Description

THESIS

Goosehead Insurance is a recent independent Personal Insurance Agency IPO which offers home and auto insurance options. Independent Insurance Agencies give customers a variety of insurance options; as opposed to a captive single carrier agency like StateFarm or Farmers that offer just one option. We like Goosehead because it’s franchisor model presents its target franchisee’s superior economics to their existing alternatives which should allow the Company the ability to grow their franchisee base and franchisee unit economics to multiples of their existing footprint.

The corporate insurance agency industry has given a scale moat to players like AON, WLTW and BRO’s who are able to offer their clients lower premiums/better coverage due to a group pricing model. We think they present an interesting case study on how this industry will evolve and should benefit GSHD as they scale. In summary, GSHD is on the right side of an evolving industry in a business model with attractive economics that should yield a deeper and wider moat as they grow.

COMPANY BACKGROUND

GSHD insurance was founded in 2003 by Mark and Robin Jones who remain as the largest shareholders today with 60% of the equity. The story goes that Robin was frustrated with the single-carrier options on the market so she started GSHD to give customers multiple carrier choices. Mark was a long-time Dallas based Bain partner until he decided to leave and join her in 2004 to manage the Company as CEO, a role he occupies today.

The business started as a standard independent agency that took Bain’s on-campus recruiting model and built an army of brokers that otherwise probably would have joined a historically more prestigious industry out of school. As a result, they were able to build a company whose brokers are half the age of the industry average but can produce 3.5x the revenue production while maintaining a 90 NPS score (never seen a score this high).

The corporate channel infrastructure of claims agents, carrier relationships and technology allowed GSHD to build a franchisor business. They marketed the franchise to more experienced captive agents who were looking to build an uncapped income and a stand-alone business. They also offered a back-office of claims agents that allowed franchisee’s the ability to focus exclusively on selling rather than babysitting clients trying to file a claim (something that didn’t exist elsewhere in the industry).

The franchise model that Goosehead offers has been highly attractive to captive agents and today the Company has 583 operating franchisees (828 signed up) growing at ~10% quarter-over-quarter. The Company says that they have 70k franchisor opportunities in their pipeline that they will continue to convert over the next few years. There are 400k+ insurance brokers in the US so a 70k pipeline doesn’t seem that crazy. As a result, we think GSHD has a long runway to build their franchisee base.

INVESTMENT MERRITS

In Q1, 2018 the Company IPO’d to a $12 share price and ~$500M enterprise value but and has soared to the current price of $40 and a $1.4bn implied EV. For a Company with $85M of revenue and $20M of EBITDA (run-rate) the price tag is obviously enormous. But we see a couple of levers over the next few years that should give investors a margin of safety and significant upside. These levers include the following:

1.      Take-Rate Flip from 20% to 50% – the structure of the Franchise Disclosure Document suggests that GSHD only gets to keep 20% of the “New Business” commissions produced by their franchisee’s. However when a customer comes back (and they always do with a 90% retention rate), GSHD takes 50% of the recurring revenue. Since GSHD has been adding franchisee’s at a fast clip over the last few years their average franchisee age is less than a year and as such all of their commissions produced would be “New Business” and taxed by GSHD at 20%. As the book of franchisee’s mature the VIG that GSHD collects will jump to 50%.

2.      Young Franchisee Base at sub-scale revenue production – the franchisee’s who partner with GSHD are usually captive agents with existing books but they are not allowed to take their books from StateFarm or Farmers to GSHD. As such, when they begin building their business they are generally starting from scratch. Their annual total commissions obviously grows rapidly through their first 3+ years. As previously mentioned, the average age of a GSHD franchisee is under 1 year so they are in the infancy of their commission production. As they mature they should begin to produce multiples of their current commission production.

3.      Attractive Economic Franchise Model for Captive Agents – The average compensation for a Captive Agent is ~$50k/year and can fluctuate up or down 20%. This presents a problem for many type-A insurance agents who don’t want to be limited by an income cap once they have built a legitimate book of business.

Historically, they have then chosen to start their own business at a captive agency like StateFarm…but that option gives you the ability to only offer one policy to your customers. As a result, independent agencies that offer customers a variety of options have become increasingly attractive for potential franchisors. Goosehead carries one of the most attractive financial algorithms in the independent agencies. They tend to put up similar annual profits to the competition however their model allows franchisors to build a much smaller retail footprint and therefore a lower entrance cost.

Additionally, the company has a claims department that takes care of all of the maintenance of a customers need after the sale allowing franchisors to focus solely on customer acquisition. This is a part of the business that most franchisee’s prefer to focus on.

4.      Commercial Space Provides Good Case Study -  The commercial P&C space has created a couple of large agency players that are able to offer group pricing packages to their customers. When we channel checked the premium pricing on GSHD vs smaller independent agencies and they came in noticeably cheaper. As the Company grows we think they can begin offering lower premium prices from insurance companies trying to grow their book. This group pricing model will permeate throughout the franchisee base allowing them to continue to take market share.

Risks

Anytime you have a high valuation like this you are going to be reliant on a bunch of growth to justify the price paid. The company has a little over 800 franchisees signed up. If they do nothing but wait until these franchisees mature, we think the stock is worth $20. For every additional 200 franchisee’s we expect another $5 increase in the stock. So, to justify their current price alone they’d need an additional 800 franchisee’s. That might sound like a lot but the franchisee sales headcount has more than 2x’d in the last year and should continue to grow given the large pipeline. A majority of their base is in Texas which only represents <10% of the market and their pipeline includes 70k opportunities out of the 400k brokers in the US. Not to mention, the franchise opportunity seems more attractive than many of the other franchisor businesses we have studied. Given the attractive franchisee economics and the scaled pricing advantage that all the franchisee’s should receive as they grow we think the franchise count could be multiples of the existing base.

Catalyst

Continued geographic growth

Scale pricing power

Take-Rate flip

Franchisee maturation