Description

Investment Thesis:

• GSHD is a mixed corporate / franchised home and auto insurance broker. The company signs distribution agreements with various insurance companies and collects a commission on sales of policies to individuals. Commission for policies typically range from 8% to 13% depending on the agreement.
  
  

  • Franchisees collect 80% of the commission on new business and earn 50% of renewal commissions thereafter

  • Perceived value add of being a GSHD franchise to agents is GSHD’s technology and service support

    • GSHD tech allows brokers to quickly quote pricing across firms and franchise agents don’t have to handle customer service of existing policies, GSHD centrally handles all claims and issues

• Since coming public in 2017, GSHD has seen top-line CAGR at ~35% (’17 to ‘22) as it aggressively grew its franchise base and hired corporate agents. Over the last few quarters however, the business has begun to slow meaningfully, and what management and street view as temporary issues we believe are structural.
  
  

  • GSHD’s franchise model is fundamentally broken, evidenced by incredibly high 2Y and lifetime churn rates of franchisees even in their most recent “highly trained and highly selective” franchise classes

  • Looking at reported data, legacy franchise cohorts experience a failure rate of almost 80%+. Quality of franchise classes has also gotten incrementally worse evidenced by a declining 2Y success rate (# of franchises still in business after 2 years)
    
    
    

  • Similarly, when looking at the data on a blended basis, experienced franchise churn continues to worsen with the most recent quarter showing a -26% YoY decline in experienced franchises (365 experienced franchises left the system)
    
    

    • Experienced franchises are almost 2-3x as production as new franchises that are still ramping

  • Key to Model: Total Written Premiums (TWP) are key to GSHD’s revenue model and as management notes are “the leading indicator for future revenue growth”. Since 2017, Franchise TWP has grown from 58% to 80% of overall TWP.
    
    

    • However, GSHD has begun to reduce their franchise count (cutting low quality franchises but also seeing continued franchise churn). Assuming ‘20 - ‘22 cohorts experience similar deteriorating churn (they had worse churn vs. ‘17-’19 in fewer years) but ‘23 and ‘24 cohorts experience similar 2Y success rates as ‘17 and ‘18 cohorts (best available), Total Franchise will still continue to decline in ‘24 and ‘25!
      
      

      • This assumes ~80 net adds in ‘24 and ~130 net adds in ‘25 (Q4’23 and Q1’24 added 25 new franchises)

      • Consensus continues to model ~15% top-line growth in ‘24 and ~30% top-line growth in ‘25 (return to normal), but logically speaking I believe this to highly unlikely given a continued declining franchise count

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  • GSHD ‘take rate’ across TWP has marginally eroded over the last few years, however recent commission cuts by insurers in key markets will only continue to serve as a meaningful headwind to revenue growth:

  • Simplistically, we define GSHD’s take rate on TWP as L12M rolling Franchise Only Revenue / L12M TWP → As we can see below this has declined over-time, but this decline is now accelerating
    
    
    
    

    • Commission rates are not the same across states and not the same across policies (Home generally higher vs. Auto, as mix increased overall rate has come down)

    • As of 2024 however, commission rates on renewals have actually started getting CUT in Texas specifically. As the # of natural disasters has increased, insurers have been running TX policies at a loss. The cut to commission rates is an attempt to increase profitability for TX policies

    • We were able to corroborate these recent commission cuts via expert calls and via reddit. While management believes these cuts are “one-off” and isolated*,* I strongly believe we are simply seeing the early innings of these cuts
      
      
      
      

      • https://www.reddit.com/r/InsuranceAgent/comments/182zkuq/commission_cuts/

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      • https://www.reddit.com/r/InsuranceAgent/comments/1cqp19l/the_future/

    • Illustratively, a 2% cut in renewal commissions impacts GSHD / Franchise revenues by 15% → this has the knock-on effect of making franchise economics worse (potential to see worse cohort failure rates in ‘22/’23/’24 but for now we assume an improvement to give credit for ‘better selection’

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  • GSHD client retention rate continues to worsen. 55% of current book of business driven by Texas, market dynamics continue to worsen

  • Client Retention % indicates what # of customers renew with GSHD, historically this has been 89% but has now fallen to 85% in Q1

  • Management specifically calls this out as anomaly because of the rapidly rising homeowner / auto price increases in Texas (2x national increase). They believe this will normalize by ‘25 which I believe to be highly unlikely given recent trends

    • Between 1980 and 2023, TX experienced an average of 4 natural disasters per year with damages in excess of $1B. Between 2019 and 2023, Texas suffered 11 $1B+ events a year with 16 in 2023 alone. Good background here.

    • Hurricane Beryl which impacted TX on July 8th, 2024 is expected to be a $750M - $1.2B event alone (source)→ making it the earliest Category 4 Hurricane in the Atlantic in recorded history

  • Worsening retention rates, specifically driven by the Texas insurance market, will continue to serve as a headwind to GSHD’s TWP growth and as a function, their revenue growth

  • Management has recently shown little ability to accurately forecast their business. Negative view on management also confirmed by speaking with formers who call out constant turnover and strategy changes.

  • Full laundry list of recent mis-guides below, quite clear that given ongoing idiosyncratic and market related issues that management doesn’t have a handle on the business

    • Policies in Force Re-acceleration: Q3’23 Earnings: “Policies in force up 18% YoY. We expect a re-acceleration of the PIF growth rate in 2024 as aggregate new business production increases, more highly productive producers are added and we see retention rate improvement from normalized product environment”

      • Since Q3’23, PIF have decelerated from 18% in Q3 to 16% in Q4 and to 13% in Q1

        • Part of this is being driven by client retention declining (87% to 85% in Q1) and part is due to declining new TWP / Agent (new TWP / franchise is still growing)

      • Q4’23: “PIF grew 16% YoY and we anticipate growth in PIF to accelerate in 2H of 2024 with further acceleration in 2025”

        • Management changed language from all of 2024 to 2H of 2024

      • Q1’24: “PIF grew 13% vs. a year ago as temporary declines in retention rates are muting the impact of improved new business generation. We expect to see a reacceleration in policy enforced growth rate beginning in Q3’24”

        • Management changed language again from 2H of 2024 to Q3’24 **

    • Franchise Reductions: Q3’23 Earnings: “This quarter we had 89 terminations. WE still think it will be high in Q4 but believe 2024 will trend back to normal. Medium term should be a 10-15% range as we gross up the gene pool”

      • To begin, on a YoY basis in Q3’23 overall franchises were down 118 (-4% YoY) not 89, experienced franchise churn was even more elevated at 372 franchises >1 year tenured lost vs. the prior year

      • Secondly, since Q3’23 the franchise situation has gotten worse, not better

        • GSHD continues to churn ~360+ experienced franchisees in Q4’23 and Q1’24

        • YoY avg. franchise operating count has gone from -4% to -11% to -15%

      • Q4’23 Earnings: ”Confident we will see strong overall franchise growth production in 2024.”

        • Q4’23 reported on Feb 21, in reported Q1’24 numbers (March end) franchise count went down by 71 vs. up! Clear to me management has close to little visibility on forward franchise count

    • Compensation Expense: Q3’23 Earnings:“ Employee comp as % of rev is down (excl. SBC basis). Is this sustainable? Mgmt: Yes, we shouldn’t be losing scale dramatically in employee type of benefits as we onboard new agents. We are too focused on productivity to let that happen”

      • Since Q3’23, comp expense (excl. SBC) as % of revenue is actually up to 54% of revenue in both quarters (in dollars as well). Clearly mgmt. was not as focused as they should have been.

    • Corporate Sales Agents: Q4’23 Earnings: “Corporate sales headcount up 20% from its low of around 250. We plan to continue to grow the corporate team in ‘24 and the foreseeable future.”

      • In Q1’24 corporate headcount actually reduced further to back under 300
        
        

• Probability Tree:
  
  
  
  

• Q&A / Other
  
  

  • Other Angles:

    • More homeowners going self-insured in high insurance states, FL as an example has seen self-insurance go from 8% of households in 2016 to 20% today

    • Case Study on California Market, California didn’t allow insurance companies to increase premiums at true market rate and insurers started sending out non-renewal notices

      • Texas has a free market, but also has a ‘public option’ which is growing in importance, try to track down what % of homeowners switching to public market

  • What does management say about declining client retention?

    • “We are seeing very temporary challenges in our retention rates, but are highly confident we will return to our historically high retention as we progress through the market cycle”

Catalyst

Believe this breaks going into 2H'24 - management will have to reduce their FY'24 guidance and FY'25 numbers will be brought in tandem as a result. 

• Street currently expecting $300M in FY'24 Revenue ($143M already reported) and $381M in FY'25 Revenue (+27%) vs. our $280M in 'FY'24 and $311M (+12%) in FY'25 due to slowing churn, declining 'take rate' and Texas / Florida / California specific homeowner insurance market issues.