Cabot’s “Insurance Disruptor” revisited

by Travis Johnson, Stock Gumshoe | April 12, 2019 11:04 am

Bonus article! This teaser pitch originally appeared as part of a Friday File[1] on March 1, and now that the story has changed a little and some time has passed I’m releasing it for everyone to read… with a few updated thoughts from yours truly at the end.

From 3/1/19:

I got a teaser pitch from Tyler Laundon[2] for his Cabot[3] Small-Cap Confidential[4] about a “small company disrupting a $300 billion industry” … and it turned out to be an insurance pitch, so that caught my eye.

Here’s a little bit of the tease to get you started:

“While it may not be sexy, stable market demand makes insurance big business.

“Personal lines insurance alone — cars, houses, boats, and health — is a massive $300 billion industry!

“Yet oddly there has been little real innovation in this industry.

“In general, when you need a policy you do the same thing you did decades ago: call around and talk to agents, or a direct-to-consumer carrier like GEICO (owned by Berkshire Hathaway by the way)….

“In these situations, people often devote aggravating amounts of time to dealing with insurance agents, trying to get the coverage they need or the reimbursement they expected.

“All too often insurance agents are more interested in selling new policies than servicing the policies they already sold.

“In short, this industry is ripe for disruption. And this is the company doing the disrupting!”

So he’s pitching what’s not really an insurance company, but a slightly different model of insurance agency — a service company, not one that underwrites risks itself.

And it’s got what has been the magic word lately, too: “Cloud.” Here’s more from the ad:

“The company’s secret lies in a powerful cloud-based technology platform. As in so many industries, cloud-based technology has the potential to transform the personal lines insurance market. And this company is showing how.

“The short version is that the company has centralized customer service activities on a robust cloud-based, SaaS platform then integrated solutions to handle specific activities like call center, document signing and policy comparison shopping.”

And it has been growing, apparently:

“… while the personal lines insurance market is growing in the low single digits, this breakout stock has been growing by more than 30% annually for the last three years.

“And growth is expected to accelerate to 40% this year!”

He describes this as a “new independent agency model” in insurance, and shares some slides from the company’s investor presentation, so we ought to be able to get you an answer pretty easily. The key seems to be their separation of service and sales functions, and the ability that gives them to provide faster and better service to customers. Here’s one final bit of the pitch:

The effectiveness of this platform shows up in the company metrics:

“Customer retention rate of 88%

“Net promoter score of 87 (about twice that of industry average and better than many leading consumer brands, including Amazon and Apple)

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“Average annual organic revenue growth was 35% (last three years — far and away the fastest growth in this industry)

“Expected revenue growth over 40% for next couple of years”

A lot of that growth is expected to come from franchising their model to new agents, helping to dramatically expand their addressable market (they cover less than half the US now), and it’s still fairly small, with a market cap of about $1.2 billion and went public in just the past year.

So who is it? This, dear friends, is Goosehead Insurance[5] (GSHD), which will be reporting earnings next week (after the close on Thursday).

And I’ve never heard of that one before, but it did go public last Spring at about $15 and has doubled (though it’s also down 20% or so from the recent highs), and, at first glance, looks pretty impressive. They have an investor presentation up here from last month[6] (yes, that’s where the screenshots in the ad came from), and they make a good case for their ability to dramatically ramp up their sales volume with new franchise agents… and, importantly, to be as profitable as established insurance agencies while growing much faster.

The problem, of course, is that it’s in aggressive growth mode and spending very heavily, including a lot of stock-based compensation, so they trade at a nosebleed valuation that means you really have to be convinced that they have invented a better mousetrap for a very old industry. Yes, insurance is certainly ripe for new ideas and disruption, and it could very well be that Goosehead has developed the right model… but I don’t really know much about insurance agencies (despite investing quite a bit in insurers), and I expect there are probably other strong and disruptive growth models in the space as well.

Heck, maybe some of the lovely folks out there in Gumshoedom are themselves insurance agents — what do you think? Is it attractive to join on with a firm like this as a franchise agent and pay royalties in exchange for an (arguably) improved back-room service operation for your customers so you can focus more on new sales? If so, and if Goosehead is better than their competitors and can recruit hundreds of agents a year and scale up really quickly, then there’s huge growth potential… if not, if some other competitive model or network (or direct sales operation) takes share and raises selling costs, then maybe this is just a nice-sounding idea that won’t work.

The financials look pretty compelling because of the high growth rate in what should be a high-margin business, but so much of the compensation is running through to employees in the form of stock awards that they may not have a lot of room to maneuver if growth slows. There aren’t many analysts following the stock, which is understandable since it’s small and new, but they expect about 40% revenue growth and even better earnings per share growth in 2019, with estimates for 41 cents in EPS this year… but at $30 a share, that’s still a forward PE of 73. Maybe not too high for a fast-growing cloud services company, but awfully high for an insurance agency.

I find it interesting enough to watch this one, and will pay attention to their earnings report on March 7, but that’s too steep a price for me to pay without knowing a lot more about how insurance agencies work. I’ll let you know if I change my mind.

And back to the present…

Goosehead reported more or less as-expected numbers on March 7, though their forecast for revenue growth in 2019 was a little bit lighter than anticipated and the estimated earnings for the year now stand at 37 cents a share, down from 41 cents (that’s non-GAAP, they still have huge stock-based compensation that will cut that down). Earnings are still expected, by those few analysts, to grow sharply to 62 cents in 2020, and that kind of growth is definitely impressive in what is generally a low-growth sector, but that still means you’re paying a forward PE of 48 for an insurance broker.

The key to making the current price at all rational is the continued rapid growth of the franchise operation, which generates much of the revenue growth, and at much higher margin than their corporate sales (mostly because their royalty on renewal business is huge, at 50%, far above the 20% margin on new business, which means they should see an acceleration in royalty revenue in the coming years because more than 2/3 of their franchises are less than a year old).

That seems like it’s still a fairly new idea in insurance retailing, the idea of a franchised operation instead of a captive agent/owner operator relationship like agents might have with a parent like Farmers Insurance, State Farm[7] or Allstate, so the big question is whether they’ll be able to keep recruiting franchisees and keeping them happy and productive. I still don’t really have enough of a handle on the potential of Goosehead to take a chance on them at this valuation, which is a huge premium to the more established national insurance brokers like Brown & Brown (BRO)[8], Arthur Gallagher (AJG) or Marsh & Mclennan (MMC), though those larger firms are also different in structure and scope.

But I do remain tempted, I liked the way they described their business and goals in the fourth quarter conference call last month[9], their huge insider ownership is impressive and should incentivize management (particularly founder Mark Jones, who still owns a controlling stake, though he’s also an active seller), they paid out a special dividend this year that might be repeated because of their relatively low cash needs even though they’re in what they call “land grab” mode as they try to quickly scale the business, and they claim (latest investor presentation here[10]) substantially above-average performance for their agents that should help with franchisee recruitment. If you just look at the growth and the potential national rollout, without thinking too much about the fact that this is a high price to pay for an insurance broker, you might be able to talk yourself into buying shares… I’ll keep watching.

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