Root Stock: Not Addressing The Root Causes (NASDAQ:ROOT)

In October 2020, I believed that Root (NASDAQ:ROOT) was an interesting business as it was focusing on innovative insurance models. At the same time, I believed that while potential was there, the promise still had to be seen in the results, let alone as valuations were far too demanding to get involved.

The company went public at the time, trying to provide better insurance premiums for better drivers, in essence trying to revolutionize auto insurance based on the principle of fairness, as that was the “root” of the business.

IPO Take

The description above sums up the basic idea of Root, as traditional insurers have put people into risk pools based on a few simple metrics, which simply is not fair at the individual level. By focusing on technology and data science, Root aims to differentiate much better, not just providing a fair premium, but providing an easy experience as well.

The industry is huge as auto insurance in the US totals a quarter of a trillion per year. The business model is often still based on old practices which include fat commissions. Part of the “privacy pain” of this principle is that distraction will need to be measured, something not really loved by all drivers of course.

The company went public at $27 per share and raised nearly $600 million at these levels. Funds associated to Silver Lake actually bought half a billion worth of shares at the offer price. With 270 million shares outstanding, Root was awarded a $6.7 billion valuation, a huge number, even if we factor in a $1.3 billion net cash position. This valuation should be seen in the light of just $43 million in revenues being reported in 2018, with operating losses reported at $68 million.

Sales were up a factor of 7 times to $290 million in the year 2019, with operating losses increasing to $260 million, by now coming in just below the reported revenues. Revenues rose at a rate of 2.5 times to $245 million in the first half of 2020, as operating losses came in at $130 million, marking further operating leverage. With third-quarter revenues seen at just $50 million, and operating losses seen around $70 million, this was worrying and attributed to a change in the reinsurance structure during the quarter. All of this meant that despite the innovative character of the business, I did not see any appeal.

Trading at 10 times sales while growth was decent and losses were big, industry giants traded at just 1-2 times sales, while they were vastly profitable.

All Downhill

Despite the potentially disruptive business model, that does not always translate into solid returns for investors as it was all downhill from there, with shares down to $10 in spring of 2021 to keep falling to $1 per share by now. The reason for that is easy as fourth quarter revenues for 2020 only came in at $50 million, with operating losses increasing to $90 million and net losses being even greater following some interest costs. This all demonstrated that the business model simply was not economical, certainly as the company guided for 2021 revenues at just $270-$300 million, with operating losses set to surpass the half a billion mark.

Fast forwarding another year, Root posted $345 million in total revenues in 2021, flattish compared to 2020 as operating losses widened to $485 million, essentially a bit better than guided for at the start of the year, albeit the results are dreadful by all measures, as no guidance was provided for this year. With roughly 250 million shares outstanding, and net cash down to $700 million, shares were essentially trading around the net cash position early this year. This came as investors were essentially fearful about continuation of losses.

First quarter revenues did show a recovery to $85 million in revenues as operating losses narrowed to $76 million, encouraging results in still a dreadful situation. That was about the good news as second quarter revenues fell back slightly to $80 million as operating losses increased a bit again on a sequential basis to $80 million. This remains a dreadful situation as the company is unable to grow nor able to narrow operating losses. While cash holdings approach $900 million, the company has taken on $285 million in debt, resulting in higher interest expenses going forwards as well.

Still Avoiding

With the company only representing a quarter of a billion valuation here, trading below net cash, the reality is that the losses are so substantial and so little progress is seen, that we should simply expect more moderation of the business and continued and large losses. Part of the problem is that pricing is too fair, with losses eating up pretty much all the written premium margins, as overhead is resulting in huge losses. After all, the good drivers are cheap and cheap for a reason, yet the fairness principle is hurting the own business, actually.

With a reverse stock split now in the works, the reality is that there is simply is no fundamental reason to be involved here in the shares. Lack of growth and the simple height of losses make this a very easy avoid.