SOFI - Upstart: Time To Brace For Impact

2023-05-05 14:04:58 ET

Summary

• Upstart investors saw its stock fall further in April, nearly re-testing December 2022 lows.
• The market has likely priced in further weakness for its upcoming Q1 earnings, worsened by the headwinds from the recent banking crisis.
• Could Upstart be compelled to park more loans on its balance sheet, as market conditions have not been constructive?
• Upstart management needs to promulgate confidence in its guidance that the worst is likely over before dip buyers have the confidence to return more aggressively.

Upstart Holdings, Inc. ( UPST ) investors saw the stock of the AI-lending platform crash back toward its December lows as dip buyers who bought in March likely fled.

The fallout from the regional banking crisis continued as the market battered the holders in PacWest Bancorp ( PACW ) and Western Alliance Bancorporation ( WAL ).

Short-sellers are likely speculating that these banks have to undertake significant losses on their assets, pressured by the possible need to look for " strategic options. " PacWest intends to "sell a $2.7 billion loan portfolio as held for sale." WAL management highlighted that the bank " hasn't experienced unusual deposit flows following the sale of First Republic."

However, confidence in regional banks is highly fragile as short-sellers look for the next bank to "fry." US regulators are looking into possible " market manipulation " as one of the factors leading to the recent volatility.

Fed Chair Jerome Powell attempted to assure investors that the turmoil in the regional banking sector was not spiraling out of control. However, the confidence crisis could continue without "blanket guarantees" of uninsured deposits, leading to an unexpected contagion, taking down even healthier regional banks.

As an AI-lending platform, Upstart is likely facing significant headwinds as its banking partners are expected to pull back lending further, given the banking crisis.

In March, the company released its proprietary Upstart Macro Index , or UMI, sharing deeper "near real-time insight into the financial health of American consumers."

The UMI is designed to "isolate and estimate the impact of the macroeconomy on losses within Upstart-powered loan portfolios." As such, it aims to provide lenders better ability to assess the loss likelihood predicated on the state of the macroeconomy.

While the UMI showed that the loss likelihood peaked in October, the recent fallout has likely upended an expectation of a near-term recovery in lending sentiments.

Therefore, Upstart investors have likely anticipated that the company could disappoint at its upcoming earnings call on May 9, as UPST inches close to its December 2022 lows.

Will the company continue to utilize its balance sheet to retain more loans? Notably, Upstart's loans held on its balance sheet surged to $883M at the end of 2022, up from $143M at the end of 2021. It represented nearly 46% of its asset base, increasing the risks of a further markdown in value, attributed to intensifying macroeconomic risks.

Digital finance company SoFi's ( SOFI ) recent earnings commentary could also have spooked investors further. SoFi management highlighted that they did not conduct whole loan sales in Q1 but managed to access the ABS market with "spreads that outperformed their expectations."

Therefore, it will be interesting to assess whether Upstart has been able to access the capital markets productively in Q1 and its assessment of the conditions for the rest of FY23.

Consensus estimates are likely not optimistic, as UPST is tagged with a consensus "Sell" rating.

Analysts expect Upstart to report revenue of $99.8M, down 67.8% YoY, worse than last quarter's 51.8% decline. In addition, the company's adjusted EBITDA is expected to fall further to -$45.4M, down from last quarter's -$16.6M.

Notably, analysts have penciled in a possible inflection in Upstart's operating performance from Q2, with losses expected to peak before recovering in H2. Hence, investors will need to assess management's guidance carefully, even though market operators have likely baked in significant pessimism.

Seeking Alpha Quant reflected a "C-" valuation grade for UPST which is much improved from the "F" grade three months ago. Hence, UPST's valuation is likely in the neutral zone.

However, its "F" profitability grade and weak revisions could hold investors from returning aggressively unless management could rectify its flawed business model sustainably.

With that in mind, investors should remain patient and look for other opportunities in the financial sector.

Rating: Hold (Reiterated).

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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