At the recent Lendit conference, CEO Scott Sanborn made an interesting argument: that online lending is currently in a similar place to online retail at the turn of the millennium. He read passages from a 1999 Barron's story, "Amazon.bomb," which criticized Jeff Bezos and foretold the end of Amazon (NASDAQ: AMZN) as we know it. As Amazon investors are well aware, that didn't happen!
Sanborn is certainly being optimistic, given the performance for Lending Club's stock in the past year. Though, to his credit, Amazon's 1999-2001 stock chart looks a lot like Lending Club's current chart.
Does Sanborn have a point? Will Lending Club recover to be as wildly successful as Amazon in the decades ahead? Let's dive in to each of Sanborn's points and evaluate them to see if Lending Club might one day be a buy.
Online lending and retail parallels
Sanborn believes that online lending platforms have the same network effect as online retail. Online marketplaces connect buyers and sellers from all over the world). The more people get on the same network, the more valuable the network becomes. This value then attracts more customers, in a virtuous circle.
In online retail, eBay (NASDAQ: EBAY) was a first mover in online auctions during the dot-com boom. It quickly became the leading two-sided auction network, and survived the dot-com bust.
Just as eBay connects sellers to interested buyers, Lending Club connects borrowers with investors, then charges a transaction and servicing fee. Like eBay, Lending Club does not hold its inventory (i.e loans) on its balance sheet, though Lending Club sometimes buys loans temporarily, either in anticipation of a securitization or when investors pull back from the platform.
Lending Club was also a first mover in its field, and commands a leading 45% market share Sanborn argues this scale enables a similar "network effect" that will allow Lending Club to get through this tough period.
The second parallel Sanborn drew was cost savings. Just as online retailers like Amazon cut out the costs of physical stores, Lending Club and other online lenders don't need bank branches or human underwriters. These costs savings allow online lenders to offer loans at lower rates than credit cards, which is how people traditionally obtained unsecured personal loans.
Sanborn's final point was that online shopping can offer a better experience for customers. Customers who shop for goods online can see entire worldwide inventories from the comfort of home, without taking the time to go to a store, or being limited to what that particular store has in stock that day. Likewise, online loan shoppers can look at a variety of loans and terms from the comfort of their own homes.
But online lending is not exactly the same thing
I think all of Sanborn's points have merit. However, there are also big differences between online lending and online retail marketplaces.
One big difference is that lending marketplaces rely on sustained investor interest to buy up loans. This was the problem last year when institutional loan buyers paused their buying as a result of Lending Club marking some of its loans incorrectly in order to sell them. Of course, Lending Club has a large cash reserve -- $803 million as of December 31 -- with which it can step in to buy loans, but that is not its model. And while sites like eBay and Amazon need buyers, investors in high-yield loans are more fickle. The current low-interest rate period has made high-yield online loans attractive -- but that could change if the Fed raises interest rates.
Another difference is that Lending Club's relationship with borrowers doesn't end with the transaction. Borrowers must continue to prove they are creditworthy over the life of the loan, which can run 36 or 60 months. If defaults spike, Lending Club's underwriting algorithms would come under scrutiny, and lenders might flee the platform again. In contrast, an Amazon customer pays right away, a good is shipped, and the transaction ends. And while Amazon needs to cultivate repeat customers, Lending Club is much more dependent on the financial behavior of others on an ongoing basis.
Summing it up
There are definitely parallels between online lending marketplaces and online retail marketplaces. However, investors should understand companies like Lending Club are still financial companies that depend on the creditworthiness of others, economic cycles, and underwriting ability. This is much more of a challenge than selling a book or pair of shoes.
In 2017, investors should keep a lookout for whether Lending Club can return to the robust revenue growth it experienced prior to 2016. The company guided for 15-20% revenue growth for 2017. Meeting or exceeding the full-year guidance would help restore confidence that Lending Club will survive and go on to great success like Amazon or eBay. Failing to restore growth this year would suggest Lending Club may be falling prey to competition, or a reduced appetite for high-yield personal loans. That would indicate Lending Club may become like the 90s-era dot-coms that never made it to the other side of 2000.