Popular insurance technology company Lemonade (LMND 1.64%) is finally finding favor with investors again after several years of disappointments. Not only is growth still strong, but there have also been real indications that it has a viable model as it moves toward net profitability. Lemonade stock is up 63% this year, but it's still 87% off its high from 2021.
Just when things were looking good, Lemonade announced it would start using "synthetic agents" to promote its business. I was fooled by that statement, and in case you were, too, let me clarify what this actually means.
How does Lemonade get customers?
Lemonade operates a completely digital business that relies on artificial intelligence and chatbots to onboard customers and evaluate claims. It has heavy marketing expenses to reach new customers, but there has never been any kind of human agent involved in the process. Claims filing can reach a human when the system can't evaluate it on its own.
Lemonade's growth has been strongly connected to its marketing efforts. In an interesting twist, though, management said it would reduce marketing spend and sacrifice the resulting high growth to focus on improving profitability. Despite this, it demonstrated higher-than-expected growth in the first quarter while meeting its cost-moderating goals.
LMND Revenue (Quarterly) data by YCharts.
Capital isn't cheap anymore
Although its strategy is bearing fruit, management was still wrestling with the challenge of what it calls a "cash-flow gap." Unlike retail, where even up-front inventory costs are repaid in resale value fairly quickly, in insurance, a company outlays money in customer acquisition costs (CAC) and only regains that investment back in about two years. Lemonade says it gets back about $3 for every $1 it spends on customer acquisition, but that's over the lifetime of the client.
CEO Dan Schreiber explained that so long as capital is cheap, it makes sense to use it to finance new, profitable growth opportunities. But that time is not now. So, instead, it has come up with what it calls synthetic agents.
It's not what it sounds like
So let's first dispel the illusion that there are any agents. This is simply a capital structure that management says gives it the benefit of what agents do, but without being tied down to the detriments. While that does sound confusing to investors, Schreiber explained it in a long and complicated blog post.
In traditional insurance setups, agents bankroll the CAC and take a large cut from the premium cost for the lifetime of the customer's policies. Lemonade would love to have someone else bankroll the CAC, but it wouldn't want to lose out on the lifetime value of the revenue stream, explains Schreiber.
Working with one of its original funders, General Catalyst (GC), it came up with a plan for GC to finance 80% of CAC and receive a commission of up to 16% on customers who sign up for policies at a capped rate. After that cap is reached, regardless of whether GC recoups its initial investment, 100% of the remaining stream accrues to Lemonade.
Why Lemonade thinks it's a great idea
This seems like a strange update, considering that in last year's second-quarter report, management had already told shareholders, "We've moderated our growth spend and hiring pace, and expect our existing capital to suffice until we're profitable." Schreiber downplayed that by saying that while it doesn't need the capital, Lemonade was thinking about ways to close the cash-flow gap and monetize new opportunities instead of letting them slip through its fingers.
Why investors should wait and see the results before they agree
This is either just a financial maneuver, or a move toward traditional insurance. Either one would at least be a yellow flag for me. If it's just financial, it means Lemonade really needs more capital to keep growing than it's willing to admit. And if it's a move toward traditional insurance, that is its own red flag. The latter seems less likely since no agents are involved in this scheme. It just sounds like a scheme which has a negative connotation. Why go through these semantics when it's simpler to call it what it is?
Schreiber is raving about the potential here and how great it is for the company. He may be right, but I'd suggest not just take his word for it. Investors should keep an eye on how it plays out to see whether it's a brilliant financial move or just a desperate way to raise money in a higher interest rate environment.
