Trupanion: We're Sending This Pet Insurance Company To The Dog House

by Sonya Colberg, Senior Editor - 8/10/2015 9:44:13 AM

Stock in Trupanion (NYSE: TRUP) has transformed in recent weeks from a bad, bad dog into the Lassie of the pet insurance world.

But hold onto your leashes. This Seattle, Washington-based company has been quietly growing enormous pit-bull fangs and looks ready to turn on shareholders.

Our executive summary highlights why TheStreetSweeper is bearish on this stock and believes TRUP will ultimately bite those loyal shareholders right in the wallet.

* Hello, 2021: Unraveling TRUP’s numbers reveals up to 23 quarters to wait for the possibility of any meaningful profit.

*TRUP’s insurance product: Negative reviews dog the company.

*Dog-gone bad 16-17 percent margins: Why we shouldn’t be surprised...TRUP is not a high-margin tech company. It's a niche insurance company.

*TRUP recasts numbers: Even they can't save customers' value-to-cost ratio.

*States’ insurance commissioners: Let’s jump TRUP.

*Sell, sell!: Insider unloads company stock.

*Company headquarters: In a less-than-swanky part of town.

While the company has not responded to TheStreetSweeper’s request for comment, investors may read bullish viewpoints here.

* TRUP’s pet enrollment numbers revelation: Wait ~23 quarters for scale up, any possibility of meaningful profit.

TRUP went public in June 2014 and has suffered significant net losses since inception 16 years ago. But shareholders will sometimes hang in there with a company awhile as long as they can imagine light at the end of a rather short tunnel.

When we ran the numbers, however, we were shocked at how long TRUP investors apparently will have to wait.

Cash flow break-even should happen by mid-2016, CEO Darryl Rawlings said during the May earnings call. But he indicated anything resembling meaningful profitability will come only when TRUP can scale enough to reach 650,000 to 750,000 enrolled pets:

“We manage our business base on cash flow and we are on track to achieve cash flow break even by the middle of next year. Once we achieve operational scale of 650,000 to 750,000 enrolled pets our intention is to have our fixed expense scale as a percentage of revenue and our discretionary margin should continue to expand.”

So the obvious questions are: How many more pets will TRUP need to enroll in its insurance program before they hit the target?

And how long will that take?

TRUP currently reports 241,808 subscription pets enrolled. If the company can stay on track at around 12,500 net additions per quarter (which, if even possible, will likely mean gobbling up millions more in marketing), it should take TRUP somewhere around 14 quarters to 23 quarters to hit the target.

Yipes ...That’s about three to six years.

That means TRUP should reach the target sometime between the years 2018 and 2021!

TRUP is expecting investors to be phenomenally patient at that rate.

Particularly true if we factor in the stock performance (down ~30%, depicted by the blue line) versus the Dow (up ~2%), NASDAQ (up 5%) and S&P 500 (up~14%) over the past year, as shown below.

(Source: Yahoo Finance)

*The product: Bad comments dog TRUP

Now, let’s take a look at TRUP’s product.

TRUP faces roughly 20 competitors. Rivals aren’t publicly traded but they’re growling and barking at – and winning over – the same teeny segment of pet-loving customers that TRUP targets. In fact, our recent Google search for “pet insurance” found TRUP in the unenviable number 8 spot in free searches.

So TRUP rightfully wrings its paw over how customers view the company.

CEO Rawlings commented during the Aug. 4 earnings call that member retention was 98.7 percent, adding:

 “Today, we continue to invest and focus on our customer experience …”

But it seems TRUP gets mixed reviews from customers online. The majority are negative. Many describe nightmarish bills, obnoxious customer service reps, randomly increased premiums and – very frequently - refusals to pay claims. The claim refusals are especially ironic, considering that cost of claims nearly set a record in the second quarter, consuming 73 percent of revenue. See all Yelp reviews here.

Here are just a few recent examples of feedback from customers about their TRUP experiences:

“I’m disgusted that I paid more than a year’s worth of premiums for this worthless policy. Run, don’t walk, away from this company…” wrote Melia F. of Oakland, California.

                                                            ***

“My nightmare with Trupanion just started,” wrote reviewer Jimmy L. on June 5. He noted TRUP’s refusal to pay toward a cat’s emergency C-section. The situation, according to the pet owner, prompted his vet to angrily say he would never recommend Trupanion to clients.

                                                            ***

Deborah V. of Coronado, California wrote: “We bought insurance for our puppy, they took our money, NO PROBLEM, but when we filed a claim, they found a reason to NOT COVER IT.  Typical insurance company - always finding an excuse to not pay!  We cancelled and will get pet coverage elsewhere.  Stay away from this unreputable company!!!”

                                                            ***

Under the heading, “Holy Moly! Unprofessional folks!” L.B. of Larkspur, California, described the lengthy ordeal of trying to cancel an insurance policy with TRUP. Here’s an excerpt:

“After insuring my cat for about a year and a half with Trupanion, I realized the increased premium of 33% after only one year (having made no payout claims whatsoever) wasn't worth the expense. My biggest problem was the non-coverage of veterinary office visits, which I compared to my dog's existing Go Pet Plan insurance, where the visits are covered.

“When I called to cancel three days ago, Trupanion was so ill staffed that they told me I'd have to wait 72 HOURS for a callback!”

                                                            ***

And here’s what one former customer said about the positive TRUP reviews on Yelp:

“You're wasting your money!  They will find any excuse to deny your claim.  We had all four Yorkies insured with them.  Biggest mistake of my life. Methinks the great reviews are employees or friends of the owners of Trupanion.  Alice N.”

*Dog-gone bad margins: Why we shouldn’t be surprised

TRUP faces challenges as huge in the financial department as in the customer service department.

Let’s consider TRUP’s gross margin … which is, well, paltry.

And getting slightly worse.

In the last earnings call, management touted the subscription segment’s 17.4 percent gross margin. But they failed to tell investors the margin for all segments combined, which was only 16.3 percent (per 10-Q: $5.8m gross profit (or revenue - cost of goods sold) / $35.6m revenue = 16.3%).

It’s great that TRUP’s revenue grew almost 7 percent last quarter. But the cost of that revenue grew, too.

It now takes $93 for TRUP to make $100.

The chart below indicates how heavily TRUP’s low 16 to 17 percent margins weigh on financials.

(Sources: SEC filings1, 2,3, CC transcript, also here)

But, really, low margins are to be expected from TRUP.

Why? Because it’s a pet insurance company.

Insurance companies may have the reputation of being the over-stuffed villain but the margins aren’t obscene …. They’re rather modest.

Though typical insurance companies target the much larger human population, which is actually required to be insured, let’s look at those gross margins for comparison. Also, look at the software-as-a-service or SaaS companies’ margins. Check out the chart below:

(Source: Morningstar set 1, set 2, set3, set4, set5, set6)

So here’s what’s happening to TRUP. Because there are no specialty insurance company analysts, those covering TRUP tend to specialize in tech or software coverage. Canaccord is one example. On Aug. 5 after the earnings call, the firm wrote that its “buy” and $10 price target remained unchanged and talked about the TRUP subscription business – which is a different animal than the actual software-as-a-service business.

Again, TRUP sells pet insurance.

Online marketing and veterinary referrals are the chief ways customers find their way to TRUP insurance. TRUP’s “subscription business” simply refers to the monthly subscription fee customers pay for the veterinary medical plans.

Yet average investors are following the lead of tech and software analysts who, we contend, are over-valuating TRUP because they’re used to the valuations commanded by those Wall Street darlings.

The opportunity simply isn’t there for a niche insurance company like TRUP to generate the gross margins that shareholders so desperately need to see.   

*TRUP Recasts Numbers: Impacts Value-to-Cost Ratio

The company uses what it calls “LVP to PAC” to determine its return on investment. TRUP’s pet acquisition cost, incidentally, rocketed 72 percent over six quarters earlier, hitting $2.9 million.

Investors may find a description of the “lifetime value of a pet” to “pet acquisition cost” here on page 13. It’s probably easiest to think of it as “Value to Cost” ratio.

If the ratio goes up, that’s good.

If the ratio declines, the lifetime value has declined and/or the cost of getting a pet signed up has increased.

At first, according to registration statement figures, the ratios improved from 2010 to 2011. But then ratios started declining:

(Source: SEC filings set a, set b)

TRUP doesn’t want to see that ratio decline.

So, suddenly TRUP “recast” its numbers in the first quarter. The company shifted “certain pets from the subscription business segment to the other business segment.”

Let’s see how this affects the LVP/Pet Ratio, what we’re calling Value to Cost ratio…

*”Woof-woof! Timmy’s In The Well,” Or Ratio Is Low Despite Recast Efforts

Below are the LVP/Pet numbers for Q4 – before the recast – versus Q1 2015 and Q2 2015 – after the recast.

(Sources: SEC filings set 1, set 2)

The ratio appears to be stabilizing at an undesirable level even though the numbers have been recast.

If these recast numbers do nothing else, they do spur big questions about TRUP’s transparency.

*California, Washington insurance commissions jump TRUP

Meanwhile, it seems TRUP’s been one misbehaving pup in the eyes of California and Washington.

Tucked away under “commitments and contingencies,” TRUP’s SEC filing suggests troubles with the Washington insurance commission:

"The Company received an inquiry from the Washington State Office of the Insurance Commissioner (OIC) in December 2012 concerning whether subsidiaries of the Company were properly licensed, and whether certain of its employees were properly licensed, under Washington law. A regulatory examination took place during the third and fourth quarters of 2014. As of June 30, 2015 and December 31, 2014, the Company had accrued liabilities of $0.3 million and $0.2 million, respectively, for this matter. Adverse outcomes beyond recorded amounts are reasonably possible. At this stage in the matter, however, the Company is unable to estimate a possible loss or range of possible loss beyond amounts accrued."

And suddenly, this quarter’s SEC filing contains no mention of the trouble with the California insurance department that was previously noted in an SEC filing in May:

"The Company’s subsidiary, APIC, a New York insurance company, received an inquiry from the California Department of Insurance (CDOI) in 2011 alleging APIC’s trial insurance policies issued in California are in violation of California law. The Company disputed this assertion. On February 12, 2015, APIC and CDOI entered into a Stipulation and Waiver whereby APIC voluntarily agreed to remove its trial certificate program in favor of a new program that was approved by the CDOI. APIC also agreed to pay a fine and reimburse CDOI expenses in an aggregate amount of $0.4 million which was accrued as of December 31, 2014. Pursuant to the stipulation, APIC did not admit any wrongdoing and continues to believe that its program was permissible under California law; however, the Company determined that it was in its best interest to resolve the dispute amicably.

“The outcomes of the Company’s legal proceedings are inherently unpredictable, subject to significant uncertainties, and could be material to our operating results and cash flows for a particular period.” 

*Chief executive yells “Sell!”

The chief executive, Mr. Rawlings – who received $3.9 million compensation in 2013 and $482,550 in 2014 - is the only insider who’s been trading TRUP in the last three months. He dumped more than 44,000 shares, as shown below.

(Source: Nasdaq.com)

*Poor headquarters

TRUP runs its operations out of an interesting building. While two other businesses have apparently left the building, Trupanions’ headquarters shares space with the local housing authority in this 1979 building – next to a dilapidated wooden shed – across from a fishing gear shop – generally located in a not-exactly-swanky part of Seattle, Washington.

*Conclusion:

In the past few weeks and months, TRUP’s stock price has jumped up and bayed at the moon. But don’t get caught up in the misplaced excitement.

Pet insurance is a tiny market unlikely to find general acceptance in the larger, mainstream US market, despite management implications that the market is wide open. The negative reviews show that pet lovers who do buy insurance may be sorry and then aren’t shy about encouraging others to stay away.

And TRUP’s gross margins – even with recast numbers – have been very low and remain awful. As TRUP increases marketing and sales to try to attract more customers, the costs will continue to slice into those razor-thin margins. It’s just really hard to make money under those conditions. In fact, TRUP’s own numbers unraveled indicate the chance of bucking 16 straight years of losses and making any meaningful operating income remains about 6 years away – that’s 42 dog years!

Finally, consider this: How much profit has TRUP generated with the money shareholders have invested so far? We find TRUP’s return on equity is a staggering negative: -382 percent!

All in all, we’re smacking a generous $2.75 per share price target on TRUP and sending it to the dog house.

* Important Disclosure: The owners of TheStreetSweeper hold a short position in TRUP and stand to profit on any future declines in the stock price.

* Editor's Note: As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies that they cover. To contact Sonya Colberg, the author of this story, please send an email to [email protected].

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