ROOT - Root Stock: Still Not A Good Value Despite Generous Takeover Bid

2023-06-23 09:42:05 ET

Summary

• Root stock has soared recently due to reports of a potential acquisition by Embedded Insurance, but the deal remains uncertain.
• Root has struggled financially, with declining revenues, increasing losses, and weak financial strength compared to competitors.
• The potential gains from the acquisition may not be worth the risk for investors, as the deal may not happen and Root remains a struggling company.

Root, Inc. ( ROOT ) stock has soared in the last few days on reports it would be acquired by Embedded Insurance. The proposal was made several times by Embedded Insurance to Root's management. However, the latter issued a noncommittal statement saying simply that it would " evaluate how best to deliver shareholder value in accordance with its fiduciary duties. " This could mean the deal will not take place. It may, of course, happen, but there is still uncertainty around the acquisition.

In my view, the takeover is a really good solution for Root's stockholders because the price offered per share is $19.34, over and above the current stock price. This would mean a total acquisition cost of more than $80 million for Embedded Insurance. Meanwhile, Root, the troubled car insurer, has been struggling for almost two years as the post-pandemic demand for used cars has decreased. Let me explain why I am not enthusiastic about ROOT stock anyway.

Root's short history and the takeover proposal

Root has been suffering losses for a while. Its IPO took place in October 2020. At the time, its market capitalization topped a whopping $6 billion. The public debut was considered to be very positive for Root’s venture-capital backers, including Drive Capital and Ribbit Capital. There was plenty of enthusiasm about the company before and just after the IPO. That could be attributed to the fact that Root went public after other fancy technology-powered insurance firms including SelectQuote, a rate-comparison website, as well as Lemonade and Hippo backed by SoftBank. These companies all were part of the last venture boom associated with increased consumer spending on cars stimulated by the pandemic-related government checks.

Unfortunately, these businesses have since suffered dramatic selloffs in their shares. This was partly caused by a decrease in consumer spending, but also by the fact investors have started seeing higher loss ratios associated with accidents by their clients. Since its inception, Root has incurred net losses on an annual basis.

Root, founded in 2015 and based in Columbus, Ohio, is a tech-enabled insurance provider. It uses artificial intelligence and data science to faster figure out customers’ rates and streamline the claims process. The company expanded its product range in 2019 when it introduced renters' insurance.

Carvana Co. (CVNA), an online used car retailer, invested $126 million in Root in August 2021. Together they started offering insurance to clients in 2022. But declining post-pandemic used-car prices have affected Carvana’s sales and profits. Obviously, the value of this agreement for Root also decreased.

Earlier this year some of Root's executives left the company. For example, Daniel Rosenthal, the company's Chief Revenue and Operating Officer, resigned . Rob Bateman, the Chief Financial Officer and Treasurer, apparently was "terminated for cause" according to an SEC filing . It was only said that he violated some of the company's policies. The point I am making is that things do indeed look quite grim for Root. Let me also present some of the company's financial data and its sales and income history.

Root's financial fundamentals

First, let us start with Root's earnings history . In short, they have been quite horrible in recent years. I have only presented the company's earnings history for the 2018-2022 period. But as I have mentioned above, Root has never recorded a positive net result.

As you can see from the table and the diagram below, the revenues increased dramatically between 2018 and 2019. But Root's sales started falling between 2020 and 2021.

Root's revenues and income

(In Millions of United States Dollars ((USD)) except per share items)

But the biggest problem, in my view, is its substantial losses that increased between 2018 and 2019. But in spite of the high sales, the worst year in terms of losses was 2021.

However, the problems do not end here. Root's financial strength is not brilliant either. This is true of its debt position. We understand that the company's EBITDA is negative. But Root's equity (the difference between its assets and liabilities) is also quite low. We can see this from the debt-to-equity and the debt-to-EBITDA ratios below that are substantially worse than these of Root's competitors.

The same sad situation obviously applies to Root's cash flows, which have been declining for a while.

So, overall, we cannot say that Root is a very financially sound company.

Root Stock Valuation

Let us first start by looking at Root's stock price history. If you take the 3-year period, you will see that the current stock price is really low.

However, if you look at the 52-week period, you will see that the stock price increased significantly thanks to the rumors of Root's acquisition.

Now, let us look at the valuation multipliers. I was unable to take the price-to-earnings (P/E) ratio because the company has never been profitable.

But here is a price-to-sales (P/S) ratio. It is well below 1 right now. This is really low.

The same can be said about Root's price-to-book (P/B) ratio. It is currently lingering well below 1 as well.

So, although the stock does not seem to be overvalued, it looks like it is a value trap.

Risks for bulls

Root has been suffering very tough times. It has never been profitable and is now quite a small and struggling company. Some investors or rather said speculators might be tempted to buy Root's stock in the hope Embedded Insurance would acquire the company for $19.34 per share.

But it may not happen, unfortunately. Root's management has already been made the proposal several times. And anyway, as I am writing this, the company's stock price is near the $13 mark. So, in my view, the potential gains are not worth the risk because the deal may never happen. If the acquisition does not take place, the stockholders will be left with a struggling company.

Another significant risk I always name in all my articles is that of a prolonged recession. Large and profitable companies usually survive economic crises but struggling ones often go out of business. I am not saying this would happen to Root, but the risk is there.

Risks for short sellers

Obviously, all short sellers face the risk of unlimited losses if the short sale does not go according to the plan. But if you bet the deal will not take place, you may well be right. At the same time, there is too much uncertainty right now. Moreover, even if the takeover does not happen, you may lose your money the way it happened to GameStop's ( GME ) short sellers. As you might remember, there was a meme stock mania when unprofitable and problematic companies' shares soared to unseen before highs. Can you imagine what losses were recorded by the short sellers? You should not forget this risk, either.

Conclusion

The takeover deal for Root, Inc. may never happen. But the price seems quite generous. Although ROOT was once a very popular stock, the company's financials seem to be quite poor right now. Never in its history has Root, Inc. managed to record a positive net profit. So, I would personally suggest staying away from buying this stock ahead of the takeover deal. At the same time, although it is likely the acquisition will not happen, I would not sell Root, Inc. stock short, either, because of the risks involved.

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