2023-05-11 07:32:57 ET
Summary
- Upstart made a huge step in rebounding from the downward spiral the lending platform had been going on over a year.
- The fintech announced committed funding of $2+ billion crucial to a turnaround, but the company didn't provide any details.
- UPST stock is reasonably valued here at 3.2x '23 sales estimates that require considerable 2H growth to hit targets.
Upstart Holdings ( UPST ) signaled a key shift in their AI lending marketplace, making the business model far more appealing. The big question now is the details on the new committed lending partners, but at least the fintech has ended the downward spiral. My investment thesis is more Neutral on the stock following the big rally off the lows.
Source: Finviz
Hitting Bottom
Upstart reported Q1'23 revenues collapsed to only $103 million after peaking at $310 million back in Q1'22:
The AI lending marketplace has lost 66% of the business in just a year due to the lack of committed funding. Upstart appears to have turned the corner here, but management didn't provide a lot of details on the new committed funding deals.
The CEO made the following statement on the Q1'23 earnings release about the committed funding:
Despite the headwinds facing our industry, we secured multiple long-term funding agreements, together expected to deliver more than $2 billion to the Upstart platform over the next 12 months.
The unknown here is the commitment of these lending partners. The historical problem with lending marketplaces is that lenders and investors disappear when the economy faces recessionary pressures.
Upstart needs committed funding in order to thrive and other platforms like LendingClub ( LC ) have moved towards a digital bank with sticky deposits to keep funding loans during economic weakness.
The $2+ billion commitment would be a solid start, though the platform funded nearly $1 billion worth of loans during Q1 alone. The platform is on the pace for $4 billion in annual loan originations and $2 billion committed to the platform would only be a fraction of the outstanding loan balances serviced by Upstart.
Back in Q1'22, Upstart originated $4.5 billion worth of loans in just the one quarter. A big unknown is how much of these committed funds are new to the platform or from a partner already actively lending and now just committing to keeping the funds on the platform
While Upstart reported solid gross realized returns, even during the weakest period with late 2021 vintages, the company still failed to meet targeted cash flows. The fintech is now targeting gross realized returns in excess of 11% after a year of weak returns.
Outside partners and investors always have a difficult time remaining committed to these lending marketplaces, questioning why Upstart doesn't look for a digital bank to fund their own loans. While a lending platform collecting fees without the credit risk is appealing, one has to wonder why the company wouldn't want to participate in these high returns when lending partners disappear.
Improved Margins
The best part of the turnaround is probably the improved expense structure. Upstart cut 30% of the workforce starting in Q4 and the company was able to boost the contribution margin in Q1 by 11 percentage point in the process despite the weak revenues.
The fintech produced a contribution profit margin of 58%, up from 47% last year. The contribution profits of $68 million still dipped over 50% from last year due to the substantially lower loan volumes.
Amazingly, Upstart lowered sales and marketing expenses by over $100 million from last Q1. More importantly, the company used the costs savings to double product development to over $110 million with a large portion of these costs via stock-based compensation for data engineers.
While Upstart still posted a large loss in Q1, the company really turns the corner with revenue predicted to rebound in Q2. The fintech is guiding to revenue of $130 million leading to a meager adjusted net loss of $7 million and flat adjusted EBITDA.
The stock has rallied to $19, and a diluted share count in the 95 million range leads to a market cap of $1.8 billion. The stock trades at about 3.2x 2023 sales targets of $560 million, which requires a hefty growth rate for the year to achieve.
The fintech has tons of catalysts when the economy improves with the move into auto loans and HELOCs. The big question remains the details on the committed funds and whether Upstart can actually lock in forced lending regardless of the economic cycle.
Takeaway
The key investor takeaway is that Upstart has ended the downward spiral that sent the stock from nearly $400 back in late 2021 to only $12 recently. We're upgrading the stock to a Neutral rating, stopping short of a move to a Buy based on the lack of information on committed funding. The fintech only becomes appealing when funds will not exit the platform for an extended period of 3 to 5 years and such a tight contract doesn't appear likely.
For further details see:
Upstart: Turning The Corner (Rating Upgrade)