How Disruptive Is Upstart?

Shares of lending platform Upstart Holdings, Inc. (NASDAQ:UPST) have seen a lot of volatility since it went public on Dec 16 2020.

With a high-interest rate environment still in place and inflation refusing to moderate to the Fed’s desired level, the company is facing quite a harsh environment at the moment leaving some to wonder: is Upstart a legit company? In short, yes Upstart is a legitimate company that generates almost $1 billion in revenues and with a unique risk-grading system to evaluate borrowers.

On the other hand, the company’s AI-based lending platform has a lot of potential at the moment, so is a bullish outlook warranted?

How Does Upstart Holdings Operate?

Upstart’s platform works by connecting lending partners and customers. The platform is highly automated, using AI models and cloud applications for the consumer credit underwriting process. The aim of the company is to facilitate frictionless credit, for which it is shoring up more and more lending partners.

The company generates revenues from the use of the platform and borrower referral services by charging fees, which can be fixed or variable. 

Upstart compares target returns set during the issuance of core personal loans to the actual realized returns. For instance, an equal investment in all vintages of Upstart-powered core personal loans with the origination date in Q1 2018 through Q3 2023 returned an approximate blended target of 9%.

One reason for investor optimism is that the company has a huge addressable market of $3 trillion in annual loan originations. Of this figure, the majority ($1.4 trillion) comes from home loans.

The company’s models are trained on more than 65 million repayment events, which add an average of 82,000 new repayments each business day.

So, Upstart’s platform is essentially a disruptor in the lending backdrop and the company boasts of greater efficiency than traditional lenders. For instance, Upstart’s model is claimed to provide 44% higher approvals and 36% lower APR than traditional models.

It also has a unique risk grading system, which is claimed to be better at differentiating risks than the traditional FICO credit score.

Is Upstart Worthy Of The Hype?

Upstart’s disruptive technology has a lot of prospects, especially in a backdrop where tech (mainly AI) is proliferating broadly. 

The company went public in 2020, and things were looking good initially. The COVID-era loose monetary policy was quite conducive for the company.

In 2021, the company’s bank partners originated 1.3 million loans, totaling $11.8 billion. As a result, revenues grew by 264% year-over-year to $848.59 million. Profits were also rising at this point.

However, there was a huge pivot in monetary policy, when the federal funds rate started climbing. Between March 2022 and July 2023, interest rates were raised by the Fed a whopping 11 times. This pivot affected Upstart considerably.

For FY2022, the company’s transaction volume declined to a total of $11.2 billion, while the conversion rate went down from 24% in 2021 to only 14% in 2022. Revenues were marginally down from the prior year to stand at $842.44 million.

On a GAAP basis, a loss of $108.67 million was posted, a huge pivot from rising profits between 2020 and 2021. On an adjusted basis, net income declined by 91% to $19.37 million.

Last year, the situation did not get any better for the company, with a transaction volume of only $4.6 billion, posting a revenue of $513.56 million, a 39% decline from the prior year, and the net loss deepened to $240.13 million – even on an adjusted basis, a net loss of $46.93 million was reported.

As of the last quarter, the company’s conversion on rate requests came in at 14%, up from 8% in the prior year’s period.

Revenue has shown some resilience, increasing 24% yearly to $127.79 million but it is still down 9% sequentially. The company’s profitability is still in the red, although Upstart has been able to curb some of its losses compared to the prior year’s period.

Is Upstart a Buy, Sell or Hold?

Upstart’s hefty prospects as an AI giant in the field of lending need to be backed up by its fundamentals.

For now with interest rates elevated, consumers need to borrow money but are struggling. So, while the risk-to-return potential is quite high, investors may well have the appetite for it to invest in UPST now.

To its credit, the stock has a reasonable valuation, with its price sitting at 3.65x forward sales but Wall Street analysts do expect the stock’s price tag to go down further, with an 18.7% potential downside.

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