Upstart Stock: Buy On Strong Growth Prospects & Reasonable Valuation (NASDAQ:UPST)
Ordinary Holdings (NASDAQ:UPST) has strong growth potential and now has a reasonable valuation after the recent price weakness, making it an interesting play for long-term fintech investors.
Upstart is a Fintech company with a business built on a cloud-based artificial intelligence (AI) lending platform to improve access to credit while reducing the risk and cost of lending to banking partners. It was founded in 201, has been publicly traded since 2020 and currently has a market capitalization of approximately $6.3 billion.
Upstart’s platform aggregates consumer demand for credit and connects its network of banking partners, using the company’s AI algorithm to price risk and reduce underwriting costs. This allows for improved economics compared to traditional loans that are shared between consumers and their banking partners.
Consumers benefit from the company’s platform by receiving lower interest rates, higher approval rates and an efficient and digital lending process, while its banking partners benefit from new customer acquisition, lower fraud and loss rates and increased automation in the lending process.
Regarding the underwriting process, the FICO score is the financial industry standard for determining who gets loans at what interest rate, and in addition, banks typically use a set of simple rules-based analyzes that consider a limited number of variables.
This is where Upstart offers value and a certain competitive advantage by having a lending platform with AI-based models that better quantify the true risk of a loan, based on more than nine years of experience and incorporating more than 1,500 variables. and the use of growing data sets that allow his models to be recalibrated to real-world data.
Upstart uses data from all lending originations in its platform, which means each banking partner also benefits from a higher data set for their lending decision than if they were solely relying on their own underwriting experience. This access to data is critical in the technology industry to have a competitive advantage, something Upstart capitalizes on by achieving higher approval rates and lower interest rates for the same loss rate compared to traditional bank lending processes.
Business Model & Growth
Upstart’s business is powered by its cloud-based lending platform, which is made available to banking partners through an application that streamlines the end-to-end process of loan origination and administration while consumers apply for a loan through the Upstart website through a bank -partner product or on the bank’s website. For its banking partners, Upstart’s platform is configurable, allowing each bank to define its own lending policy and determine what parameters it wants in its lending process.
In terms of funding, loans originated through Upstart’s platform can be funded in three ways: retained by original banking partners, distributed to investors, or retained on Upstart’s balance sheet. Over the last year, the vast majority of loans were not backed by Upstart’s balance sheet, meaning the company ultimately doesn’t carry much credit risk and its business is more exposed to its technological capabilities than to a “financial” institution. In 2021, roughly 80% of loans originated through its platform in 2021 were purchased by institutional investors and 16% were retained by the originating bank, meaning only a small portion of Upstart’s loans are self-funded.
Upstart’s primary source of revenue comes from fees paid by banks, which can be brokerage fees for each loan brokered through the website and granted by a banking partner, platform fees for each loan granted, and loan administration fees when consumers repay their loans.
In terms of customer concentration, Upstart had 38 banking partners at the end of 2021, but a large portion of the loans originated through its platform came from Cross River Bank (CRB), which accounted for 56% of all loans brokered through its platform (vs. 67% in 2020). ) and accounted for 56% of Upstart’s revenue. The Company’s contract with CRB began in early 2019 and has an initial term of four years with an option to extend for a further two years.
Its second-largest client represents another 36% of the loans originated through its platform and is responsible for about 27% of Upstart’s revenue. As a result, about 83% of Upstart’s revenue generated over the past year comes from just two banking partners.
This means customer concentration is a significant risk, and particularly if CRB decides not to renew its agreement with Upstart for any reason, the financial impact on the company’s finances will be very significant. The other contracts generally have a term of 12 months and are automatically renewed, subject to certain early termination provisions.
In terms of its growth strategy, as a startup company, Upstart has historically focused primarily on improvements to its AI models and technology upgrades to show that its technology and platform works. As the business matures, Upstart has many sources of growth by offering more types of loans, increasing the number of banking partners, and potentially expanding into international markets.
Still, Upstart’s growth over the next few years should be more focused on technological improvements and gaining more trust from banking partners in its platform, which should result in higher lending volumes directly on its platform and potentially also lower funding costs while making lending more competitive compared to others distribution channels and also leads to higher volumes.
As the banking industry is typically quite conservative, Upstart’s lending platform is not expected to be rolled out quickly, but as the company shows that its AI models can provide an advantage over traditional lending processes, more small and regional banks could be attracted to its platform will . Considering that Upstart’s revenue is currently very heavily concentrated in its two largest customers, there is significant potential for growth as Upstart continues to diversify its banking partners, potentially being accepted by a large bank in the medium to long term, giving a big boost could increase loan volumes through Upstart’s platform.
In terms of verticals, Upstart started out offering personal loans and expanded into auto loans in 2020, but there is an opportunity to expand to other types of loans, including small business loans or mortgages, which are a key source of growth in the near future. By adding more products to its platforms, Upstart can cross-sell to existing consumers and expand its customer base, which is a key growth driver for its business over the long term.
Financial Overview & Valuation
Although Upstart is a young company and therefore still in the early stages of growth, it is already profitable in terms of its financial performance, which is fairly rare for a company with a high-growth profile.
The recent growth story is quite good, considering that revenue has jumped from $164 million in 2019 to $848 million in 2021, while it was originally forecasting around $500 million in revenue. The bottom line also improved significantly during this period from a net loss in 2019 to breakeven in 2020 and a profit of $135 million in 2021. This was justified by the much higher loan volume achieved over the past year , which together with good cost control, including stock-based compensation, enabled the company to break even in a very short period of time.
Beyond achieving GAAP profitability, Upstart’s free cash flow was $159 million, which represents a very good cash conversion rate and shows that Upstart has a great, high-margin business with a strong cash flow generation capacity . This is good for the shareholders of a high-growth company, as Upstart can fund its growth from its own resources rather than dilute shareholders through further stock issuance, a financial profile rare for early-stage growth companies.
In addition, the company’s balance sheet is quite strong with a net cash position to the point that Upstart is already engaged in share repurchases, it has authorized a $400 million share repurchase program, a remarkable achievement and very unusual for a very young company. This is because Upstart’s business is highly profitable and already allows it to invest in growth through retained earnings and return excess capital to shareholders.
For 2022, growth is expected to remain fairly strong given the company’s revenue guidance of approximately $1.4 billion, up approximately $550 million or 65% year over year, supported by growth at both Personal and car loans. The market seems to think that number is achievable, considering that current analyst estimates also expect sales of $1.4 billion in 2022, while net income is unlikely to increase significantly year-on-year due to higher costs. For years to come, revenue growth is expected to slow due to a higher base, but current estimates still call for revenue of $3.15 billion by 2025, at a CAGR of 39% from 2021-25 a very high growth rate.
In terms of valuation, like most high-growth companies, Upstart’s multiples have fallen significantly since the peak valuation reached last November and are now much more reasonably valued. At its peak, Upstart was trading at more than 200 times forward earnings, while it is currently trading at around 32 times forward earnings, as shown in the next chart.
While Upstart’s trading history isn’t very long, this is its lowest rating as it’s making significant gains, and buying a high-growth company at just over 30x earnings seems reasonable for long-term investors.
Upstart isn’t your typical high-growth company, as its business model is already profitable, generates high amounts of cash, has a strong balance sheet, and has very little chance of shareholder dilution in the years to come. Additionally, the company is already buying back shares, a strong signal that management is making its stock look cheap after recent weakness.
On the other hand, Upstart is still a risky investment given that its business is centered on two major customers and its AI models have not been tested during an economic recession. I think that’s the final proof Upstart needs to show banking partners in order to mature its lending platform and grow even more from there. This will certainly take a few years, and investors need to be patient and invest in this stock for the long term, looking at periods of weak share prices as buying opportunities.