3 lessons from Root’s IPO pricing

Last night neo-insurance provider and former startup Root priced its IPO at $27 per share, $2 per share ahead of its $22 to $25 target price range.

According to Root, it sold 26,830,845 shares in its IPO, including 24,249,330 from the company itself. Its underwriting banks have the option to buy another 4,024,626 at the IPO price, less “underwriting discounts and commissions.” The remaining shares are being sold by existing shareholders.

At $27 per share, Root raised $654,731,910, but that figure will rise to $763,396,812 if its underwriters exercise their option in full, using the full $27 price for our calculation. Per its S-1 filings, both Dragoneer and Silver Lake will purchase $250 million of Root stock at the IPO price once the IPO has closed.

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Root will therefore raise north of $1 billion in its IPO, once all shares sold are counted. Doing some loose math, Root is worth around $6.8 billion at its IPO price, though Renaissance Capital, an IPO specialist, puts the figure at $7.1 billion on a fully diluted basis.

For the Midwest, Ohio-based Root’s IPO is a win. The company shows that it is possible to build high-growth technology companies worth billions of dollars far from coastal hubs. For the broader insurtech space, Root’s IPO is a win. The company follows Lemonade to the public markets, setting a strong valuation mark again for the neo-insurance startup market.

For similar companies like Clearcover, MetroMile and all startups that related to Root and Lemonade, it’s a good day. Let’s get into what we can learn from Root’s pricing.

Three lessons

Insurance multiples are hot. Key from Root’s IPO is the fact that we can now see insurance revenue being treated similarly to software revenue. How so? In multiples terms. Let me explain.

Root generated $245.4 million in revenue during the first and second quarters of 2020. That’s a run rate of around $491 million. At $7 billion, that’s a 14x revenue multiple. For an insurance provider with scant gross margins! Wild. Given Root’s weak-looking Q3 2020 revenues, that number isn’t going to fall anytime soon.

For companies that are not pure-play software outfits and want to go public, Root’s strong, above-range pricing makes it plain that there is investor demand for more than one type of revenue growth.

Investors are betting that Root’s history of growth will continue. In the first half of 2019, the company’s revenues were a mere 42% of what it pulled off during the same period in 2020. If the company can more than double again next year, then, hey, maybe all the numbers work. But to see public shareholders take such a growth-and-valuation flyer on an insurtech player is notable.

Kyle Nakatsuji, co-founder and CEO of Clearcover, another neo-insurance provider, explained to TechCrunch via email what he thinks is going on: “It’s clear that the market is aware of the massive opportunity for technology-enabled disruption in the category and it is rewarding those companies that focus on customer-oriented, digital innovation. The rapid growth of key players in the space is now proving this will play out and the winners will be consumers seeing lower prices and investors seeing better returns.

Investors are into more than software growth stories. A key story in 2020 has been the ascent of the value of software companies. This was already a narrative leading into this year, but after COVID-19 shook up the global economy and accelerated companies’ digital transformation efforts, it became clear that software companies were well-situated for the future.

That meant that investors were willing to pay more for their shares today in expectation of better growth in the future. Software companies have strong gross margins, implying large future cash flows. All you have to do is mix in a bit of optimism, and you can pay nearly anything for software revenues today if growth expectations are large enough.

Root shows that this sort of optimism is not constrained to software companies. For companies that are not pure-play software outfits and want to go public, Root’s strong, above-range pricing makes it plain that there is investor demand for more than one type of revenue growth. (Could this augur well for Airbnb, which won’t have Slack-like gross margins?)

To be clear, 14x revenues for a high-margin software company with strong net-dollar retention would have been great not that long ago.

The IPO waters are still warm directly before the election, giving succor to companies that hope to debut in early December. Finally, forget everything you were ever told about the IPO timing around IPO years. Forget not going public during an election year. Forget not going public near an election.

Screw it. Go public whenever. Investors want growth in a zero-interest-rate world and don’t care about whatever else is going on.

This is great news for the wave of IPOs I have heard people chat about that come in early December, or, variously, early next year. Why? Because Root’s above-range pricing and upsized IPO imply that it doesn’t matter what is going on politically for public offerings.

So, no matter who wins the election, or how the transition goes — if the markets stay rich, the IPOs can flow. After all, if Root going public during early voting is not a big deal, what could be? The old rules are from a time when there was yield in the market, making risky IPOs less attractive. Now there is no yield, making IPOs year-round fare.

I’m talking to Root later today after it starts trading, so we may be back on this topic tomorrow.