What I Like and Dislike about Trupanion (Part 1)

Quick Summary

• Can see valuation upside.
• All the pieces fit. Large under-penetrated TAM means long growth run way. Unique value proposition. The activity/value chain is specifically tailored to that value proposition and hard to duplicate. 
• On the other hand if your entire value chain is tailored to a value prop that's not appreciated by market, that’s a problem!

Trupanion (TRUP) has been a fascinating company to look into. This post will sketch out Trupanion valuation upside, as it's not so obvious. A later article will discuss more qualitative considerations.

Is This Worth Our Time? Sketching Out The Upside

Trupanion will have about $380mm revenue for 2019. The company plans to keep spending on acquisition cost such that it grows 20%-30% a year. This is possible due to an under-penetrated TAM (penetration rate in single digits).

Even if they undershoot that growth CAGR, I can see them reaching $1bn revenue in 5-6 years.

What will margins look like? Trupanion targets 15% margin before acquisition cost, depreciation/amortization (“D&A”), and stock based compensation (“SBC”). This is broken down into 70% claims payout, 10% variable cost, and 5% fixed cost. TRUP is already close to those targets.

We need to figure out what normalized acquisition costs look like once they reach scale and exit growth mode.

How Will Acquisition Costs Look At Scale? 

In other words, how much will Trupanion have to spend on acquisition cost to keep its pets enrollment steady?

The company gives its dollar acquisition spends each quarter. That and other pieces of data allow us to back out the quarterly acquisition and attrition as follows. 

Quarterly additions and attritions are about 8% and 4%, respectively, of pets at beginning of each period. 

To maintain its number of pets, Trupanion would scale down its acquisition spend, such that its pet additions matches its attrition rate. Since attrition are mostly 50-55% of additions, they can scale down their acquisition by that ratio.

Acquisition spend runs about 9% of revenue. Scaling that down means TRUP needs to spends ~5% of revenue to maintain its pet enrollment. 

Upside 

Trupanion appears to be on its way to reaching its target of 15% margin before acquisition cost, D&A, and SBC. We just estimated that they need to spend another 5% on acquisition cost to maintain pet enrollment.

That means about 10% adjusted EBITDA margin. Take out another 3%-4% for D&A and SBC leave us 6-7% EBIT margin.

$1bn revenue at these margins means $60-70mm of GAAP EBIT, or $100mm of adjusted EBITDA. At $36/share, TRUP has under $1.3bn market cap. It has little debt. So it’s trading at <13x 2025 adj EBITDA or 20x 2025 EBIT. I think there’s upside at these valuations, given the long growth runway even when we get to 2025.

Depending on market conditions, an established market leader with steady subscription revenue and long growth runway can easily be at 20x EBITDA. That would be 50% upside but spread over several years. More if you’re willing to look further out in time. 

This is not a ton of upside, but I like this business enough that I'd be interested at a lower price. I will share more of what I like in a later post.

Note: In reality TRUP’s EBIT will be lower at 2025, since it will spend more than 5% of revenue to grow, not just keep subscribers steady. But the market should value the company on future profitability outlooks (which are the 6-7% EBIT / 10% EBITDA margins)