Description

We recommend a long position in Hagerty Inc. (NYSE: HGTY), a ~$4.8B market capitalization / $4.3B Enterprise Value specialty insurance company. If you invest by running screens and buying the quantitatively cheapest options, move on – if you are interested in an entrepreneurial CEO who is building a much larger company by leveraging its current dominant position in a niche industry and aggressively investing to monetize its customers at far higher rates over time, read on.

HGTY shares trade at $14 today and we believe offer a potential 2.5-3x return over the next 5 years, driven by organic growth within the company’s current customer base and substantial growth from new partnerships with State Farm and a second large insurer (currently undisclosed; more on this later).

Description

Hagerty, Inc., the leading specialty insurance provider for collector cars (~2M vehicles covered), recently came public through a merger with SPAC sponsor Aldel Financial, Inc. Launched in 1984, Hagerty continues to be a largely family-owned (~52%) and operated business. Second-generation CEO McKeel Hagerty began selling insurance policies for Hagerty at 18 years old and has scaled the business from ~100 employees and 58,000 members in 2000 to ~1,500 employees and 1.8M members today. This is by no means a traditional car insurance company and the economics of their current product offerings, in addition to emerging opportunities, are very attractive.

There are two large, strategic investors involved with Hagerty: leading U.S. property & casualty and auto insurer State Farm Insurance and diversified insurance and financial services conglomerate Markel Corporation (NYSE: MKL).

• Markel took a 25% stake (~$213M) in Hagerty in 2019 and invested an additional $30M in the PIPE as part of the 2021 SPAC business combination. Today, Markel’s holdings equate to ~23.5% ownership of Hagerty and represents 29% of the total voting power.

• State Farm invested $500M in the PIPE (~71% of the total PIPE raised) and announced a strategic partnership with Hagerty. We estimate the strategic partnership will contribute an incremental 1-1.5M new policies to Hagerty. It is worth noting that State Farm rarely makes acquisitions or strategic investments, particularly of this magnitude. In fact, its $400M acquisition of GAINSCO in 2021 was its very first acquisition over its 99-year history, and the $500M strategic investment in Hagerty is now its largest. State Farm CEO Michael Tipsord has also joined Hagerty’s board of directors.

Investment Thesis

While some may see Hagerty as just another insurance company, we believe this is a particularly attractive business for the following reasons:

• Strongest player in an under-penetrated, niche market

Hagerty is ~2x larger than the #2 player (NSM Insurance, a subsidiary of White Mountain Insurance Group) when measured on a controlled premium basis, and earns ~3x the commission revenue. With an estimated 43M insurable collectible cars in the U.S. (the vast majority of which are not insured under a specialized collectible policy – more on this later), Hagerty has ample opportunities to continue growing from its ~2M insured vehicles today.

• Temporarily under-earning due to up-front partnership investments

Partnerships with State Farm and “Project Pershing” require substantial up-front investments in technology infrastructure, service capacity, and sales professionals. The company spent an estimated $40M in 2021 and expects to invest an additional $36-40M in 2022 to support these partnerships, but those capital expenditures will be completed at the same time as new partnership revenues come online.

• Organic growth driven by “hunting license” on existing partners

Once a partnership is set up, Hagerty works with the partner and independent agents to roll out its customer penetration strategy, which requires minimal marketing spend. As they monetize existing customer bases, Hagerty has continued to grow double digits even within their partnerships over 5 years old.

• Large reinvestment runway with attractive returns on incremental capital

Hagerty’s business is asset-light, leveraging its partners’ balance sheets for insurance products. The company generates sufficient free cash flow and should not need to raise additional capital from equity markets to fund its growth strategy. Excluding its reinsurance business, we believe Hagerty can generate 50-60% incremental margins as its growing subscription revenue drops to the bottom line. The reinsurance business is no dud, generating ~10.5% operating margins that are levered ~3.5x (capital requirements being less than total premiums), earning ~35% on every incremental dollar retained.

• Exceptional management team with a great culture and substantial ownership

CEO McKeel Hagerty, who was also Chairman of the Board (2016-2017) for the global leadership community YPO, has constructed an exceptional management team and board of directors, as exemplified by Hagerty’s win of Private Company Board of the Year at the Private Company Governance Summit in 2016. We believe that management incentives are strongly aligned with shareholders given that the Hagerty family continues to own ~52.8% of the overall business, with ~15.3% owned by McKeel Hagerty personally. Additionally, strategic investors Markel Corporation (~23.5% interest) and State Farm (~17.2% interest) maintain positions on the board of directors and have a vested interest in creating value for shareholders. 

Business Overview/Segments

The company’s current profitability is dominated by its insurance segments, but the beauty of the business (and its future potential) is more evident when broken down into the following segments:

• Insurance Agency

• Hagerty Drivers Club

• Reinsurance

• Other

Insurance Agency – Hagerty maintains an omnichannel distribution network consisting of independent insurance agents, partner insurance companies, and direct-to-consumer capabilities. Here, Hagerty acts as the Managing General Agent (MGA) and collects a set commission from each policy written.

• Fixed 32% commission on each policy sold, with an incremental 10% contingent commission if the loss book performs as expected.

• Lower churn than traditional auto insurance policies because classic vehicles have a longer holding period. The average Hagerty insurance policy has a 10-year life. Of the 10% of policies that churn in a given year, ~80% of those churned because they sold their single collector vehicle.

• Profitable customer acquisition tool for Hagerty’s higher-margin membership product, Hagerty Drivers Club.

Hagerty Drivers Club/Other Memberships – For $45/year, subscribers to Hagerty’s membership organization get access to various benefits, including the #2 automotive magazine (Hagerty Drivers Club Magazine), guaranteed flatbed towing with soft straps, access to members-only events (car shows, track days, seminars, etc.), and exclusive discounts on automotive products/services (transport, storage, etc.). We think this is a very attractive aspect of Hagerty’s business, given:

• Growing membership with sticky subscription revenue

• ~75% attach rate for each new insurance policy issued

• Potential incremental growth from the recent launch of Radius (high net worth) and Garage+Social memberships, which both have higher membership price points

• High incremental margins, primary costs related to magazine and towing benefit

Reinsurance – HagertyRe is the company’s wholly owned, captive reinsurance entity that participates in risk retention through quota share agreements. Their quota share has increased from 35% in 2018 to 60% in 2021 and will contractually increase to 80% by 2023. This crawl-walk-run setup allowed Hagerty to benefit from low loss ratios inherent in their classic auto policies while giving them time to build out a strong balance sheet. While there is very little disclosure on HagertyRe, what is disclosed shows an incredibly attractive and profitable operation. Some key features of this business include:

• All earnings retained and $0 additional capital contributions after initial investments of $25M in 2017 and $13M in 2018.

• 2018 – earned $9M on $38M of capital

• 2019 – earned $11.3M on $47M of capital

• 2020 – Earned $18.3M on $63.4M of capital

• ~3.5x leverage due to reserve requirements

• 42% loss ratios and 48% expense ratio mean they generate 30-40% returns on each incremental dollar retained.

• Lowest loss ratios in the auto insurance industry, primarily because people view their classic cars as their “babies” and drive them less (cannot be a daily driver). Another interesting dynamic that results in fewer claims stems from Carfax reports and their impact on valuations. High-value collector vehicle owners will typically make a claim only in the event of a total loss. The reason? An $80K insurance claim on a $3M car might see its value drop by $500k-$1M.

• Biggest P&L drivers here are growth in written premiums, loss ratio, and cost of reinsurance. If reinsurance costs increase rapidly, Hagerty’s growing balance sheet will allow it to take on more of the risk.

Other – This segment consists of Hagerty DriveShare (think AirBnB for classic cars), Garage+Social (upscale storage with entertainment/clubhouse environment), Hagerty Valuation Tool (go-to source for car values), events (some of the largest, most popular car shows), and its emerging marketplace/auction business. While none of these products contributes meaningful revenue today, we believe they offer an attractive upside option to the core insurance and subscription business.

• Marketplace / Auction – Hagerty recently took a 40% stake in Broad Arrow Group, a newly launched company consisting of senior executives from RM Sotheby’s. Over time, this experienced group will take over the in-person auctions at Hagerty events. In 2021, it’s estimated that $1.2B of vehicles were sold at live auctions. There is also a large opportunity here for Hagerty in the private market sales, which totaled $15-20B in 2021.

• Hagerty DriveShare – This peer-to-peer rental business, akin to Airbnb, currently has ~2,600 vehicles on its platform around the United States. Renters pay a 10% booking fee that covers operational costs (background checks, ID verification, roadside assistance, etc.) and the car owner pays 30-35% of the rental amount to Hagerty. While the absolute dollar profit may not grow to a meaningful part of the business, it has the potential to be not only a profitable product but also an excellent direct-marketing channel to convert DriveShare car owners to a Hagerty insurance policy.

• Garage + Social – There are 6 facilities in operation today, 5 in the U.S. and 1 in Canada. Each facility has an average of 250 vehicle storage slots, which range from $400-600 per month. There are also interesting potential use cases for these facilities, including add-on vehicle services, photography services for listing a vehicle on a marketplace, etc.

• Hagerty Valuation Tool – As the go-to tool for vehicle valuations, we believe there are interesting opportunities here to create major data advantages. The information asymmetry dynamic in private vehicle transactions could make a “Hagerty Seal of Approval” product an attractive value proposition for both buyers and sellers.

• Events/Sponsorship Opportunities – Hagerty has been purchasing a number of high-profile car shows over the past few years, including the Amelia Island Concours d’Elegance, Greenwich Concours d’Elegance, Pebble Beach Concours d’Elegance, and others. We believe these events provide opportunities to strengthen their brand, control the ecosystem, and offer attractive sponsorship deals on a national scale. Furthermore, given the extremely limited number of venues for effective advertising, Hagerty’s ownership of these shows cuts off potential advertising locations for competitors.

Growth Opportunities

Hagerty’s growth prospects have both a secular and company-specific component. Secular growth drivers include reclassification of production year cohorts to classic/collector cars (early 2000s cars being a prime example), increasing car valuations driving organic premium growth and higher auction/marketplace GMV, and increased production of premium luxury cars. In any given year, ~3% of new vehicles produced (think McLarens, Bugattis, Lamborghinis, Corvettes, etc.) would be eligible for a Hagerty policy. With an estimated 15.5M new cars being built throughout 2022, this would add an additional 465,000 new vehicles to Hagerty’s opportunity set, all of which would consist of higher premium policies than today’s average.

Company-specific growth prospects consist of new partnerships, direct to consumer opportunities, existing partnerships, and international expansion.

New Partnerships – Hagerty has publicly mentioned two new partnerships, code named Project Shelby and Project Pershing, that will drive significant growth over the coming years. There is also the potential for new partnerships over time, with companies such as GEICO, Chubb, and AIG.

• Project Shelby – In conjunction with the SPAC deal announcement, Hagerty revealed that Project Shelby was State Farm (#1 U.S. Auto Insurer). The product will go to market through State Farm’s Classic+ offering and will begin rolling out in 2022-2023. Based on our research and conversations with industry insiders, there are 1-1.5M vehicles within State Farm that should fall under a Hagerty policy. Since Hagerty has ~1.2M policies today, this is a major growth vector.

• Project Pershing – Hagerty has not yet confirmed the identity of this new partner, but we are highly confident that it is USAA (#5 U.S. Auto Insurer). If this is the case, we estimate an additional 400-600k vehicles should fall under a Hagerty policy. How did we conclude that USAA is the mystery insurer behind Project Pershing? A bit of sleuthing:

• Our first clue comes from Hagerty’s public filings that describe their partnerships as including “9 of the 10 top auto insurers, including new partners” and then qualify top auto insurers as measured by auto premiums written.

• We were able to confirm Hagerty partnerships with all but 3 of the 10 insurers listed above: American Family, USAA, and GEICO (Berkshire Hathaway). 

• Our second clue comes from the only other mention of USAA in any Hagerty filings. On pages E-7 and E-8 of the proxy statement, within the Fairness Opinion offered by specialty broker ThinkEquity, is this:

• Noting that Project Shelby (starts with “S” and is a car) correlated to State Farm, we wondered if the name “Pershing” could have any sort of connection to USAA. With a quick search, we discovered that General John J. Pershing was one of the first military leaders to recognize the value of the automobile in military operations while pursuing Pancho Villa in Mexico. Bonhams, a private auction house that includes classic/collector vehicle auctions, highlights the story in its auction of General Pershing’s 1918 Locomobile Model 48-2 Sportif Touring Car (it sold for $161,000). Given USAA’s military affiliation, the historical connection of General Pershing to the car industry, and additional industry calls, we strongly believe that USAA is the logical mystery partner.

Direct to Consumer – Today, 45% of Hagerty’s sales are generated through direct distribution, a channel which can be driven from numerous angles.

• Hagerty’s brand is recognized as a top brand in the classic/collector car space. On many related affinity forums/blogs, you will frequently see people who inherit a car from a relative and ask about its value. The overwhelming response is, “call Hagerty.”

• Partnerships/placements within the online marketplaces are another source of potential customers. RKmotors.com, a popular marketplace for classic/collector vehicles, has a direct link to Hagerty for insurance quotes. The platform is owned by Rob Kauffman, who is also a member of Hagerty’s board and was the CEO of the Aldel Financial SPAC.

Existing Partnerships – Hagerty has existing partnerships with the top auto insurers as well as independent agents/brokers (10 of the top 10 brokers by revenue).

• These channels have consistently driven double-digit growth with minimal marketing spend, driven by further customer penetration and growing customer bases within partners.

• Deeply integrates with partners’ omnichannel capabilities. In addition to partner agents advertising the product, customers acquired digitally are automatically directed to Hagerty.

International Expansion – Hagerty is well positioned to capture additional market share in Canada and has the infrastructure/agreements in place for a larger UK/EU rollout.

Why Should Hagerty Win?

Value Proposition to Customers – When we think about the value proposition here, we need to differentiate between the car owner/enthusiast and the insurance partners (which, yes, are essentially customers). Hagerty’s Net Promoter Score (NPS) of 84 compared to the insurance industry average of 39 is indicative of customer experience. When discussing a partnership with big insurance companies, McKeel Hagerty tells them, “I guarantee you, when we talk to your customers, they like us better than they like you.”

• Car owner/enthusiast – significantly lower (30%+ in many cases) annual insurance premiums than those under traditional auto policies and substantially better coverage.

• If an accident happens, traditional auto policies only payout depreciated or actual cash value, which can be a fraction of what the vehicle is actually worth. With a Hagerty policy, you agree to a value upfront and receive that value if there is a total loss claim.

• Many accidents don’t result in a total loss and repairs can be an incredibly intricate process for classic cars, requiring an in-depth search for scarce replacement parts. Not only does Hagerty cover original parts, but it also has a team of parts finder specialists that will help you track down the parts you need. While 15 minutes may save you 15% with GEICO, they certainly won’t be helping you track down a 100-year-old windshield to bring your baby back to its original glory.

• Insurance partners – partnering with Hagerty is a strategic offensive and defensive decision for traditional auto insurers. Hagerty’s sole focus is on the classic/collector car enthusiast, resulting in a better customer experience, enhanced service, and increased efficiency, all while avoiding channel conflicts with their partners.

• Defensive Benefits: the complexity of underwriting and servicing a classic/collector car policy cannot be understated. Each and every policy is unique because each car being insured is unique and claims take ~3x longer to handle. Given that classic/collector policy premiums are a fraction (~8-10%) of the overall household premium (daily driver, home, valuables, umbrella, etc.), traditional insurers would rather cede the $350 in premium to Hagerty than risk bungling a claim and losing the entire household. In fact, independent agents actively hunt for this customer profile (particularly if the classic car is on a traditional policy) and peel the household away from State Farm/Progressive/etc. by switching the classic car to Hagerty and pairing the daily driver/home/umbrella policies with a regional insurer (which typically pays a larger agent commission).

• Offensive Benefits: Hagerty partners can exploit the defensive weaknesses of non-partners. Given that a vehicle on a Hagerty policy is typically 30%+ cheaper than when the same vehicle is on a traditional policy, a State Farm/Progressive/Allstate can hunt for these customer profiles within GEICO or other traditional insurers and offer better coverages at a lower combined price. State Farm/Progressive/Allstate earn a commission from Hagerty but more importantly, they profit from the substantially larger household premium inherent to customers acquired using this approach. Reinforcing this point, Hagerty states that “each of the top 5 partners reports double-digit growth and segment acceleration” within these partnerships.

Emerging Data Advantage – Hagerty’s products, services, and intimate reach within the classic/collector car ecosystem are creating an emergent data advantage that we believe will drive substantial value creation and create sustainable competitive advantages.

• Extremely Rich Data Sources – as part of the insurance underwriting process, Hagerty receives a substantial amount of first party data on the applicant (name, location, credit score, etc.). For those policyholders that also become members of Hagerty Drivers Club, the information vectors multiply. Data such as media consumption/engagement, types of vehicles or valuation ranges that are being looked at in the Valuation Tool, interactions on message boards, DriveShare rental history, etc., can all be used to build detailed customer profiles. Reinforcing their data advantage on the valuation side, Hagerty sees 200k+ vehicles flowing through its membership ecosystem each year, in addition to the 20,000 vehicle data points from public auctions. There is a reason Hagerty does not require an appraisal when underwriting their policies – they have more and richer data than the appraisers do!

• Proprietary Decoder – data is only useful or valuable if it can be cleaned and arranged in a way that facilitates better decision making or product development. In the insurance business, it is of paramount importance to know what exactly it is that you are insuring. However, vehicles manufactured in 1981 or earlier had serial numbers instead of VINs. While VINs are universally decodable today, serial numbers were non-standardized, and each car manufacturer had a different numbering system. In the classic/collector car space, not knowing what the serial number is indicating could result in large losses, potentially issuing a $100k policy coverage on a vehicle that is only worth $20k. Hagerty created and patented a serial number decoder covering ~87% of all U.S.-registered vehicles that can “tell you what it is, where it was built, and where it’s resided for the last couple of decades.” 

• Future Monetization – we think the combination of rich data sources and proprietary insights will allow Hagerty to better target new and existing customers in interesting ways. One example would be within their emerging marketplace offering. Hagerty knows the type and number of cars a customer owns, where they are stored, and their overall financial picture, and also may be able to determine intent to buy/sell based on digital behaviors. This could lead to interesting and effective targeting for specific vehicles being offered on the marketplace or in private transactions.

Valuation

We believe 28x EPS is reasonable for Hagerty because of its long growth runway and attractive returns on incremental invested capital. Comps of slower-growing insurance distribution businesses trade around 25-30x EPS today and have substantially less attractive prospects for incremental capital deployment. These expectations result in a $37 share price in 5 years, representing a ~22% IRR from today’s price.

Our base case assumes an ~18% CAGR in policies-in-force, reflecting a gradual uptake in new adds from the State Farm and Project Pershing partnerships. This case reflects a 41.5% normalized loss ratio, a 75% attach rate for Hagerty Drivers Club (in line with historical reporting), and 4-11% market share in the online/live auction and private marketplace.

Our bull case assumes a ~22% CAGR in policies-in-force, reflecting a more rapid uptake in new adds from the State Farm and Project Pershing partnerships. This case reflects a 100 bp improvement in loss ratio to 40.5%, an 85% attach rate for Hagerty Drivers Club, and 12-18% market share in the online/live auction and private marketplace.

Our downside case assumes a ~12% CAGR in policies-in-force, reflecting muted uptake in new adds from the State Farm and Project Pershing partnerships, as well as slowing growth in existing partnerships. This case reflects a 100 bp deterioration in loss ratio to 42.5%, a 67.5% attach rate for Hagerty Drivers Club, and 1-5% market share in the online/live auction and private marketplace. 

Why does the opportunity exist?

Hagerty went public via a SPAC (a hated space today), has no sell-side coverage, and has a thinly traded float (~$2M/day). It also screens horribly (~88x 2022E EPS) due to current investments in capacity to support valuable upcoming partnerships. These costs will be rolling off at the same time new partnership revenues come online, which will lead to drastic changes to the P&L statement.

Risks

• Risk 1: Reaching for incremental market share results in substantially larger loss ratios.

• Risk 2: Loss of a large insurance partner or botched rollout of State Farm / Project Pershing partnerships

• Risk 3: Focus shift away from narrow niche to the broader auto or insurance market

Additional Resources

• 2021 Capital Markets Showcase – Link

• Classic Motorsports Interview w/ McKeel Hagerty – Link

• Hagerty Interview: The Changing Role of the CIO – Link

• McKeel Hagerty – Life & Leadership Without Boundaries – Link

• Constant Transformation w/ McKeel Hagerty - Link

Catalyst

Upcoming earnings release illuminates attractiveness of business and sell side coverage initiations.