IPO Launch: Root Seeks $568 Million In U.S. IPO
Root (ROOT) intends to raise $568 million in an IPO of its Class A common stock, according to an S-1 registration statement.
Columbus, Ohio-based Root was founded to utilize car data to adjust car insurance pricing based on the driver's personal driving habits.
Management is headed by co-founder and CEO Alexander Timm, who was previously in various management roles at Nationwide Mutual Insurance Company.
Below is a brief overview video of Root's approach:
Source: Root Insurance
The company says it is a 'full-stack insurance carrier...[that owns] nearly every aspect of policy design, origination, underwriting, claims and back-end processing, which enables us to iterate constantly.'
Root is currently licensed to provide insurance in 36 states and is active in 30 states, with a goal to be licensed in all 50 states by 'early 2021.'
Root has received at least $560 million from investors including Drive Capital, Ribbit Capital, Tiger Global, SVB Financial Group and Redpoint Ventures.
The firm obtains more than 75% of its customers direct [DTC] via online digital marketing through Facebook and Google.
Management believes that over time more of its business 'will naturally mature as renewal premiums outweigh new premiums, driving profitability.’
Sales and Marketing expenses as a percentage of total revenue have been dropping markedly as revenues have increased.
The Sales and Marketing efficiency rate, defined as how many dollars of additional new revenue are generated by each dollar of Sales and Marketing spend, rose to 2.7x in the most recent reporting period.
According to a 2020 market research report by Allied Market Research, the global auto insurance market was an estimated $739 billion in 2019 and is expected to reach more than $1 trillion by 2027.
This represents a forecast CAGR of 8.5% from 2020 to 2027.
The main drivers for this expected growth are an increasing number of road accidents in many countries as well as mandated insurance coverage in more regions and implementation of stringent government regulations.
Also, emerging economies will also see an increase in discretionary income producing growing demand for motor vehicles and their attendant insurance coverage requirements.
The Asia Pacific region is expected to produce the fastest growth through 2027 as it increases its adoption of mobile telematics technologies.
Root faces competition from traditional automobile insurers that may adjust their go-to-market and technology offerings to cater to those drivers who wish to include their telematics information in their policy calculations.
Root’s recent financial results can be summarized as follows:
- Sharp growth in topline revenue
- A swing to gross profit and positive gross margin
- High operating losses, but reduced negative operating margin
- Continued high cash used in operations
Below are relevant financial results derived from the firm’s registration statement:
Source: Company registration statement
As of June 30, 2020, Root had $241 million in cash and $633.6 million in total liabilities.
Free cash flow during the twelve months ended June 30, 2020, was negative $(132.7 million)
Root intends to raise $568 million in gross proceeds from an IPO of 24.2 million shares of its Class A common stock, offered at a proposed midpoint price of $23.50 per share.
The company is selling 22 million shares and the selling stockholder is selling 2.164 million shares.
Class A common stockholders will be entitled to one vote per share and Class B stockholders will be entitled to ten votes per share.
The S&P 500 Index no longer admits firms with multiple classes of stock in its index.
Dragoneer Investment Group and Silver Lake affiliated funds have indicated a non-binding interest to purchase shares of up to $500 million in the aggregate at the IPO price in concurrent private placements.
Assuming a successful IPO, the company’s enterprise value at IPO would approximate $5.3 billion, excluding the effects of underwriter over-allotment options.
Excluding effects of underwriter options and private placement shares or restricted stock, if any, the float to outstanding shares ratio will be approximately 9.67%.
Management says it will use the net proceeds from the IPO as follows:
The principal purposes of this offering are to increase our capitalization and financial flexibility, and create a public market for our Class A common stock. We intend to use the net proceeds we receive from this offering for general corporate purposes, including working capital, operating expenses and capital expenditures.
Management’s presentation of the company roadshow is not available.
Listed bookrunners of the IPO are Goldman Sachs, Morgan Stanley, Barclays, Wells Fargo Securities, Credit Suisse, Deutsche Bank Securities, Evercore ISI, Truist Securities, Cantor, JMP Securities and Siebert Williams Shank.
Root is seeking public investment capital to fund its continued growth plans, although its large concurrent private placement means it can still tap the private markets for significant working capital.
The company’s financials indicate strong topline revenue growth and a swing to positive gross profit but continued high operating losses and operations cash flow burn.
Sales and Marketing expenses as a percentage of total revenue have been dropping markedly as revenues have increased; its Sales and Marketing efficiency rate has also improved to 2.7x.
The market opportunity for providing a new way to market to younger demographic customers and calculate their insurance premium appears to be large and ripe for disruption by Root.
Goldman Sachs is the lead left underwriter and IPOs led by the firm over the last 12-month period have generated an average return of 66.0% since their IPO. This is a top-tier performance for all major underwriters during the period.
As to valuation, management is asking IPO investors to pay an Enterprise Value / Revenue multiple of over 12x.
Compared to a basket of public general insurance carriers compiled by noted valuation expert Aswath Damodaran in January 2020, which had a multiple of 1.95x, ROOT’s proposed multiple is more like an enterprise software company.
Given its revenue growth trajectory, direct-to-consumer marketing model and reliance on data to iterate its approach, ROOT is more of a software company that provides insurance than the other way around, so I’m inclined to give it the benefit of the doubt.
While the IPO isn’t cheap and the firm will need to achieve greater scale while retaining customers for renewals, my opinion on the IPO is a BUY at up to $23.50 per share.
Expected IPO Pricing Date: October 27, 2020
(I have no position in any stocks mentioned as of the article date, no plans to initiate any positions within the next 48 hours, and no business relationship with any company whose stock is mentioned in this article. IPO stocks can be very volatile in the days immediately after an IPO. Information provided is for educational purposes only, may be in error, incomplete or out of date, and does not constitute financial, legal, or investment advice.)
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