Upstart: The Consumer Lending Space
FY 2020 Highlights, Earnings Recap & What to expect in 2021
Good afternoon Everyone,
Overview of Today’s Upstart Report:
Upstart Company Overview
Full Year 2020 - Financial Review & Highlights:
What Investors can expect for 2021
Summary & Bottom-Line
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Upstart Holdings (NASDAQ:UPST)
Upstart is a leading AI-powered lending platform, using machine learning model to assess the credit worthiness of a consumer and determine their ability to payback the loans with the ultimate goal of making credit assessments more accurate. Upstart uses around 1,600+ data points and over 10milllion of trained data around repayment events to accurately identify and measure credit risks.
The business model involves partnering with bank partners or institutional investors. Upstart provides a consumer facing cloud application that streamlines the end-to-end process of processing and servicing a loan to the Bank from Upstart. Its important to remember Upstart does not issue loans nor bear any risks from default, the company simply routes the loans. You can read more below
The value proposition is that the AI model enables the bank partners to have higher approval rates, lower loss rates and a highly automated digital experience for the customers. Upstart looks at the holistic person’s perspective when determining eligibility for credit loans. Individuals who don’t fit within the required scores for example, those with poor credit scores can be eligible for loans with banks using Upstart’s platform and they can price risks and create better rates for the clients. The ecosystem is laid out below:
I don’t plan to go into a lot of detail, so I *highly recommend* visiting the link below for a short description of the Upstart article which I spent a lot of time creating this past week: 👇
The link provides information about the company, discusses the competitive advantages that Upstart holds within the industry, the top class management team and some of the risks to consider. The link provides a brief overview in short-form allowing for a quick read.
Full Year 2020 - Financial Review & Highlights:
I’ll assume you’ve read all about the company, so we will dive into reviewing the full year 2020 highlights. I’ll pick three points.
1) Revenue Growth [$233M - Up 42% YoY]:
Upstart attributes its growth to higher conversion of members and higher loan volume transactions in the latter half of the year as more people felt comfortable with borrowing and its associated risks.
Its important to note that the Covid-19 pandemic and the elevated economic risks meant less borrowing especially in Q2 2020 - it’s therefore remarkable to note that Upstart managed to grow by over 42% - what would have happened without Covid? The digital offering ended up being an advantage. Revenue growth figure is below including the guidance for 2021
Lastly, management attributed growth to a massive improvement in their underlying AI models and technology. During the pandemic last year, while the business slowed- Upstart significantly invested into R&D [on a side-note - this is how you detect a visionary and forward-thinking leadership team]. You’ll notice that the company doubled investment in engineering and product development by increasing hiring.
The AI model improved steadily in that it became more accurate, increased their ability to underwrite risks on behalf of their bank partners - ultimately leading to more conversion of people to take on loans. Also, the pandemic was a major *shock* to the AI models since there had not been exposed to a recessionary environment where they had to predict consumer repayment abilities - therefore becoming better at pricing risks. Overall, Upstart has come out of the pandemic in even much better shape with regard to leveraging technology.
2) Scalability, Operating & Bottom Line Metrics:
This is another unique feature of Upstart among the MANY fintech and tech companies. The company remarkably grew top-line revenue at over 70% annualized WHILE - still being profitable, generate free cash flow and massively investing into Research & Development and increasing sales and marketing expenses. This demonstrates efficiency.
Secondly, Contribution Profit was up - meaning [Upstart’s Revenue from fees minus (-) variable servicing costs for borrower acquisition, verification and servicing] = CP. This is an important metric to track with Upstart. We will observe that they have been growing their contribution profit over the last 3-years. For Q4 it was up 41M and 77% YoY. For the full year 2020, Contribution Profit was $105M, Up 115% YoY. Although management warned that this number will stabilize overtime, it is remarkable they can keep more dollars ($).
Other notable metrics:
Income from Operations: $11.8M (Up 357%) YoY
Adjusted EBITDA: $32M (463%) YoY with an EBITDA Margin (13%)
Cash flow positive of $231M and $311M in unrestricted cash from IPO
Without going too much into details, the metrics point towards a company that is incredibly growing fast while being rapidly efficient, capital light and scalable. Bodes well for the future.
3) Customer Metrics:
Another important operating metric for Upstart is the number of loans transacted and the conversion rates: The #No of loans transacted by the number of loan inquiries received. We can observe that the company had a decent volume growth in 2020 and has been growing at a CAGR of 62% over the last four years. Chart shows a steady growth.
The conversion rate is defined as the Number of Loans transacted in a period divided by the number of rate inquiries received. This is a third notable metric because the more people the company is able to convert to take loans using their platform, the more revenue and trust built with bank partners. Chart shows a steady growth.
Finally, the % of loans automated was around 71% in 2020 from the low 60% in 2019- this will continue to be important to track because it helps with margin improvement, it was high and they expect it to normalize overtime. As automation and digitization has improved, the percentage of fraud rate for loans approved is still very low at 0.30% - good to see. I will note that they have also increased their banking partners from 10 -> 15 banks utilizing Upstart’s platform.
Bottom line, the business performed well inspite of the pandemic which bodes well for 2021. Next up.
What Investors Can Expect In 2021: Future Growth Drivers
Based my key takeaways from the earnings call and CEO interviews:
1) The move into Auto Loans & the Acquisition of Prodigy Software:
This will be a game changer for Upstart. More than $1-Trillion dollars worth of cars are sold and financed in North America. It is arguably one of the largest Buy now-Pay later markets, and the auto market is worth over $625B/year.
Prodigy software Inc is a company that provides software that aims at simplifying the car buying process. The software acts as an intermediary between dealerships and car shoppers. Consumers can refinance their loans at better rates saving around $72 per month. This also benefits the auto dealers/financial institutions behind the loans.
Regarding revenues from Prodigy, it will not contribute materially to revenue in the first half of 2021. Upstart management started this as a pilot year for Auto-loans. The program has been launched in 1 state - now expanding into 14 states. The plan is to improve and make the entire auto loan process better while gradually growing the business. Bottom line is that the acquisition should lead to = Better Affordable financing + simplified consumer experience + higher approvals for dealers which means more revenue = A win-win for all parties involved.
2) 2021 Revenue Forecast of $500M [Growth-rate of >100%+]
The company expects rapid revenue growth of over 100% coming into 2021 and Q1 2021 revenue of about $112M, representing a growth of over 80%. As outlined, the business was affected by the pandemic, so over a normalized growth, we will get around 70% growth YoY. This is impressive.
Equally important to note is that revenue from Prodigy has not yet been considered, but I expect this to contribute much later into Q3/Q4 2021 which should further boost growth.
Upstart expects that as the economy reopens with consumers high-saving rates, there will be more risk appetite amongst consumers to take on loans as they get more involved in the economy.
The company has stated that it is working on getting new bank partners as well as other financial institutions beyond banks to take on more loans. CEO discussed how this is going to be the future. Upstart’s platform is developed in such a way that it flows loans through to capital markets and institutional buyers if banks are not ready and willing to fund the loans and hold them. Here’s one of the business secrets - Upstart is not entirely dependent on one party within the ecosystem. A strong pipeline on the funding side from institutional clients is anticipated, so I expect this to be another business driver. All these factors should lead to better growth in 2021.
3) Banking partners swimming in Cash:
Banks in 2020/ 2021 are swimming in a cash pool of large deposits due to the current historic 10-17% consumer savings rate in the economy. Hence, in 2021 more banks are looking for more sophisticated tools to lend out cash reserves in a responsible and profitable manner. As indicated in one of my articles, in a 2018 study, Upstart demonstrated to several large U.S. banks how the AI-based lending platform could triple approval rates while holding losses constant, compared to their current risk rating models. This is gold for banks! Upstart investors can expect increased activity in this space.
Management indicated definitely seeing increased interest from larger banks in helping banks obtain loans from the platform.
Increased digitization of banking is helping with lesser people going into the branches. One of the issues I’ve observed with Upstart is the long sales process involved in attracting a new banking partner, but they making great progress. In the second half, they were able to onboard a few banks from start to finish, in about a 90-day process which was one of the fastest. Overall, I expect to hear more news going into the future.
4) Launch of Spanish language AI product:
The Spanish language AI lending application is one of the first of its kind among digital lending platforms in the U.S (says a lot). Management mentioned that restaurants and retailers routinely offer Spanish language alternative but, we have not seen any with AI online lenders.
Management mentioned they intend on targeting a different demographic “underserved” by traditional lending models. This could imply expansion within the Hispanic population within the Southern parts of the US, or expansion into financial institutions within countries in Latin America or possibly Europe. I have a good feeling the former, further expansion into Latin American countries might be the next expansion markets, so I expect to hear more news in 2021.
5) Some Risks to Observe:
Impact of Stimulus checks as a risk-reward situation: When more people receive significant stimulus cheques over the next couple of months, we can assume that they will have more money in their pockets which *might* lower demand for loans and credit. Although, the reward is that consumers might also take on smaller loan sizes (which is Upstart’s target market). Leading to the fact that if consumers are confident with the vaccine rollouts, people will want to spend more, travel more or dine out. They will spend more money, ultimately leading to a higher demand for loans. This makes Upstart a perfect reopening play. We’ll see how this impacts them.
Operating and bottom-line metrics: Management also explained that contribution margin will moderate and there will be a slightly lower net-income in early 2021. I get an impression that in 2021, the company will grow aggressively, so it will be important to monitor if that erodes some metrics on the bottom-line especially as the business normalizes in 2021.
Customer Concentration: one of the risks that we will keep monitoring is how well Upstart can diversify the customer base and increase the number of bank partners. As mentioned earlier, this should not be an issue, but something to monitor. Also, the diversification and effectiveness of marketing campaigns and conversion rate of customers will be a risk to monitor.
Upstart is a major disruptor using Artificial Intelligence effectively to disrupt Lending and the Fintech Ecosystem. Surprisingly, the company lacks any major competitor that significantly threatens their position. In 2021, the business is catching up to where the technology has improved to over the past year if we didn’t have Covid-19.
In summary, investors can expect growth rates of over 70-100% throughout Q1-Q4 2021 even after adjusting for the Year-over-Year effects from Covid-19, because of the move into a larger TAM for Auto loans, the potential of increasing new banking partners/institutional partners and lastly targeting new underserved demographics. We will remain objective by monitoring the risks and operational metrics, customer concentration and approval rates.
My valuation suggests a price target of $185 by end of 2021 on $550-million in Revenue and assuming a 25x sales multiple - Why - Considering the economy reopening, strong financial health, TAM market expansion, new products and operating leverage. The price is currently overvalued but I believe there is still “more gas left in the tank” considering the factors outlined above. Short-term, I expect the price to moderate to around $80-$90 for a better entry-point for new investors.
Finally, the story for Upstart is early. With no direct competitors and having captured even a 1% market-share and take rate within the existing TAM of $700B - (excluding the vast opportunities in the large credit card and home mortgage loan markets). You’ll understand why this is a company destined for a bright future over the next 3-5 years!
Thanks so much for reading. Have a great weekend! 🍏👌
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