In this episode of Motley Fool Money, Motley Fool Senior Analyst Bill Mann discusses:
- Tesla‘s (TSLA 1.11%) margins are being compressed and are still the envy of rival automakers.
- How Tesla is (and isn’t) comparable to Netflix.
- Amazon (AMZN -0.91%) is using “pocket change” to make its third-largest acquisition.
Motley Fool contributors Jason Hall and Matt Frankel engage in a “Bull vs. Bear” debate over Lemonade (LMND 2.24%), and both wish the artificial intelligence-driven insurance company would hurry up and close its acquisition of micro-cap auto insurance company Metromile.
To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on July 21, 2022.
Chris Hill: Tesla surprises Wall Street and Amazon makes another investment in healthcare. Motley Fool Money starts now. I’m Chris Hill joining me today, Motley Fool Senior Analyst Bill Mann. Thanks for being here.
Bill Mann: Hey Chris, what’s happening?
Chris Hill: We’ve got earnings season. That’s what’s happening and we’re going to start with Tesla.
Bill Mann: It feels like we just had earnings season no more than three months ago, but we’re back.
Chris Hill: I know, isn’t it great? Tesla’s second-quarter profits were higher-than-expected, but margins are getting compressed, which really shouldn’t surprise anyone given the cost of materials going higher and supply chain conditions continuing to be, let’s call it less than ideal.
Bill Mann: Yeah. Given the circumstances, Tesla’s quarter was great. But yes, you went right to the spot that, the people who would suggest that Tesla is not as great of a company as I believe it to be. Their margins came down for production, which is an important distinction for Tesla because they also have environmental credits from 30 percent to 26 percent, which is in fact, it is a reduction. It is higher than nearly any other car company, Volkswagen, for example, which is a really fantastically run company, their margins range from 16-18 percent. Yes, it was not perfect for Tesla, but it was absolutely fine.
Chris Hill: A welcome distraction for Tesla’s shareholders to actually get results from the company, because really the conversation around the CEO of this company has had nothing to do with Tesla. It’s had everything to do with Twitter. Among other things, it’s a nice reminder that, oh right, Elon Musk has built himself a pretty large and powerful company here.
Bill Mann: Yeah. I mean, Tesla still has a valuation that is nearly the same as all of the remaining car companies combined. They have some challenges this quarter. I mean, maybe you’ve heard about supply chain issues impacting everyone, Tesla was by far not immune to that. The computer chip issues were still out there for them. But the company did rather well. I mean, both their earnings and their revenues were down sequentially and they’re growing at about 43 percent and Elon Musk did come out and say that they intend to continue to grow at 50 percent plus for the next few years. They have a little catching up to do on what is a rather audacious goal that he’s laid out for the company.
Chris Hill: Anyone who’s watched this company for a while knows, if nothing else Musk, is a fan of putting out audacious goals and if the company falls short from time to time, so be it. It’s not going to stop him from doing that. I’m wondering what you think about this company 10 years from now and the example I’m going to use is Netflix. Because Netflix changed home entertainment completely and for a while, it wasn’t just the biggest game in town, it was the only game in town. Now, because it changed the home entertainment landscape, Netflix spawned many other competitors and it’s in a tougher spot as a stand-alone public company. Tesla changed the automotive industry by making electric cars, among other things, really cool.
Bill Mann: Yeah.
Chris Hill: Which is not something that shows up on the balance sheet and yet, when it comes to production, all the other automakers are now onboard with electric vehicles and the competitive landscape is tougher, 5-10 years from now, what do you think is a reasonable expectation for Tesla shareholders to have about this company and where it is and the competitive landscape?
Bill Mann: Chris, it’s funny you say that because you look at what Netflix did and I love that as an allegory for Tesla, because on every single measure, Netflix has been wildly successful. They absolutely positively changed entertainment as we know it. Tesla has done the same exact thing, but the environment is changing rather quickly for Tesla just in terms of the competitive forces. You saw today that Ford is laying off 8,000 workers because it is putting more emphasis on electric vehicles and so they are making a shift. These are very credible, well-heeled, deep-pocketed competitors. The difference between Tesla and Netflix is that Tesla, at this point, given its balance sheet and given its market cap, actually has more resources to bear than any of its potential customers. They have the new factory that is open in Germany. They have a new factory that has opened in just outside of Shanghai in China. They actually are in a much better place than Netflix was even at its most dominant.
Chris Hill: Let’s move on to Amazon, which is scheduled to report earnings next week. But in the headlines today, because Amazon is buying 1Life Healthcare, a primary care practice that operates under the name One Medical. Amazon’s paying 3.9 billion, this is an all-cash deal, $18 a share. It’s the third largest acquisition Amazon has made behind Whole Foods and MGM. Based on the reaction from the market, it seems like this deal is getting a thumbs-up.
Bill Mann: Yeah, it’s crazy to me. When do you look at Amazon, how little of its growth has actually come from acquisitions? They have grown more or less organically, which again, I know maybe this isn’t some enormous observation, but Amazon really has done something that’s different from any other company, I think in history, maybe with the exception, with the possible exception of Walmart, just in terms of how broad they got from where they started. Yeah. It’s an interesting transaction for them. One Medical is a subscription healthcare business. The medical system and the process by which medical care in this country is completely broken. A subscription system run by a very deep-pocketed Amazon I think it’s an interesting bet for them as they try and get to a point where the lowest cost components of healthcare are done on more of a subscription basis than on a pay-as-you-go basis.
Chris Hill: The price of this deal gives a premium to 1Life Healthcare of nearly 80 percent.
Bill Mann: Yeah.
Chris Hill: Congratulations to all the 1Life Healthcare shareholders out there. I’m tempted to ask, did they pay too much? But based on the reaction from the market, shares of Amazon are basically flat today, so that’s signals to me that no, this was a good price to pay.
Bill Mann: Well, keep in mind, and I hate to say this about nearly $4 billion, but that’s pocket change for Amazon as a trillion dollar plus market cap company. I really, from an Amazon perspective, this is the type of bet that they ought to be making. This is almost the same thing as they’re like, let’s put some chips on black and see what happens with a spin of the roulette wheel. Now, it is $4 billion, $3.9 billion and Amazon has not become the power that it is by being profligate with it’s money. But it does bear remembering that this for Amazon really truly is a tiny bet and what they’re hoping to happen. One Medical has 125 offices around the US. What they’re really hoping to do is to bundle that in with other services that Amazon already offers. Imagine having this somehow become a component of prime, that becomes an almost unbeatable service offering to have within the framework of what Amazon is providing versus other forms of primary healthcare.
Chris Hill: Well, and thank you for the reminder that most of Amazon’s growth is organic and it hasn’t been through acquisition because this is not the first run at healthcare that Amazon has made as a company and somewhere along the lines clearly they figured out. Maybe this is the difference between Andy Jassy and Jeff Bezos. Where Bezos was more of the mindset of, let’s build this ourselves, and under Jassy’s rule in the corner office, it’s like, no, we can spend $4 billion and we can buy our way into this space.
Bill Mann: Yeah, it bears remembering that whole food was bought under Bezos and not Jassy and Amazon did launch Amazon Pharmacy in 2020. I think this is probably a continuation, but it’s still very much a bolt-on for Amazon at this point. As a citizen of this country, to me, the most interesting thing about this is the capacity or the willingness of these large companies to be innovative in how we as citizens pay for our healthcare in this country, and I think that Amazon is in an ideal position. Just to give it a shot, just to look at a different model than the one that we are so accustomed to here in the United States.
Chris Hill: Safe to assume we’ll get some more color on this next week on the conference call with Amazon.
Bill Mann: I think it’ll come up. It should come up.
Chris Hill: Always good talking to you, Bill Mann. Thanks for being here.
Bill Mann: Hey, thanks Chris.
Chris Hill: Lemonade is trying to disrupt the insurance industry by using AI. But first, it’s got to get a few other things right. Jason Hall and Matt Frankel join Ricky Mulvey for a Bull versus Bear debate on Lemonade and you get to decide if this beaten down insurance company can make it come back.
Ricky Mulvey: Today, we have a very special Bull versus Bear on a company that has a little bit of controversy behind it. I would say the stock is Lemonade. We’ve got two analysts. We flipped the coin to decide the sides. Jason Hall, you are the Bull, Matt Frankel, you are the Bear. Thanks for playing on this company.
Jason Hall: Yeah, absolutely. We disclose here all three of us actually own this stock.
Ricky Mulvey: Yes, that is an important circle of trust thing we should establish. I would say, we all own Lemonade. I don’t know if I would say we’re all happy we own Lemonade right now.
Matt Frankel: Well, there’s no such thing as a stock that’s off 90 percent from its highs that you can’t find a good bear case for. It’s really important to know the bear cases at Investor and do a little bit of digging into that and the question is, does the bear case outweigh the 90 percent discount, is what investors really need to establish?
Jason Hall: I’m here to sweeten up this sour situation by the way. That’s my role.
Ricky Mulvey: [laughs] Let’s get it started. Jason Hall, you have the bull case on Lemonade. You have five minutes.
Jason Hall: Yeah. This is not a great run so far for Lemonade. This is a stock that’s down since its IPO, it’s down around 60 percent. If you look at it from the high, it’s down almost 90 percent at this point. What’s happening because this is a business that is growing by leaps and bounds? I think that’s a really important part of the bull case. For me is that this is a company that has continued to add new customers. You look at just last quarter, it’s enforced premium. In other words, that dollars of premiums and enforce policies increased 66 percent. Has over 1.5 million customers, that’s a 37 percent increase year over year. While the stock is down, Lemonade continues to attract new customers. The average premium per customer is up 22 percent, that’s a product of Lemonade expanding as an insurer.
This is a business that started out focus just on rental insurance and pet insurance. What’s happened since then? It started to expand into homeowners insurance, life insurance policies, and more recently, and this is a big thing that it’s working on right now is auto insurance. It’s operating in a couple of states. It has a pending acquisition of a company that’s going to get it into another 48 states, 49 states, I believe, with the licenses that come along with that and it’s moving forward in ways that are very customer-friendly. I think that’s the thing that’s so compelling to me about the business. We hear a lot about its AI and the failures of its AI because here’s the bear case. I’m going to go ahead and lay out the bear case, Matt is going to hung on.
That’s the fact the insurers have to be good at ensuring. They have to be good at underwriting insurance and this is the big problem. The company has to be able to make money and it’s looking to have a gross loss ratio of around 75 percent, meaning that about 25 percent of the premiums money is leftover on a gross basis, and that’s the money that is leftover for Lemonade to keep. Its last two quarters, the first quarter at gross loss ratio was 121 percent, meaning it paid out 21 percent more on a gross basis than abroad in, in premiums. That’s the first quarter of 2021. The first quarter of this year was 90 percent. I think it’s been around that 75 percent mark. Maybe two quarters out of the past six quarters, that’s not a good look for an insurance company.
But what isn’t getting enough attention and this is the bull case for me, for lemonade is the way that it’s using artificial intelligence and the way that it’s decoupling the incentives and the transactional friction from the traditional insurance agencies in ways to improve its relationship with clients be more sticky. A couple of things that it does, again, it looks to keep that certain percentage, and everything that’s left over, it pays out in claims. Most insurance companies focus on float. It’s in their economic incentive to retain every dollar that they get in premiums and to delay paying it out in claims. That’s completely different from Lemonade’s economic model.
That change in incentives is very important. The way it’s using AI to support its customers by using it to pay claims faster, using it to establish policies more quickly is helping it drive out cost. The insurance industry, by and large, is a very manual, people-driven industry. Lemonade’s looking to drive a lot of those inefficiencies out and also leverage the changes in relationships and those frictions that are built into the way the industry is structured today. Again, it’s very compelling if you look at how many customers it’s attracting, you look at its growth rates. Again, the obvious issue here, guys, hasn’t proved that it can actually be a good insurer, its underwriting so far has not been very good. Management has made this the core focus.
They’ve brought in a lot of experts, executives with long tenure track records in the insurance industry to focus on this thing and improve it. I think they’re going to be able to do it. I am a shareholder, I’m not buying right now. I think this is in prove-it mode, but I think they’re going to be able to do it. Why am I really bullish right now? The market is so down on this business, it trades for about 1.4 times book value. Obviously, if they can’t figure out the underwriting thing, doesn’t necessarily matter. But if they figure out the underwriting, which I think is going to be the low lift, I honestly think that’s the low lift. They figure out the underwriting, being able to buy this business at 1.3 times present book value at the rate that they’re growing that book value could be the deal of the century if we look back in five or 10 years.
Ricky Mulvey: Deal of the century. Strong close. Thank you for the bull case, Jason Hall. Matt Frankel, you have the bear case.
Matt Frankel: Since Jason spent a fair amount of his time actually arguing the bear case for me, I’m going to give you just a couple bull statistics before I rush in. Jason, he just mentioned correctly that Lemonade trades for about 1.3 times book, but I need to put that into context. It’s got a $1.3 billion market cap and a billion dollars of cash. That’s where the book value is coming from, the cash and investments on its balance sheet. Lemonade’s business is being valued at less than $300 million when you back out the cash, just the business itself. That’s not a very optimistic market right there. As you mentioned, if they could figure it out, it could eventually be a home run. There’s a lot going for it. I wish the auto insurance rollout would happen a little faster.
The Metromile acquisition is taking forever, it seems. They just got regulatory approval recently. But that’s definitely a positive catalyst long term. They’ve done a great job of hiring. They recently hired the ex-chief insurance regulator of New York state to be their government contact. Can’t really do better than that. But now, let’s get to the bear case. As Jason mentioned, they haven’t gotten underwriting right. I’ve said this when it comes to a bunch of companies, a great product does not always equal a great business. It really remains to be seen if Lemonade can be a great business. It is definitely a great product. Look at some of its reviews. It settles pet insurance claims in three seconds, literally three seconds in most cases. It’s a great product with a very happy customer base. That’s how it’s growing faster than any, it grew to a million members faster than State Farm did. It’s really caught on with customers.
That gross loss ratio scares me, and it’s because if you’re not underwriting well as an insurer, and Lemonade’s a small insurer. Once you become a big insurer, that can kill your business in a quarter or two, if you’re not underwriting well. Right now, Lemonade has about $400 million in outstanding premium. If they misjudge the loss ratio on that, you’re talking of $10 million in one direction, $10 million in the other direction. If they become a larger insurer like they want to and have $50 billion of premium on their books, which would make them not even one of the biggest insurance businesses in the country. If you get underwriting wrong, you’re losing billions of dollars in a quarter if you got underwriting wrong on that, if you’re paying out too much on $50 billion of premium. Not only has underwriting not been good, as you mentioned, a 90 percent gross loss ratio in the first quarter, it hasn’t been consistent at all.
If it’s consistently, say, 90 percent or even coming down by a percent each quarter, it’s easier to identify what went wrong, and what they need to do, and what needs to be tweaked in the algorithm, but it’s been very inconsistent. The company still expects its multi-year average loss ratio within that 75 percent target range. I don’t see how they get there within the next year or two. Look at some of these numbers. Even with their small size right now, they’re a small insurer. I interviewed CEO Dan Schreiber on Industry Focus a while ago, and he correctly pointed out they could 100x this business, and that would make them a midsize insurer. They’re a small insurer right now, and they’re losing more money than they’re bringing in in revenue.
In the first quarter, Lemonade generated about 44 million in revenue, it lost $75 million. That’s a negative 168 percent profit margin. That’s not good. That’s not sustainable. Yes, they have a billion dollars of cash and investments in the bank, but they’re projecting to lose on an adjusted basis about $300 million this year. If that’s what they’re losing on an adjusted basis, that means their net loss is going to be roughly $400 million this year. They’re not going to have a billion dollars on their balance sheet that long. The cash is somewhat misleading because they’re hemorrhaging money right now. They’re giving $60 million of stock-based compensation this year, which $60 million in stock-based compensation for a $1.2 billion company, that screams late ’90s dot-com boom. That’s how they were all paying their employees back then.
They need to get expenses under control. It’s not just underwriting, to be fair. They need to get their expenses in check, they need to get underwriting in check. Like I said, with the stock almost 90 percent off the highs and about 60 percent down from its IPO like Jason said, the risk reward can still make a whole lot of sense here because this is a massive market opportunity that is in dire need of disruption. The auto insurance claims property, even with a tech-focused insurer with modern technology, is clunky at best. There’s a big opportunity here if they’re successful, they’ve got to get underwriting right. That’s what takes this from a great product to a great business, and that’s the biggest question mark right now.
Ricky Mulvey: Matt Frankel, thank you for the bear case. Jason Hall, thank you for the bull case. As a reminder, you can vote on who you think made the better argument @MotleyFoolMoney on Twitter. We will have a poll there. It’s very important that you vote because one of these contestants is going to win this fabulous prize.
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Chris Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don’t buy or sell stocks based solely on what you hear. I’m Chris Hill, thanks for listening. We’ll see you tomorrow.