High-Flying Upstart Falls Even After Strong Earnings

(Piotr Swat)
(Piotr Swat)
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One of the most popular stocks on Fintwit this year has been Upstart (UPST). Into yesterday’s earnings call, shares were up over 600% since the beginning of the year. Following Q3 earnings, shares sunk over 20%. Today, we look at why investors are dumping this stock.

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Overview

  • Upstart Holdings (UPST) is a cloud-based AI lending platform.
  • The platform aggregates consumer demand for loans and connects it to a network of Upstart AI-enabled bank partners.
  • Upstart’s mission is to enable credit based on true risk.
  • For more background on the company, read our original write-up on Upstart from June here.

Q3 Earnings Highlights

Financials

  • Total revenue for the quarter was $228 million, up 250% year-over-year. Total revenue from fees was $210 million (92% of total revenue).
  • Income from operations for the quarter was $28.6 million, more than double last year, but falling 21% quarter-over-quarter.
  • Net income followed a similar trend up 3x from last year to $29.1 million, but falling 22% quarter-over-quarter.
  • Contribution profit was $95.9 million (46% margin).
  • Adjusted EBITDA was $59.1 million (26% margin).

Key Metrics + Operational Highlights

  • For the quarter, bank partners originated 362,780 loans, totaling $3.13 billion across the platform.
  • The percentage of fully automated loans fell from 71% last quarter to 67% this quarter.
  • Conversion on rate requests was 23% in the quarter, up from 15% in the same quarter from last year.

According to Sanjay Datta (Upstart’s CFO), the increased number of borrower profiles on the Upstart platform, including more traditionally prime borrowers, exerted downward pressure on conversion rate and the percentage of loans automated. Borrower segments that are newer to the AI models will tend to convert at lower rates than segments with longer histories. As the platform develops more history and greater loan volume for models to train on, the percentage of automated loans will start to creep up.

Management Commentary

Dave Girouard, Co-Founder + CEO

“Since Upstart’s IPO a year ago, we’ve more than tripled our revenue, tripled our profits, tripled the number of banks and credit unions on our platform, and tripled the number of auto dealerships we serve”

  • On bank partner growth: “A year ago, we had 10 bank and credit union partners in our platform. Today, we have 31 partners, and we’re adding them faster than ever. We’re also making progress in how rapidly we can onboard these partners. In fact, our most recent bank partner went live on the platform in less than 50 days.”
  • On bank partners dropping FICO scores: “Last quarter, I told you that, for the first time, an Upstart bank partner decided to eliminate any and all FICO requirements for their borrowers. Today, I can happily report that of those who are approved for Upstart-powered loans because of this change, 59% were Black, Hispanic, or low- to moderate-income. And even better, I’m also pleased to tell you that 4 Upstart bank partners have now dropped their FICO requirement.”
  • On better serving high credit score borrowers: “While a lot of our energy goes towards serving “future prime consumers” currently left out of the financial system, we’re also launching initiatives to better serve those with no shortage of credit options. This makes sense because borrowers who use Upstart often see rapid improvements in their credit score and become suddenly very interesting to the entire consumer finance industry.”
  • On growth in auto lending: “We rebranded the company and the product formerly known as Prodigy to Upstart Auto Retail, but our progress in auto retail went far beyond rebranding. In fact, we’ve now tripled the number of dealers on our platform compared to a year ago.”
  • On new small-dollar loan product: “We’re working toward a small-dollar loan product designed to help consumers with unexpected and immediate cash needs, think a few hundred dollars repaid in just a few months. But importantly, we’re building a bank-ready product at bank-friendly APRs, always operating within the 36% rate cap prescribed to nationally chartered banks and to those who serve U.S. military service members. In short, with better technology, superior risk models, and a dramatic reduction in the cost of origination, we hope to welcome millions of Americans into the mainstream financial system who would otherwise be left with far less attractive options.”
  • On new small business loans: “While there’s no shortage of credit options to business owners, we aim to deliver the 0-latency, affordable credit solution that modern businesses require. This is another product in high demand from our bank and credit union partners, and we hope to bring it to market during 2022 as well.”
  • On breaking into home mortgages: “This is an opportunity that we’re excited about and we’ll begin to invest in significantly throughout 2022. While this initiative has a longer time horizon on it, we felt it’s important to share our intention right now.”

Sanjay Datta, CFO

  • On the macro outlook for personal loans: “In terms of macro outlook, we are seeing the early signs of a return to the pre-COVID consumer profile with personal savings rates in the economy now having fallen back to pre-COVID levels and credit card balances steadily edging upwards to within 90% of pre-COVID levels. We expect the continuation of this trend to eventually lead to an increase in consumer default rates, consistent with pre-COVID levels.”

Fourth Quarter Guidance

Valuation + Analysis

  • After falling after-hours, UPST stock will likely open below $250 per share. At $238.50 per share, the company is valued at a fully diluted market cap of just under $23 billion.
  • Accounting for net debt, the enterprise value of Upstart at these levels is $22.5 billion.
  • Based on the Q4 guide from management, the company expects to do north of $800 million in revenue for the fiscal year.
  • Analysts currently expect revenue to grow to $1.08 billion next year which represents a 21x 2022 sales multiple.
  • The long-term contribution margin (revenue from fees minus variable costs for borrower acquisition, verification, and servicing) is 45%. If we apply that rate to 2022 sales, UPST currently trades for 46.5x 2022 contribution profit.

KR:

From an earnings perspective, nothing in this report is worrying about the future of the business for those that believe in Upstart’s technology and approach to personal lending. Conversions, automated loans, and margins were down from Q2 to Q3, but management acknowledged those levels were unlikely to remain that high. With the market pricing in perfection, the margin “weakness” was likely the biggest factor in the after-hours drop.

Upstart is still trading a premium after the correction, but the company is continuing to grow quickly. Revenue increased 18% quarter-over-quarter. The company believes its push into auto lending dramatically increases its TAM and continues to work on servicing more customers.

JO:

It’s very curious that the market is punishing the stock price by 24% despite a great report. It makes me think that the market is now looking for reasons (if they even exist) to rerate growth stocks to more-reasonable valuations.

Even after the drop, at $230 per share, an investor needs to believe in the company 10x’ing in size in the next 5-10 years. The high valuation keeps $UPST as a speculative growth stock where an investor will be honed in on momentum and a huge long-term vision. But it grants a much better entry point for an investor who believes Upstart will serve as the underwriting software backbone of the banking system.

I personally am warming up as someone who believes this might be the case, but I’m also wary of holding a big basket of these types of investments if macro factors cause a wholesale rerating downwards of nosebleed valuation, speculative TAM growth stocks.

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