Summary
Upstart is an all-digital lending platform that uses artificial intelligence to determine a borrower’s creditworthiness. UPST connects consumers to AI-enabled bank partners.
Not unusual to see fast growth in a FinTech company. But it’s quite rare to see that growth paired with real profits.
71% of loans are instantly approved and fully automated.
>96% of UPST’s revenue came from fees it collected from Banks or Services; even though it is a lending platform, it has NO credit exposure.
The Company has a distinct advantage over alternatives credit risk models.
– It is cheaper at scale;
– statistically more reliable;
– produces lower rates for customers, as well as higher conversions and lower default rates for banks.
Expansion into automotive lending could drive revenue growth.
Upstart does exhibit concentration risk in two key areas- customer and traffic.
Company Overview
UPST is a fintech company aiming to disrupt the industry by providing banks superior data used to determine credit risk. The Company partners with banks and writes unsecured loans to borrowers who have a moderate to low-income credit profile. Oftentimes these borrowers are traditionally charged higher interest rates.
The company’s model increases many people’s access to credit. Banks typically assess several factors, including FICO score, when assessing a borrower’s level of credit risk. However, this process may prove to be inefficient for many borrowers; applicants often find themselves either rejected or saddled with interest rates that are higher than their true risk level warrants.
UPST is able to facilitate higher approval rates, lower interest rates, and an overall better user experience. More than 70% of loans processed in 2020 were don’t instantaneously. Using Consumer Financial Protection Bureau criteria, the company showed it approved 27% more borrowers than traditional high-quality lending models with 16% lower interest rates.
UPST’s algorithm measures alternative metrics when assessing a potential borrower. For example, it accounts for a borrower’s education and where they went to school, in addition to job history, rather than just traditional income and asset metrics. Management claims that its decision process can reduce default rates by 75%. In fact, UPST boasts greater than 170% more approvals for the same overall loan loss rate.
UPST’s model connects consumers with banks and uses AI to determine true credit risk. The AI powered platform uses nearly 15 billion data cells to predict the likelihood of default, regular payment or early retirement of the debt. Upstart’s AI model is built with 10.5 million historical repayment events and relies on more than 1,000 variables. Compared to traditional banks, which have more historical repayment statistics, UPST uses a much larger pool of independent and dependent variables for their assessment.
Upstart partners with banks that pay a fee to originate loans based on the AI model. Upstart has its own interface for customer acquisition on the homepage, Upstart.com.
Borrowers submit a loan application through a bank that utilizes the UPST Application Program Interface (API). The Company uses a simple cloud-based application as a bank-branded loan portal via the website or mobile app. Lenders are able to customize decisions based on risk tolerance and financial factors like duration, hurdle rates, and personal finance ratios. Again, this is a much more customized approach than is typically used today; an approach that tends to under approve and overprice credit. That being said, the Company has been iterating its predictive model with more robust techniques for over 9 years.
Upstart’s model has been met with lots of excitement since its IPO in December 2020. Again, Upstart carries no credit risk itself, as the Company solely facilitates lending process providing services on a fee basis. UPST differentiates itself from Square, PayPal, and SoFi, which lock customers into their individual ecosystems; Upstart instead offer its loans to everyone. The Company has no intentions of being a bank or a direct lender. Instead, UPST is focused on being a technology company that builds the best AI to provide loans to a wider audience.
Leadership
UPST’s founders David Girouard and Anna Counselman are both former Google Executives.
Paul GU is the driving force behind the Company’s predictive models.
Girouard own’s roughly 17% of Upstart, including stock options.
Ownership
UPST has a diverse ownership structure with a broad base of long-tem investors.
Market
Upstart has a lot of room to grow as it expands into new markets. Management estimates that it makes up less than 5% of a $100 billion dollar market for unsecured personal loans. Some of its offerings include personal loans, wedding loans, credit card consolidation, and car loans.
The annual percentage rate for an Upstart loan is in the range of 8.27% to 35.99%, depending on the product.
Upstart recently added auto loans to its offerings and aims to enter the mortgage and credit card origination markets. Expanding into these categories would expand its addressable market to $3.4 trillion. UPST has already partnered with 18 banks, a number which will likely continue to increase in coming months, providing new streams of revenue to the Company.
Total non-housing consumer debt in the US was more than $4 trillion in Q1 2021, including about $745 billion in “revolving credit.” The Covid-19 pandemic disrupted the consumer credit market in 2020. But economist, such as Oxford Economics, are projecting strong rebounds in consumer spending. The group projects US consumer spending to increase 9.6% in 2021 and 5.1% in 2022. Online credit inquiry volumes have been steadily increasing since the start of 2021. And with stimulus checks in the rearview mirror, many consumers will turn towards lending opportunities.
Risks
Upstart earns its revenue through fees, so it must scale efficiently with loan volume. To date, the Company’s application has been used to evaluate relatively small, personal loans. Customers consist of regional banks and credit unions competing with larger financial institutions. Will UPST be able to tap into the ecosystem of larger lenders with a more national presence?
What we would be most concerned about, however, is concentration risk in two key areas- revenue and referrals. Cross River Bank in New Jersey accounted for 63% of Upstart’s revenue coming from loan origination. Additionally, over half of the traffic to Upstart comes from referrals via Credit Karma, the site that, analyzes your credit history. In 2019, 38% of Upstart’s traffic came from Credit Karma, but by the end of 2020, this number swelled to 52%. Credit Karma is owned by Intuit, which could be seen as a competitor down the road if it so wanted. It has the resources and a wealth of consumer data to drive historical analyses.
Upstart, like many names in the Fintech industry has not been operating for a long period of time.
Financials and Valuation
In 2020 Upstart’s total revenue increased 42% year over year. Upstart was also profitable in 2020, reporting Net Income of nearly $6 million- an improvement over a $0.5 million loss in the year prior.
Management revised original estimates from $500 million in revenue in 2021 to $600 million. At a conservative $500 million, this would be the equivalent of 114% year over year growth. And based on Q1 2021 results, this translates to more than $40 million in Net Income.
On May 11,2021, UPST topped analyst estimates for Q1 2021 and reported revenue of $121 million, which was equal to 90% year over year growth.
Revenue from fees accounted for roughly 95% of this revenue. The Company has grown originations, with $1.73 billion in Q1 2021, up 100% year over year on 169,750 total loans. This metric translates directly to revenue. Upstart reported 121% year over year revenue growth, and 71% of loans were fully automated and instantly approved for the first quarter of 2021.
The Company’s contribution margin expanded to 48% of fee revenue compared to 38% in Q1 2020.
Adjusted EBITDA was equal to $21 million for Q1 2021, or 17% of revenue, up 10.7% year over year. GAAP Net Income rose 583% to $10.1 million from $1.5 million in Q1 2020.
Source: Q1 2021 Investor Presentation
Source: Q1 2021 Investor Presentation
UPST has established a history of beating guidance.
Source: Q1 2021 Investor Presentation
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Upstart’s peers include Santander Consumer USA Holdings (“SC”), One Main Holdings Inc. (“OMF”), Credit Acceptance Corporation (“CACC”), 360 DigiTech Inc. (“QFIN”), and SLM Corporation (“SLM”). We feel that UPST is best of breed in this group, but are also bullish on QFIN.
New catalysts include the auto loan market, which is the second largest lending segment after housing. Total auto loans in the US grew to $1.5 trillion in 2020, and car shortages have led to higher prices and increased demand. The Company acquired Prodigy in the first quarter. Prodigy is effectively the Shopify of auto dealers- a total e-commerce solution dedicated to online auto loan origination. The acquisition immediately increased the number of dealerships with Upstart’s application by 45%. Almost $800 million in vehicles were sold through Prodigy in the first quarter.
Trailing TTM Revenue is $290 million and the company trades at a P/E multiple of 38X. Upstart is guiding for a similar amount of net income in Q2 2021. If UPST generates less than $50 million this year in Net Income, this may not be enough to sustain current valuations. However, there is solid upside for investors with a longer time horizon of three to five years or more.
Upstart Investment Strategy
UPST’s business model is delivering profits and its valuation has ballooned. Upstart trades like a growth-oriented tech company as it is effectively a software business. If the valuation is rich, is UPST still worth an investment today?
Upstart had its IPO in December 2020. In less than three months, the stock had tripled from its IPO price to $100 a share. Sellers and profit taking brought the stock back to near $60 a share before its first earnings report- Q4 2020 sent shares to over $160 dollars over several days, through March 22, 2021. Shares then retreated to the $100 dollar range amidst more profit taking and rose to the $120s after a phenomenal Q1 2021 earnings report.
The Investor Weekly built a position at $125 dollars on June 11, 2021. We anticipate a minimum of a three-year hold. My feeling is that the market has not caught up yet with the changing outlook of the business. Yes, the stock is up 4 to 5 times since the very recent IPO. But clearly, the company was mispriced at that time. Since the first earnings report in March 2021, the stock had to be repriced, which is what happened to some extent. Now, after the second earnings report was another blowout, and guidance was raised another 20% for the full year, the stock should be repriced to the upside again. This has not really happened yet, and therein lies an opportunity.
Analysts have stated that they believe that Upstart’s revenue quality is not as high as recurring revenue from other SaaS-businesses and, thus, it should not have the same revenue multiple. However, no one can dispute the fact that Upstart is a high growth company. The Company’s top line growth and strong free cash flow justify a higher EV/S multiple than a meager forward 11.0X to 12.0X. We remain optimistic about Upstart’s growth prospects.
References
Market
Oxford Economics
https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/with-vaccine-rollout-us-ignites-consumer-spending-but-china-lags-64417921
Seeking Alpha
https://seekingalpha.com/
https://seekingalpha.com/symbol/UPST
Upstart
https://www.upstart.com/
https://ir.upstart.com/ir-services/investor-faqs
https://ir.upstart.com/news-and-events/events-and-presentations
https://ir.upstart.com/static-files/ac83e54b-34ba-4f83-bdbb-d4e8796a33f0
Disclosure
I am/we are long Upstart (“UPST”) either through stock ownership, options, or other derivatives.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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