Goosehead: Insuring Coverage - [Business Breakdowns, EP.212]

30:39whereas many other agencies are basically spending a lot of money on mailers or internet leads, which are highly inefficient relative to what Goosehead's doing. And by bringing to bear not just product choice, but the technological capabilities and the service levels, it's the totality of what they do that leaves them in somewhat of a category of one within their preferred way of going to market. I sometimes try to overpower and isolate things, which I understand can't really be isolated because it all operates in a system together. On the referral partner aspects and what that's doing, I thought it was interesting you mentioned there's not actually a payment made.

31:28It's much more about what they can do. In my mind, I'm thinking if I am one of those referral partners, maybe I'm the real estate agent, I would certainly prefer to get dollars in if I can. Is Goosehead really just filling a void in the market where those underwriters that might pay that referral don't have policies, but you know you can rely on Goosehead for it? How would you describe that? Because it is an interesting dynamic when there's not dollars and cents being exchanged. You have to really think about the different types of competitors that they're competing against. A captive, as we discussed before, they're not able to compete in the vast majority of situations in terms of the best price for a given coverage.

32:16If you were a referral partner that's relying on a captive, your clients are being underserved from a product choice and pricing perspective. I think that with the affordability challenges today in the housing market and the dynamics around monthly payments, if you're able to bring down that insurance cost, it can really move the needle with respect to people being able to get into the homes that they need. So that part is really important. A more traditional IA lacks the service capability that Goosehead is so known for. Go back to the business model design of separating sales and service. A lot of traditional AIs are overwhelmed with the various aspects of running their business, including servicing their clients, that they're not able to be as responsive as Goosehead.

33:14And so in the context of the referral partner, they want to solve for that financial aspect to it. They want the service aspect to the binder and the closing process to always go off without a hitch. And effectively, they want their client to feel really well served and be willing to refer that loan officer or real estate agent to their friends or do business with them again. And so I think that in my discussions with referral partners and Goosehead agents, the cohesiveness with which they work together in shared outcomes is really paramount relative to what's really a nominal fee that someone could be paying them to get business that really isn't matching up against everything I just described.

34:06And on the individual agent side, are they compensating their agents any differently? I understand there's a separation in terms of they let their hunters be hunters and not have to worry about the harvesting aspect as much, which I think is an extremely valuable strategy, especially with something like this. But is there anything else when it comes to compensation that differs from the rest of the industry? I don't know that that's particularly different. I think what's different is the productivity levels result in an ability to scale a business either as an individual corporate producer or as a business owner in the context of the franchise channel that's otherwise much more difficult to do.

35:00And so I think the way that the franchise commission splits work is Goosehead will receive 20 % of new business commission as revenue and then 50 % of renewals. And so I think that the value proposition as a franchisee is that Goosehead's effectively providing this proven go -to market strategy and all this infrastructure training support in order to grow their business in a relatively unfettered way that's much less capped in terms of the profitability that they can generate relative to many other franchise opportunities and other ways of operating as an insurance industry. agency. I want to transition a little bit into that franchising franchisee dynamic.

35:53Is this common in the insurance space? And what would you point to in terms of the value prop of creating franchises and why it makes sense versus just having individual agents that are corporate level agents under one umbrella? It's not very common. Goose had introduced their franchise operation in 2012. There's a company called Brightway that began its franchise model in 2008. Goosehead has scaled its franchise business at a much more rapid clip. As with all franchise businesses, the franchisor, in this case, Goosehead Corporate, is effectively able to grow its distribution in a much more capital efficient manner.

36:44There's a symbiotic nature that GUSED has between its corporate agency and its franchise and to have built a very successful corporate agency and then layer on franchise, which has increasingly become the main thrust for the economic engine. In combination, that is a superior way for GUSED to thrive longer term. Effectively, the aspects that corporate has proven out can be taught as best practices, and they work side by side and cohesively in order for the franchisees to be successful. And in recent years, they've really leaned on adding additional producers to franchisees that are ready to scale.

37:35And one thing that Gusset has done very well is create effectively a recruiting machine across various lines of business in order to add very productive capacity to its go -to market efforts. The franchise model in the context of insurance works particularly well for them. Other than Brightway, I don't believe it's very common outside of those two companies. Given the history, basically, of the captive structure that they've kind of been disrupting. When I think about the growth of the franchisees, you mentioned it a little bit there in terms of the recruiting tool, is what you're typically seeing insurance agents from other agencies come over and create new franchises under the umbrella?

38:28Are they joining existing franchisees? I know it's going to depend a little bit, but is there anything else that goes into it besides a traditional recruiting process to open up a traditional franchise? From the time of its IPO through 2021, call it, the efforts on the franchising side leaned heavily on recruiting folks out of captive agencies that weren't necessarily the owners, but were motivated producers that could fit well into Goosehead's system and make a better livelihood for themselves in the context of what Goosehead was able to sort of unleash with them. There's definitely always been a portion of folks that have no insurance background that can fit well into GUSED's franchise system.

39:22But I think increasingly, the company has been focused much more on high quality franchise partners that have ambition to grow their business to be significant beyond one or two producers. And we can get into some of the components around that. But there was a pivot readjustment phase starting in late 2022 that has really been impactful to the level of profitable growth that the company has pursued and continues to pursue going forward. Maybe we can jump into that. What was the driver and the ultimate decision around what happened? Effectively, the company ran into a challenging period in 2021 and 2022, where recruiting standards had deteriorated, as they put it, resulting in a rising level of unproductive corporate and franchise agents.

40:31In addition to that, service hold times became elongated. These dynamics were amplified by a historically difficult real estate and insurance market environment. The company responded pretty forcefully with that, but I'll just walk through some of the dynamics on the housing market really quickly because that's really important to the go -to market motion. And effectively, existing home sales dropped from $5 .5 million, $6 million in 2021 and 2022 to near $4 million more recently. And Goosehead has actually been able to more than offset this drop and lead flow per referral partner by adding more referral partners and actually generating materially higher lead flow per agent.

41:17Their value prop has become stronger to referral partners and clients with the housing affordability challenges that I mentioned. But it's worth noting that only 20 % of Boosted's revenue is new business and 80 % of that is referral partner driven. So only call it 16 % of their revenue is driven by the housing market. So what happened in 2022 was Mark Miller joined as COO in May of 22. He was a board member since the IPO. He has since become CEO in July of 2024. Mark Jones Jr. was promoted to CFO in September 22. And in the second half of 2022, they basically developed a plan to refocus efforts and resources on growth that's more profitable and has strengthened its competitive mode.

42:07In short, an intense focus on operational excellence, putting in a firmer foundation for the company to scale to be a much larger business. They reorganized the sales management function, consolidating corporate and franchise sales management teams to drive significant improvements in productivity. They went through a very meaningful period of calling underperforming corporate and franchise agents and franchisees starting in late 22 that abated largely in early 24. To put some numbers around that, the corporate agent headcount peaked at over 500 in the middle of 22, troughed at around 275 in Q1 of 23, and has ramped significantly in the back half of 2024 after productivity reached excellent levels.

42:57In 23, corporate productivity was up 27 % year over year despite those difficult housing and insurance market challenges. On the franchise side, operating franchises peaked at over 1 ,400 at the end of 22 and has stabilized around 1 ,100. And this is where it gets really interesting. More importantly, franchise producers has remained relatively stable, peaking at around 2100 near the end of 22 and only dipping down by about 7 % in early 24 and now back up to 2100. And the company has really leaned in on partnering with a subset of franchisees who are in a position to scale further by helping them recruit new producers.

43:42So producers per franchise has increased from one and a half in 22 to 1 .9 by year and 24. And franchise producers were up only 7 % year over year, yet franchise new business productivity was up 49 % in 24. And what's really interesting is that when a new producer is added to a franchise, it improves the productivity of everyone in the agency. And every new producer added to a high -performing franchise is equivalent to launching almost two new franchises. So what they've effectively done is taking a much closer look at where to add productive capacity into their system in the most efficient manner to drive success.

44:31And another way that they've done that is creating a pathway for very successful corporate agents to launch franchises, beginning with a very high level of productivity and ambitions to scale. In 23, 30 corporate conversions yielded the equivalent of 200 typical new franchises. And this pathway from a corporate agent to a franchise owner is now a key part of the campus recruiting effort that they bring to bear. And so in 2024, they onboarded over 800 sales agents across the business, a record recruiting effort. And EBITDA margins expanded from 14 % in 2021 to 32 % in 2024. And EBITDA dollars increased nearly 5x over that time period.

45:21One of the things that's most interesting is the next evolution for the company, where they're building out a third distribution channel. I want to just focus on the financials for a little bit and then move on. It sounds like They had this period of time where they re -evaluated the business, trimmed some fat, really focused on leading into strengths. On that EBITDA margin expansion, what did it look like in 22, 23? Was there a drop before you saw that increase again in 24? The margins really dropped. The company generated EBITDA margins through 2020. In 2021, they dropped to 14 % and scaled from there.

46:07It's important to understand high -end corporate producers initially weighs on profitability. They ramp pretty quickly within two years. Whereas if you're putting new producers into the franchise system, there's very little cost running through the P &L that's associated with that. effectively management's attention was being drawn to unproductive parts of the system. And so that calling process created a much healthier system and they just became more efficient in sort of every way. One other aspect that's important to understand just from a P &L perspective that we sort of hit on before, but it's worth highlighting this is franchise new business, 20 % of the commissions go to goose head in year one, and the renewals, 50 % go to goose head.

47:05So there is a mechanical increase that's very significant for the renewal side of the business. And really all the money is made in the renewal side. As the business continues to mix shift to renewal. That's what's really driving the increased margin profile of the business, as is the continued mix shift to franchise and away from corporate. That all makes a lot of sense just in terms of understanding the ins and outs. If we focus on the top line, obviously, there's the underwriting of policies, there's a renewal policies. How do you just think about that formula for top line growth, whether it's recruiting new franchisees, bringing them into the system, policies, anything that you can get into that describes what a reasonable rate of growth is for revenue?

47:59Gross written premiums are the leading indicator of revenue growth. Agent count is really the key driver, but really productive capacity, as mentioned before, highly productive agents versus low productive agents can have a really big difference. Aside from agent count, productivity per agent is also key. There's also a component to policy premiums growing over time. In recent years, that's been very significant double digits, but should trend down to a more moderate single digit pace that will improve retention. And so the way to think about the way the company is growing is across the different programs that they have.

48:44So corporate is roughly 20 % of total producers. They are hiring more quality corporate agents with a large university recruiting program. On the franchise side, which is really the main focus, they have that agent staffing program whereby Goosehead has dedicated recruiters that are helping existing franchises accelerate their growth. They're launching additional franchises with a greater focus on franchises that have the willingness and ability to scale. They've doubled the franchise development team recently. There's corporate conversions that I mentioned before, launching high -performing corporate producers into new franchises.

49:28Roughly 35 or so, I believe, have done that since 2023. And there's also these middle market franchises that are a partnership in nature where Goosed is effectively embedding a franchise into other businesses that have built -in lead flow. companies within real estate, such as mortgage servicers. And this is actually an area of the business that's effectively going to turn into like the third leg of the stool in terms of their go -to market strategy, which I find really interesting and is supported by a lot of what they've built over time and is hard to replicate their value prop that they are bringing to bear.

50:18Is there a way to quantify the opportunity that would exist in that third leg? It's massive. Anyone with a mortgage is effectively going through a mortgage servicing process. Those businesses are seeking to integrate insurance economics by embedding a franchise into their existing operations or partnering with Goosehead in what they call their enterprise corporate agents, where those agents are effectively being fed inbound leads rather than the core referral partner go -to market strategy. An example of this is a partnership with Vivint Smart Home. At year -end 2024, enterprise agents grew to 65, roughly doubling year over year.

51:07That embedded middle market franchise category is really unlocking new customer pools that are distinct from their existing go -to -market approach. They have an embedded franchise with a national bank that spans both its mortgage origination and servicing divisions. These efforts are being powered by GUSED's proprietary technology. Its digital agent and its QTI technology really enhance the productivity of those efforts and accelerate the onboarding of new agents. Goose had seen a significant uptick in inbound interest from national mortgage servicers to integrate with them through one of these different options.

51:50They have a unique ability to provide product access effectively nationwide with extraordinary client service and technology that helps those brands cross -sell and makes Goose kind of the natural partner of choice. The pipeline for those types of partners is quite large. There's really a potential for the enterprise agent production to exceed Goosehead's traditional corporate agent approach over time. Mortgage servicers could be a massive unlock. relatedly, DTC Auto, which we touched on earlier as part of the industry, is predominantly so -called non -standard customers. Goosehead could potentially use its digital agent, its QTI, and its partnership approach to be a leader in a different segment of the market in a manner that doesn't currently exist in the market today.

52:46They're talking about all these different aspects, and today they're relatively small, but they could certainly grow in terms of the size of the overall mix. And it would further temper the company's exposure to the housing market dynamics that we walked through previously. It's always interesting when you have an industry that's evolving and a player that's sitting in the front row seat to drive that evolution, even if they are smaller in size today. On that point, just in terms of navigating certain market exposure, housing exposure, what type of cyclicality do you see in the top line? I think you described a little bit from an EBITDA margin perspective, but how sensitive is this business to the economy when you see swings?

53:34I know we haven't seen a material swing necessarily in a while, but any gauge for that? It's worth mentioning at the outset of the answer to that question that anyone with with a mortgage or that drives a car must have homeowners and auto insurance. It is a required purchase. It's not something that people can typically stop having in times of economic stress. Goosehead as a business is still relatively small in the context of the industry and within the home purchasing side of the business. So what they've been able to effectively do is focus on geographies that have product availability where they can match productive capacity to that.

54:26That has allowed them to navigate a historically tough environment relatively well. We didn't go into this in a lot of detail before, but effectively an agent develops these relationships with their referral partners. Well, if the lead volume per referral partner is going down because of housing market transactions, they've been able to go out and cultivate additional referral partner relationships and more than offset the decline in the home transaction market. That's been a particularly impressive aspect to the business. The most important aspect to the trajectory of the business is really around the insurance market cycle, that product availability piece.

55:15The hard market cycles are when lost trends basically unexpectedly increase such that the insurers are no longer profitable and need to go through that filing process. on a state -by -state basis. As mentioned before, that can really hurt the ability to convert new business. But what we've been seeing more recently is that there's a healing process that has taken shape. Auto is out in front of homeowners insurance. The first nine months of 24, the industry statutory auto direct loss ratios were about 65 % versus 75 % the year ago. Many of the large auto insurance carriers are pursuing growth, homeowners direct loss ratios were 67 % versus 81 % a year ago.

56:10There is that process that happens where carriers on an individual basis need to stop pursuing growth to heal their profitability. And I would just go back to the natural hedging that Goosehead's business model has, whereby as that product availability becomes more scarce, premiums are actually increasing. So while it places challenges on the new business production and can hurt retention, it's driving up the value of that renewal book. And as that cycle turns, it's clear that the product availability aspect, when it's pronounced hurts them more than the increase in the premiums that they're getting.

56:56And now they're going through a cycle or through the course of 25, the premium increases are going to come down. The rate at which the renewal book improves may not happen on a one -to -one basis, but effectively their client retention should go back to historical levels and they should be able to grow on a much more unfettered basis going forward. And so we've really gone through this particularly intense period of time, and the company has been able to grow very effectively right through it. Piecing it all together, you talked about the capital efficiency associated with the franchise model.

57:37Does the business produce cash flow? How does it manage the various capital allocation opportunities that it has? The business does produce free cash flow, generated about $60 million in 2024. The bigger the business becomes, the larger that renewal book is, particularly as it becomes more weighted to franchise, the higher the margin the company will have and the more free cash flow it will produce. historically the company had not pursued share repurchases they did in fact do so in 2024 when the stock became dislocated for some period of time which was great to see them make that choice they've done special dividends periodically they just did one recently i think the company's effectively committed to increasing margins on an annual basis, but they're really squarely focused on that long -term target of becoming the leader in the industry.

58:45And there's not a real big trade -off between growth and profitability, particularly as you add productive capacity on the franchise side, that cost isn't really being born on their P &L. And there's that delay effect that we talked about in terms of the new business being 20 % to QCED, but then flipping to 50 % on renewals. And so you've seen revenue growth come down because the corporate agency side has slowed where franchise has remained a fast grower, but there's that effect on the accounting side where it will then catch up as that renewal takes place. On the risk side of the equation, thinking about competition, how much of a threat is either existing competition or the potential for new entrants or incumbents in new markets that they try to enter?

59:43I think this is where it gets really interesting. There's no question that there's competition. There's zero barriers to entry in this market. But I would argue that there are increasing barriers to compete effectively with Goosehead in the channels in which they operate. and there's meaningful complexity across the multiple facets of the business model, I think it's helpful to think about competition at the various levels, whether it be referral partners, hiring corporate agents, franchise entrepreneurs, and partnerships. And I think Goosehead's relative value propositions have strengthened over time.

1:00:24They're still less than 1 % of the market. There's lots of room for multiple players. I would sort of pose a few questions here in the context of your question, which are, does Goosehead have the best business model, strategy, and people powered and accelerated by innovative proprietary technology? At a certain point, did it become the case that its ability to execute matters most in determining the level of success it has had and will have over time. Over time, has it become the case that the people at Goosehead are actually the secret sauce and the most critical ingredient in strong execution?

1:01:03And how hard is it for someone to replicate their success? Is it becoming increasingly difficult? And is anyone really pushing hard on that? I think that all the different components of what they do are hard to replicate. You can't just throw money at it. It takes time. There's cumulative knowledge. There's reputation. There are relationships that are built. There's room for others to succeed, but it's largely down to execution for them that will determine the pace and ultimate size of the business over time. Are there other risks that stand out to you? I think we've talked through a variety of different times of stress for the business historically, but what do you view as risks that maybe we haven't talked about as much?

1:01:51The company did experience some pressure last year with a couple isolated instances where two younger carriers that were suffering from elevated losses that we talked about in terms of the Texas homeowners insurance market. those companies got to a point where they were effectively not wanting any new business, while they needed to reprice themselves and change the structures of their policies. And honestly, we're also in the midst of shifting their own business models. And so Goosehead did feel pressure on renewal commissions being cut by those two players. I would say that that's not been something that has happened outside of those isolated instances.

1:02:39Carriers generally need quality distribution partners, and that requires paying competitive commissions. Given that many agencies are much less efficient than GUSED, and those agencies represent the vast majority of the industry, significantly reducing commissions would be very impactful and potentially shift the competitive dynamics even further into a scale player's hands. That risk will always exist in theory, but the level of partnership and the ability to drive profitable business keeps Goosehead in a good place with respect to that. There is some level of carrier concentration that exists.

1:03:23It's still a very fragmented industry. There are a few carriers that represent a meaningful portion of Goosehead's business, but not something overly concerning. I think from a disintermediation perspective in terms of the agent's role within personal insurance, we walked through the statistics around the IA channel taking share or at least maintaining it. and the captives really being the shared donors. I think GUSED's technology with its digital agent and its ability to bring large amounts of proprietary data to bear in a future state where AI becomes a greater risk and opportunity for the business, they are pretty well positioned with respect to that.

1:04:18Yeah. The truth is, and younger people may not appreciate this, but there's a lot of nuance to homeowners insurance. It's different than auto where there's maybe only a certain number of factors to understand about coverage. Whereas homeowners insurance, there's a bunch of elective coverages that you would not necessarily understand and can be recommended by an agent. And if you have poor coverage, you can really be in a financially disastrous situation if you're not covered correctly. And effectively, you're not really paying anything for that agent's advice. So I think the agent's role will continue to exist.

1:04:59But there is definitely an opportunity within that partnership structure that we referred to earlier in terms of that third distribution channel where more technology and more data can be brought to bear in a way that hasn't existed before for the industry. What's interesting about that as a final point is carriers have been extremely reluctant to create a dynamic where there's an online travel agent type situation where pricing is widely available in a comparison setting that can really hurt profitability. Goosehead has built a business based on profitable growth for carriers with agent and quality control elements to it that have gotten them to a point where they've been able to partner with this QTI technology and the digital agent to create these bindable quotes.

1:06:05And I think that's not really been seen in other parts of the industry. There is some innovation in embedded insurance in areas like home builders, where there are other players that are attacking that market. Those are the various risks, I would say. and really just their ability to continue to attract agents that can be productive and have a culture and philosophy around winning effectively. On valuation, there's a lot of different ways to look at insurance businesses, businesses that revolve around franchising. What's just the general approach from the market for valuing Goosehead, whether it's a certain metric or methodology that's used.

1:06:54My perspective on this may be somewhat limited relative to what the overall market assesses the business has, but it's really considering a range of outcomes in terms of the free cash flow per share that the business can generate over the long term. Assessing what that is informs judgment on valuation multiples that would be reasonable or not today or a few years out. I think that's the easiest way to think about it. There's not really tricky working capital dynamics that impact EBITDA to free cash flow conversion. A lot of that is pretty straightforward. And so that's, I think, how it's generally approached.

1:07:33That makes sense. And it's cleaner and more straightforward that way. So I can understand that. We close out these conversations with the lessons that you can pull away. And this is an interesting business and an interesting market doing interesting things. What stands out the most to you in terms of a key lesson or lessons that you could take away from Goosehead? I love this question. I'll answer it in a personal way and start with the question itself. When it comes to the investment research process, will you be a detective or a newspaper reporter who gets an edge over dustbound colleagues who don't solve crimes or break stories?

1:08:12Approaching your research and investment process with a beginner's mind and genuine gratitude toward those involved helps unlock insights and open doors, particularly in situations where an industry is evolving and technology is being brought to bear on the distribution of that product. I'd say there's an important thread of trust that can extend from a client to their investment manager and to portfolio company management teams that can make a material difference in driving outsized investment returns, returns that may be unattainable otherwise. Think of situations like when the stock became dislocated and the company was buying back shares.

1:08:55Was that a buying opportunity or was it not? And ultimately, for me, the key lesson here is you find what you look for and doing the hard work yourself is really the shortcut. This has been a great conversation. I've learned a lot about the industry and about this business. Thank you very much for joining us, Jeff. Thank you, Matt. To find more episodes of Breakdowns ranging from Costco to Visa to Moderna, or to sign up for our weekly summary, check out JoinColossus .com. That's J -O -I -N -C -O -L -O -S -S -U -S .com.