Elevate Credit, Inc. IPO: What Investors Need to Know

Elevate Credit, Inc. (ELVT)  made its public market debut on April 6, the only "fintech" lender to go public since the 2014 debuts of Lending Club (LC -3.58%) and On Deck Capital (ONDK). Why has it taken so long? Probably because the Lending Club and On Deck stock charts look like this: 

LC data by YCharts

Elevate was supposed to go public in January 2016 -- not exactly a good time in the markets -- so the offering was scrapped until this year. While the markets are certainly in better shape, Elevate priced well below its initial expectation at $6.50 per share, as opposed to the anticipated $12-$14 per share.

Why all the hate? Well, take two risky businesses -- fintech and subprime loans— stick them together, and presto!-- investors get nervous. But is the current skepticism an opportunity?

What Elevate Credit is

Elevate was spun off from Think Finance, a lending software company, in 2014. Elevate offers unsecured loans to borrowers with less-than-prime credit in the US and UK in three products: Rise, Sunny, and Elastic. The company's target borrowers are individuals with credit scores less than 700. If that sounds like risky business, that's because it is. That's why Elevate's loans carry interest rates ranging from 36% to 299%.

While this sounds extreme, the company's competitors are payday loan operations, pawn shops, and other businesses that charge an average of 400%, according to the Consumer Protection Bureau. In fact, management stated that the company has saved this demographic more than $1 billion since 2013. Elevate also decreases customers' interest rates if they consistently make timely payments over a certain period of time -- giving customers the opportunity to lift their credit scores. Many payday lenders don't even report to credit bureaus at all, which means reliable consumers wind up exactly where they started since their reliable payments are never added to their credit scores.

Assuming no moral objections, does Elevate make a good investment?

source: Getty Images

Positive characteristics

Elevate is a high-growth business operating in an area unappetizing to many others, which means it maybe somewhat insulated from competition. The company's IQ and DORA platforms use of Hadoop databases, which analyze a massive 40 terabytes and utilize 10 thousand different variables when assessing risk. Remarkably, machines decide the fate of 95% of loan applications, not humans. These tools have kept loan losses as a percentage of revenues stable at 42-52% over the past four years and principal charge-offs between 25-30%. . This seems high, but when you consider the average APR is 146%, you can see how that is a scalable business.

The company grew revenues at a 34% clip in 2016, but, like most other recent tech IPOs, wasn't profitable, posting losses of $22.9 million. Still, compared with its fintech peers, it looks good on several metrics:

Source: LendingClub, OnDeck, Elevate Financials, table by author

These businesses have different models and target consumers, but as you can see, Elevate is the least expensive of the bunch, as well as the fastest-growing.

There are other attractive aspects to the subprime market. One, it is very big, comprising 170 million people in the U.S. and U.K. Two, the market can actually be counter-cyclical, which means charge-offs stay the same or improve in a recession. This is because traditional lenders tighten credit in a downturn, which throws many credit-worthy borrowers into the subprime pool. This finding was based on management's "own experience during the last financial crisis," according to the company's S-1. 

But there are risks

While Elevate may look enticing based on these factors, there are a number of risks. Two big ones stuck out to me:

1. Regulation: Subprime lenders could easily become the target of regulation, either in the U.S., U.K., individual states, or all of the above. While the Trump administration and Republican congress makes this less likely, there are still federal regulators such as the Consumer Protection Bureau on the case. For instance, regulators could restrict the company's use of the automated clearing house systems, or electronic payment transfers, from people's bank accounts. It is pretty easy to see how that could impede Elevate's ability to collect payments if this were to happen. 

2. Debt financing: One of the key differentiators among online lenders is how they fund themselves. Elevate primarily funds its loans through high-yield debt from just a single source: Victory Park Capital, a privately held alternative asset manager. Victory upped its loan facility to $545 million last summer , and funds Elevate's Sunny and Rise products at a variable rate based on LIBOR plus a spread of anywhere between 9% and 18%. Moreover, Elevate earns fees to license its technology to Republic Bank, which originates the Elastic lines of credit. Republic then sells up to 90% of the loans to an entity owned by -- you guessed it --  Victory Park. Elevate also has to guarantee this entity against losses.

Conclusion

I was ready to get on board with Elevate until I got to the debt financing risk. The combination of dependency on a single lender, high costs of capital, and having to guarantee loan losses to a third party doesn't sit well with me. If Elevate can diversify its funding sources, I might be more interested, but for now, I'm sitting on the sidelines until that happens.