Lemonade (LMND 1.64%) dazzled investors when it went public nearly three years ago. It simplified the byzantine process of buying insurance plans with an AI-powered app that insures its users within 90 seconds and processes their claims within three minutes. That streamlined digital-first approach locked in a lot of younger customers; about 70% of its customers were under the age of 35 at the time of its IPO.
Lemonade went public at $29 per share, and its stock eventually skyrocketed to an all-time high of $183.26 on Jan. 11, 2021. But today, the share price is just $18. Investors soured on Lemonade as its growth cooled off, its losses widened, and macroeconomic headwinds rattled the market. Rising interest rates also deflated its frothy valuations. At its peak, Lemonade had an enterprise value of $9.8 billion -- or 77 times the $128 million in revenue it would go on to generate in 2021.
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Today, Lemonade is only worth around $1.0 billion -- which is less than three times its projected revenue for 2023. But even at that lower valuation, it probably won't attract any contrarian investors until its revenue growth accelerates again and it meaningfully narrows its losses. I've covered Lemonade's biggest problems before, but today I'll focus on three other aspects of the business that could impact its long-term growth.
1. It's still a tiny underdog in the insurance market
The bulls believe Lemonade could eventually disrupt legacy insurance giants like Allstate (ALL -1.32%), which serves around 16 million customers, or State Farm, which has more than 85 million in-force policies. Yet Lemonade ended the first quarter of 2023 with only 1,856,012 customers. That was 23% higher than the prior-year quarter, but it represented a mere 3% sequential growth from the fourth quarter of 2022.
Unless Lemonade's growth accelerates significantly and it gains tens of millions of new customers, it will likely remain a distant underdog in a mature market. To make matters worse, many of the market leaders are also rolling out their own AI-powered chatbot services to compete against Lemonade. For example, Allstate launched its own AI chatbot in 2018 to guide small businesses through the insurance buying process, and it's been deploying more AI algorithms to process claims and detect insurance fraud.
Those competitive headwinds could cause Lemonade's growth to stall out before economies of scale kick in and narrow its losses. That's why analysts expect it to rack up annual net losses of $200 to $300 million through 2025 while its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) stay deep in the red.
2. Climate change could disrupt its business
Lemonade provides homeowners, renters, term life, pet health, and auto insurance. However, it still generates most of its revenue from its homeowners and renters policies -- so it's heavily exposed to climate change and natural disasters.
In its IPO filing, it warned that "severe weather events and other catastrophes, including the effects of climate change and global pandemics, are inherently unpredictable and may have a material adverse effect" on its business. It also warned that "climate change may affect the occurrence of certain natural events," which could impact the "demand, price, and availability" of its homeowners and renters' insurance plans.
One of those natural events was the Texas winter storm of early 2021, which caused Lemonade's gross loss ratio to spike to 121% in the first quarter of that year. Its gross loss ratio subsequently cooled off over the following quarters, but any future disasters could cause that key metric to spike above the 100% threshold again. As a smaller and unprofitable online insurer, it could be tougher for Lemonade to absorb those losses than its larger and more profitable competitors.
3. It's betting heavily on the auto insurance market
Last July, Lemonade acquired Metromile, an online auto insurer that provides "pay-per-mile" plans, to accelerate its expansion of Lemonade Auto. It's only rolled out Lemonade Auto in five states so far, but it believes the expansion of its auto insurance business will diversify its top line away from homeowners and renters plans.
Lemonade believes that strategy will work because auto insurance policies are pricier than homeowners or renters insurance. But the auto insurance market is also a heavily saturated one that is dominated by entrenched leaders like Progressive (PGR -0.97%), State Farm, and Allstate. Metromile was also deeply unprofitable at the time of Lemonade's takeover, and its integration into Lemonade Auto could squeeze the company's gross margins and keep its gross loss ratios elevated.
What do these things tell us about Lemonade's future?
All three of these issues support the bearish thesis against Lemonade. Its relatively small size could make it tough to scale up its operations and break even, adverse weather events could continuously exacerbate that pressure, and its expansion into the saturated auto insurance market could cause it to rack up even steeper losses.
