2023-09-11 09:01:40 ET
Summary
- Upstart Holdings, Inc. offers an online platform that connects consumers with lending partners and uses AI models to try to better price rates.
- The company's financials have deteriorated; revenue is down 50% from its peak, margins are at record lows, and net debt is near a record high.
- Unfavorable macro headwinds and reduced loan demand have impacted the firm, leading to cost-cutting measures and a decline in customer transaction volumes.
- Despite the firm’s recent achievements such as its home equity program launch, growth in its auto retail lending, and gains in business with existing clients, Upstart’s deteriorating fundamentals offer an opportunity.
Company Background
Upstart Holdings, Inc. (NASD: UPST ) offers an online platform that connects consumers with lending partners and uses AI models to try to deliver more affordable and accurate prices. As its 10-K explains:
We are a leading, cloud-based AI lending marketplace… Our lending marketplace aggregates consumer demand for high-quality loans and connects to our network of Upstart AI-enabled bank and credit union partners, collectively our “lending partners”... Our revenue is primarily comprised of fees paid by lending partners. We charge our lending partners platform and referral fees at origination and loan servicing fees as consumers repay their loans…. Our models incorporate more than 1,500 variables and benefit from a rapidly growing training dataset that currently contains more than 44.4 million repayment events…
In H2-2022, Upstart’s total revenue amounted to $238.7m. Lending partners originated $1.2b of loans using Upstart’s platform in the recent quarter, per the firm’s 10-Q and earnings release .
Deteriorating Financials
Upstart’s revenue (LTM) peaked in Q2-2022 and is down ~50% since then, according to data from StockRow . Operating income (LTM) is at a record low and has been negative for three quarters in a row, ending its prior uptrend. Net income (LTM) is close to a record low.
The firm’s EBITDA, operating, and net margins (LTM) are at record lows.
Net debt (quarterly) is close to a record high, now standing at $1.4b. Upstart’s debt/assets ratio (quarterly) is now above 100%. The firm’s number of common shares has been in a loose uptrend and is up 14.3%
Upstart’s P/S and P/B multiples (quarterly) are depressed relative to history. Since valuations aren't elevated, a short position on this stock involves betting on sentiment staying sour (or getting worse), not betting on a reversion of extreme sentiment/hype.
Potential Catalysts
The firm encountered unfavorable macro headwinds including elevated interest rates and reduced lending activity, per the recent earnings transcript . Those factors caused several of Upstart’s lending partners to reduce their originations. The firm believes the current environment is “funding constrained” and says that the economy needs to improve in order for it to deliver profits and strong growth.
Customer transaction volumes in the recent quarter were down 65% YoY, per the firm’s 10-Q . The drop in loan demand from institutional investors compelled Upstart to tap into its balance sheet to fulfill its funding requirements. Management believes this may happen in the future as well.
Many loan books are being sold cheaply in the secondary market for the sake of generating liquidity, in management’s view, and that available supply of cheap debt reduces investor interest in Upstart’s loan offerings. The firm believes the market will “take some time” before that buying opportunity surplus normalizes.
Given the recent trend of weakened loan demand, the firm announced a plan in January 2023 to cut costs by shrinking its headcount by ~20%. Earlier, in November 2022, the firm announced another plan calling for a 7% reduction.
Risks
Some recent milestones that Upstart mentioned in its recent press release could result in the firm outperforming market expectations in the future. The company:
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Recently launched a home equity product that particularly targets prime borrowers, and its pilot program is in progress in Colorado.
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Grew its auto retail lending operations to 61 rooftops, a 56% increase.
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Fully automated 88% of its unsecured loans.
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Saw a record contribution margin of 67% in the recent quarter, thanks to a rise in activity from existing customers
If any of these events develop enough to cause Upstart to surprise the market, share prices may start rising and the prior uptrend in share price may resume.
Execution
Shorting a stock is a bet on where its price goes, not necessarily the fundamentals of the business. Since there is statistical evidence of trends in equity markets, investors who apply a scientific mindset should probably focus on shorting companies that are in a downtrend or close to starting one. Then, fundamental and macro factors can be additional requirements investors use to refine their screening process and become more selective.
Upstart’s stock suddenly broke below its prior uptrend on August 7, when it stopped making “higher lows and higher highs.” On August 9, it broke below its rolling 50-day average, and since that time is essentially unchanged, per finviz .
Zooming out, the stock had an enormous run up of 767% percent in its first 9 months of trading before seeing an equally severe reversal. It is now slightly below its first monthly closing price, a clear sign that the hype that once surrounded the name has faded.
It may be sensible to consider being bearish on this stock only while the downtrend remains in play, perhaps by requiring that the price stays below its rolling average (30, 50, 100, 200-day, whichever has stronger evidence).
A General Note on Short Selling
All else equal, I believe bearish equity positions are less likely to succeed than long positions, mainly because downtrends tend to be more choppy and harder to exploit than uptrends. Also, in many market environments, declining stocks are harder to find, and those that are in a downtrend tend to already be at a discount compared to industry average multiples. That said, I believe it's still worth noting short ideas that have multiple supporting factors (price trend, declining fundamentals, etc).
Bottom Line
Upstart’s deteriorating margins, rising leverage, and macro headwinds present an interesting short opportunity for investors. While its price continues to trend, the stock could be a reasonable bearish position for investors with a momentum-inspired strategy to consider.
For further details see:
Upstart Holdings, Inc.: Slumped Sales, Rising Leverage, And Downward Price Trend