2023-07-03 15:30:05 ET
Summary
- Upstart Holdings, Inc. came close to our single-digit target and then did a vertical ramp on better-than-expected results.
- Analysts have been upgrading 2023 numbers while reducing them further out.
- We dissect the situation and tell you our verdict.
- We also give risk-adjusted plays for the bulls and bears.
On our last coverage of Upstart Holdings, Inc. ( UPST ) we saw continued woes for the company. We did not give the AI model much value and expected the stock to eventually reach to single digits.
That gives you a GAAP loss number of over $4.00 a share. This is our base case here. Before you add in the very likely restructuring charges that should be on their way. We think Upstart Holdings, Inc. stock will be in the single digits by the end of the year. Buyer beware.
Source: Disrupters Get Disrupted (emphasis added).
The stock took an unusual path post that article. Initially, it appeared to be on the route to confirming our thesis and dropped 36% to reach $11.93. Then, it decided to go the other way, and boy, was that some rally.
As is always the case in our analyses, we focus on what we might have missed and see if it is an opportunity to learn and change our stance.
Q1 2023
Sometimes a clear catalyst is not visible and at other times you can pretty much nail down what caused a price spike. This was definitely the latter, and UPST's Q1 2023 "beat" got markets extremely excited. It is rare to see a "growth company" do so poorly on so many metrics and still get markets revved up. But that is precisely what UPST managed. Revenues from fees were down a stunning 62%. Despite interest income tripling, thanks to higher interest rates, total revenue drop was even steeper.
The company valiantly cut back on sales and marketing expense to have it fall even more than the revenue drop. Interestingly, all that cost cutting was completely MIA in the engineering and product development arena where expenses more than doubled. Perhaps the jolt came from the adjusted EBITDA breakeven expected for Q2 2023 or the raise of revenue estimates slightly. But at first glance the results were really poor. Even the very second quarter of the company's public existence had seen revenues higher than what we saw in Q1-2023.
The Trend Is Not Your Friend
No, we are not talking about the trend on the stock price. We are talking about analyst estimates for the next fiscal year. You can see below that the entire rally which started in May, was alongside rising earnings estimates for 2023. Never mind that it is Non-GAAP (GAAP will be far worse) and never mind that it is still a loss. That jump is what powered the stock. But at the same time, analysts are trimming their 2024 numbers. You can see 2024 EPS estimate has dropped from about 82 cents down to 65.4 cents.
This is due to the setup that we see too often with analysts when they are wrong on a company. There is a continuous need to project a very sharp "V-bottomed" recovery in sales and earnings. In the case of UPST, this shows in the fact that analysts were only slightly under for 2023 but were still overestimating 2024. Hence, they continue to cut estimates for further years as reality sinks in. Note that the numbers below are non-GAAP.
Outlook
The stock-based compensation ("SBC") for UPST almost tripled year-over-year, while revenues dropped by two-thirds.
We know the stock traders that placed their first bet after COVID-19 love to dismiss all things GAAP, but we just cannot get past this. GAAP losses are going to be around as far as we can project, and this is despite analyst estimates of a 40% increase to revenues in 2024.
Those losses are burning through UPST's tangible book value, and that is now down to $6.60
When will reality strike the stock again? Perhaps when short interest is lowered by the pain of a vertically rising stock with poor fundamentals.
Our valuation models suggest that our best case here is for Upstart Holdings, Inc. stock to eventually trade at tangible book value, as with other lending stocks that cannot make money. An alternate measure would be a 1-2X sales metric. Both those suggest severe downside.
UPST gets a 10 on our potential pain scale rating.
How To Play For The Bears
With 30% shares sold short, it is still dangerous to try and punt a straight short, unless position size is kept relatively tiny. One additional problem is with the stock egregiously overvalued, management can issue stock at these prices and raise tangible book value per share. This further reduces shorter term downside risk. One method we think can work would be to put put spreads for January 2024 in the $20.00-$12.50 range.
These will still be expensive but you have a defined risk-reward.
More creative option investors can consider a ratio-put spread.
1) Buy 1 $20 Put-January 2024.
2) Sell 2 $12.50 Puts January 2024.
This reduces your cash outlay put your profits start reducing below $12.50 and you actually get net long at $5.00.
Option Profit Calculator
How To Play For The Bulls
We cannot imagine why anyone would be bullish here other than the fact that nothing influences sentiment like price does. But if you are buying into this new AI mania, then the best bet would be call spreads. The implied volatilities are rather unique and you can see deep in the money options have very little non-intrinsic value. So a $20-$40 Call spread would more than double your money ($20.00 return for $9.50 investment) if UPS closes off at January 19, 2024 over $40.00 per share.
An alternate trade would be to buy the bonds which still have a 12.97% yield to maturity in 3 years.
For our part, we are just plain staying out of Upstart Holdings, Inc. altogether.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
For further details see:
Bulls Make Money, Bears Make Money, Upstart Still Doesn't