2023-09-14 03:55:04 ET
Summary
- Upstart, a FinTech start-up, has faced challenges due to high interest rates and investor skepticism, leading to a decline in its valuation and key metrics.
- The company's AI-lending platform saw success during the pandemic but struggled as interest rates rose, impacting demand for personal loan originations.
- Despite the decline, Upstart still has potential with banks/credit unions and is expecting a stabilization of its revenue base in the third fiscal quarter, which could lead to a revaluation.
Upstart ( UPST ) has been a fast-growing FinTech start-up that deploys artificial intelligence technology to bring efficiency to credit decisions, but the company has recently fallen on hard times as high interest rates and investors’ general distaste for FinTechs have weighed on the firm's valuation. Upstart has seen, due to higher interest rates, a slowdown in demand for high-interest personal loans and, as a result, key metrics are broadly on the decline. However, I see a revaluation scenario in a lower-rate world which could lead to a reboot of Upstart’s loan business and a re-acceleration of the FinTech’s top line. With shares also appearing to have bottomed out following the release of Q2'23 earnings, I believe the risk/reward is quite favorable!
Business slowdown in a high-interest world
Upstart’s valuation soared from May until August 2023, but it collapsed after the FinTech submitted his second quarter earnings sheet which showed a high double-digit decline in the start-up's revenue base. The key problem with Upstart is that the FinTech has seen a significant slowdown in demand for new loans which resulted in a serious contraction of its top line. High interest rates have cooled off demand for personal loan originations and the Fintech reported a massive 40% year over year decline in its revenue base in the second fiscal quarter.
Upstart initially benefited from the pandemic and a low-interest world which provided fuel for the growth of its AI-powered lending marketplace. Upstart’s AI technology allows banks and credit unions to rapidly make loan approval decisions which leads to reduced decision times and lower overhead for banks. As a result, Upstart has seen a surge in loan originations… but the Fed has spoiled the party for the FinTech as higher interest rates obviously disincentivize the creation of new debt.
Although Upstart has seen a decline in its top line (and earnings) in FY 2023, the FinTech still seems to have a good product that banks and credit unions value. Only recently Upstart reported that the Farmers Insurance Federal Credit Union ( Source ) and the Naveo Credit Union ( Source ) have selected Upstart’s AI platform to help provide more loans to customers.
Because of higher interest rates, Upstart reported a significant year over year decrease in transaction volume (which was down 66% year over year) in the second-quarter as well as a decline in the conversion rate from 13% to 9%. The drop in key performance metrics occurred despite Upstart increasing the percentage of fully automated loans by 14 PP year over year to 87% in the second fiscal quarter.
Catalysts for loan demand
New collaborations with banks and credit unions could help Upstart scale its product offering and bring its AI technology to more financial institutions/customers. Upstart also has the opportunity to expand into other loan categories, like auto loans which essentially require the same information. The biggest driver for Upstart, in my opinion, however, is a potential decline in interest rates which is set to boost loan demand for credit providers... and for Upstart which provides the technology. Interest rates and loan demand are positively correlated, meaning people tend to demand more loans when they are cheaper. Recent collaboration agreements with credit unions are definitely a good path for Upstart going forward and considering that Upstart focuses on the technology aspect of the lending process, I believe the start-up offers financial institutions a low-risk value proposition that could ultimately result in a revenue re-acceleration.
Outlook for Q3’23
Upstart’s outlook for Q3’23 indicates that the company does not expect a weakening market environment for its core services. The FinTech expects approximately $140M in revenues in the third fiscal quarter, implying a $4.2M increase quarter over quarter. While this may sound not like much, it indicates that Upstart is now planning with a stabilization of its revenue base which could set the foundation for a potential revaluation of Upstart’s shares going forward.
Upstart’s valuation
Upstart is not cheap and the FinTech is more expensive than companies such as PayPal ( PYPL ) which is already free cash flow-positive and achieves significant earnings on a quarterly basis. PayPal also has a certain reach due to its 431M-strong customer base and a name that people trust, especially in the online world. I am rating PayPal as a hold, however, due to a declining number of customers .
However, Upstart has considerably more upside potential, in my opinion, due to the fact that the FinTech is facing much stronger revenue growth prospects: Upstart is expected to grow its top line 41% next year while PayPal is projected to achieve a revenue growth rate of just 8%. SoFi ( SOFI ), for comparison, is expected to generate 24% top line growth next year.
Upstart has the highest P/S ratio in the industry group here, 3.4X, but the FinTech is also expected to grow five times faster than PayPal next year and 1.7X faster than SoFi. Assuming a P/S ratio of 5X, which is not totally unreasonably for a fast-growing FinTech, Upstart could have a fair value around $45 per-share.
Upstart appears to have bottomed
It is risky to go on record and call the bottom, but I am confident that the current situation for Upstart is favorable: Shares are not oversold anymore and UPST is trading above its 200-day MA. Shares have also shown signs of stabilization since the initial (over)reaction to the company's second fiscal earnings, and, as a result, I believe UPST has bottomed, potentially offering investors a solid buy-hand-over-fist opportunity.
Upstart’s risk profile
I would say the biggest risk for Upstart right now remains a continual high interest period in the U.S. economy which prevents a reboot of the loan origination business. However, as soon as rates are coming down, Upstart should be in a strong position to accelerate its loan and revenue growth again.
Final thoughts
Upstart got hammered after the AI lending start-up reported a 40% top line decline in the second fiscal quarter. However, the outlook for the third fiscal quarter implies a revenue stabilization which could be a precondition for an upside revaluation. Upstart’s outlook implies sequential growth in its revenue base and while the FinTech is not yet profitable, a reboot of the loan business could drive a fundamental improvement of key metrics, including revenues, transaction volumes and platform conversion rates. While other Fintechs, like PayPal are cheaper, I see more upside with Upstart considering that the company still achieves a relatively small revenue volume. Shares also appear to have bottomed out which I see as another buy signal for investors!
For further details see:
Upstart: This Is A Great Time To Load Up The Truck