revenues and profitability are a direct function of how much and how efficiently the Company spends on marketing. However, ROOT has been cautious in its customer acquisition efforts thus far, ensuring not to go head-to-head against its competitors who are much larger, much more well capitalized insurance Companies, who possess greater fire power to compete over and acquire policies. In fact, the Company has been opportunistic and prudent in its marketing approach, seeking to grow its top-line only in a profitable manner. In its Q1 2024 shareholder letter the Company mentioned:
"Since marketing costs can be heavily influenced by the competitive environment, we are closely monitoring these channels and diversifying our distribution through our Partnership channel, which is less susceptible to competitive fluctuations. Further, as we’ve consistently noted, we do not intend to chase growth for the sake of growth—we are laser-focused on underwriting discipline and our return on marketing spend, which we believe is the optimal approach to drive long-term shareholder value."
The partnership channel comprises car dealerships that refer car buyers directly to ROOT. The Company's most significant partner is used car sales platform Carvana (Ticker: CVNA). The Company is growing its partnership channels and is expected to announce new partners soon. Note that as of Q1 2024, 88% of ROOT's new underwritings originated from the direct-to-consumer channel, and only 12% came from partnerships.
Why Can't Other Larger Insurance Companies Replicate ROOT?
- ROOT has collected more than 20 billion miles of mobile telematics data, which gives it a significant head-start over other competitors
- Traditional insurers face cost structures that can be different from those of insuretechs, primarily due to the traditional business model versus the digital-first approach. Traditional insurers often sell their policies through brokers or agents, who receive commissions for their sales. This can increase the cost of acquiring customers compared to direct-to-customer online models where such intermediary costs are reduced or eliminated
- Incumbent insurers typically have more extensive physical infrastructure and legacy systems which may be difficult to pivot away from
Comparable Companies:
ROOT trades far below comps
- Comps are expected to grow a median of 15.8% between FY23 and FY24E, which warrants a median EV/LTM S multiple of 2.78x and EV/FY24E S multiple of 2.79x (Compare that to ROOT's expected 191.6% growth and its 0.69x EV/FY24E S multiple)
- Most notable insuretech comp is Lemonade Inc. (Ticker:LMND), a diversified insuretech that underwrites home, car, pet, and life insurance policies. According to consensus estimates LMND is expected to grow its revenues by 20.1%, a fraction of ROOT's projected FY24E growth. LMND's projected sales for FY24E (consensus estimates) are nearly half those of ROOT. In its latest quarter, LMND posted a quarterly operating loss of $44.6m
- LMND trades at 2.1x EV/LTM S and 1.83x EV/FY24E S, a considerable premium to ROOT's current valuation, albeit at arguably worse fundamentals. Similar discrepancies can be seen in the above comp set, however, I focus on LMND as a closest insuretech peer
- In the above comp set, there are multiple other instances of companies that have much worse fundamentals than ROOT, yet trade at significant valuation premia. For example, GSHD has FY24E revenue of $301m, and trades at 5.26x that. Other similar valuation anomalies are AMSF, PLMR, RYAN
- Although consensus estimates for FY24E revenue stand at an average of $1,046m, I expect ROOT to achieve more than $1,300m in sales in FY24E. This is strongly supported by the Company's latest quarterly revenue of $254.9m, $1,189m of premium in force that the Company will recognize as revenue over the next 6-12 months, as well as new underwriting of $330m in Q1 2024 (see financial snapshot above). This leads me to believe ROOT's consensus revenue estimate for FY24E of $1,046m seems a bit conservative, which may be the result of the Company not being extensively covered by analysts
Catalysts:
- Given its low float as a result of its 18:1 reverse stock split, accumulating a position in ROOT may prove to be difficult without causing a market impact (ie: buying the ask price causes the bid/ask spread to move upward almost instantly)
- As a result of this low float, market makers selling call options may find it difficult to hedge their net short position on call options. In fact, having experienced how quickly the bid/ask spread moves upwards on the slightest signs of buying, I believe that the market makers are currently selling call options naked, leaving themselves with large net short exposure on ROOT
- ROOT has already made a move from $10.47 to $63.86, which is catching the attention of retail and institutional traders alike. The fact that the shares are extremely undervalued has caused this violent move upwards, and those who have been buying continue to buy this up
- Carvana shareholders witnessed first hand how $75m gain on Carvana's warrants swung the company from a net loss to a net GAAP gain of +$28m. They are also likely to keep buying ROOT and keep recording unrealized gains on Carvana's P&L
- 1.3m shares are sold short (Source: https://www.nasdaq.com/market-activity/stocks/root/short-interest ). Only 4.2m shares are currently held by the public – rest of the 14.92m are held by institutions, corporations, and insiders. Accordingly the 1.3m shares that are short represent ~31% of the tradeable float
Fair Value Estimate of ROOT:
- The Company trades far below its IPO price of $486 per share
- ROOT is arguably very cheap relative to its peers given its (i) exponential growth, (ii) recent inflection point into positive operating profit and adj. EBITDA, (iii) imminent inflection into positive GAAP net income (iv) rich net cash balance of $229m that is more than sufficient to cover interest on its financial debt obligations, and to fund future performance marketing and (v) ROOT's industry leading accident loss ratios
- With the Company currently trading at 0.69x EV/FY24E sales (1.13x EV/LTM S), the shares seem significantly mispriced. Revenue in Q1-24 has more than doubled to $640 million in LTM Q1-24 vs. $296 in LTM Q1-23 and is expected to double once more by LTM Q4-24E to $1,300 million
- If ROOT were to trade closer to the industry's EV/FY24E multiple of 2.80x, ROOT would be valued closer to $3.6b market cap (or ~$244 per share). If it trades at a multiple similar to LMND, valuation would be closer to $2.80b (or ~183 per share)
- With ROOT tracking $1.2B-$1.3B in revenue for FY24E, and having already achieved profitability on operating income and adj. EBITDA levels, and tracking well for positive GAAP net income, I don't see any valid reasons why ROOT shouldn't trade inline with its comp set at ~2.5 to 3.0x FY24E revenue, which represents ~3x upside based on existing outlook and performance
Please do your own due diligence before deciding to invest. None of the above should be construed as investment advice – I own beneficial interest in ROOT as of writing of this piece of information. Good luck
