On Dec. 31, a short-seller group called The Friendly Bear published a scathing report on Lemonade (NASDAQ:LMND). Their basic contention is that LMND stock is set for a huge fall, as it is highly overvalued and does not have any special “secret sauce.”
The short-seller points out that the company loses a “staggering amount of money.” They believe LMND stock is going to fall up to “90%+ in short order.”
The short seller’s report has a title that says it all. The title is “How Lemonade Hijacked the ‘ESG Movement’ to Pull Off the #1 Stock Promotion of 2020.”
The term ESG stands for Environmental, Social, and Governance. It is a new fad among institutional investors to broaden their scope to have other goals than just the profit motive.
The problem with LMND stock, according to The Friendly Bear, is that Lemonade could not get an IPO done in 2019. So Lemonade created a “quasi for-profit social impact company” and promised to give away “up to 40%” of “unpaid money” to charity.
The scam, according to the short-seller, is that actually charity given out is only about 3% of unclaimed premiums. They claim that Lemonade is an egregious stock promotion disguised as a social impact company. In effect, it is making a complete farce of the ESG investment movement.
A Closer Look at LMND Stock
Lemonade does not seem to have faith in its own underwriting capabilities. According to The Friendly Bear, Lemonade “quietly reinsured the entire book of its business at the time of its IPO.”
The short-seller report states that if Lemonade really believed it had “legitimate underwriting technology” it would not have outsourced all risk to reinsurance companies.
This means that Lemonade retains a small fee for essentially being a “lead generation company.” And this comes with a further downside.
If the company doesn’t stop losing money on an underwriting basis, the reinsurers will reject its business. Then the stock will collapse to zero.
I wrote about Lemonade’s abysmal underwriting losses in my last article. Its Q3 gross loss ratio rose from 67% of premiums in Q2 to 72% in Q3. Lemonade’s adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) was negative $27.6 million.
The Problem With Lemonade’s Valuation
However, the most salient point that The Friendly Bear makes is about the outlandish valuation LMND stock now has. The stock has inexplicably risen from 161% from $46.90 on Oct. 29 to $122.50 as of Dec. 31.
But the problem its market cap is now $6.93 billion. However, Lemonade had gross earned premiums in Q3 of just $42.9 million. On a run-rate annual basis, that is equal to $171.6 million. Therefore, the price-to-Premium ratio is an astounding 40 times.
The short-seller report points out that The Allstate Corporation (NYSE:ALL), a “real insurance company,” trades at just 1 times its gross earned premiums.
For example, Allstate reported that its Q3 insurance premiums earned was $8.95 billion. That works out to $35.8 billion on a run-rate annual basis. But the market capitalization for ALL stock is $33.4 billion. Therefore the ratio is 0.93 times (i.e., $33.4 billion divided by $35.8 billion).
So, you can see the problem. Why on earth should LMND stock trade at 40 times the valuation of Allstate. Moreover, Lemonade makes less than half of 1 percent of the premiums of Allstate. But its market cap, at $6.9 billion is 20.7% of Allstate’s $33.4 billion market cap.
Even if we give Lemonade the benefit of a faster growth rate, LMND stock is still too high.
For example, let’s assume that Lemonade’s premiums rise 75% year-over-year for the next five years. After all, in the past year, they grew about 100%.
That means that its premiums would be 16.4 times its run rate premiums of $171.6 million. This implies that premiums will be $2.82 billion in five years. Therefore, the market cap ratio to premiums for LMND is 2.44 times (i.e., $6.9 billion divided by $2.82 billion).
This is still 2.82 times higher than Allstate.
What to Do With LMND Stock
Even if we forget about everything else the short seller says about LMND stock, it is still at least 65% too high. How do I figure this?
As I pointed out above, LMND stock trades 2.82 times the valuation of Allstate stock on a five-year forecast basis. Lemonade’s true price should be 35.46% of Allstate’s (i.e., 1 divided by 2.82). This implies it is 65% overvalued (i.e., 1 minus 35%).
In other words, forget everything bad about LMND stock. It still should be trading for just $43.44 per share, even if we estimate huge growth in premiums. And that is about the price it was at when I wrote about LMND stock in October.
In other words, a big fall is likely coming for LMND stock.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Mark Hake runs the Total Yield Value Guide which you can review here.
