Personal-lending technology company Upstart (UPST +2.10%) went public a month ago, and its stock has nearly doubled since. In this week's Industry Focus: Financials, Fool.com contributor Matt Frankel, CFP, and host Jason Moser discuss what Upstart does and why investors are so excited. Then, the pair take a closer look at fintech start-up SoFi, which is getting set to go public via a SPAC merger with Social Capital Hedosophia Holdings V (IPOE +0.00%). And last but not least, we discuss the recent correction in bitcoin and other cryptocurrencies, and why Matt and Jason aren't likely to buy bitcoin anytime soon.
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This video was recorded on Jan. 11, 2021.
Jason Moser: It's Monday, Jan. 11. I am your host, Jason Moser, and on this week's financial show, we're going to dig a little bit more into a brand new IPO out there in Upstart Holdings. We've got another company looking to IPO here very soon in SoFi. We're going to take a look at what's in store for banks here, as earnings are set to begin on Friday, and a little bit more. Joining me this week, it's my man, [laughs] Certified Financial Planner, Matt Frankel. Matt, how's everything going?
Matthew Frankel: Pretty good, as you can see by the background, it's another day in paradise.
Moser: [laughs] Yeah, it seems that way every week for you. [laughs] You've got it figured out. There's nothing wrong with that at all. Matt, as I said in the intro there, we're going to talk a little bit about a brand new IPO, and then a company that's talking about getting ready to IPO. These are two very similar businesses, so I'm going to be interested to get your take on then both. Let's go ahead and start through with Upstart. Upstart is a company that just IPOed, I believe in December, so this is brand new to the public markets. But one that I think a lot of folks were excited to see go public, because it's another one of those companies that's really helping reshape the space of finance, and in particular lending. In banking, we've been so used to that stereotypical, stodgy, big bank environment. You just go into the bank, you get your loan, and then that's that. Companies like Upstart are really changing that model around. We wanted to dig into this one today for listeners. Let's start just from the 50,000 foot view here. What does Upstart do? How do they make their money?
Frankel: Well, like you said, they are pretty recent IPO, and given the times, like every other IPO, they've shot through the roof since they [laughs] went public. They're up 84% since day one, which is four weeks ago. That's really not that much time. Upstart is a personal lender, that's pretty much what business they're involved in right now. When we get to SoFi, you'll see there are in a bunch of different types of financial businesses. Upstart as a personal lender, unlike most of these Fintechs, their main premise is that traditional banks either are not convenient enough, or just don't serve the population well enough, and they aim to solve that problem. In Upstart's case, they want to assess the risks better than banks do. They were founded by former Google [Alphabet] people, if that helps. They want to assess true risk as they put it. They use over 1,600 data points, not just the FICO score, they use 1,600 consumer data points to get a really good picture of someone's risk profile. For example, did you know that having a college degree is an indicator of better loan performance?
Moser: Seems reasonable.
Frankel: They use things like that. Someone has a mediocre credit score, but they just got out of college, that's something they would consider in their algorithm. Because of their over 1,000 data points, they are willing to look at consumers that have lower credit scores in a lot of other personal lenders. According to our review on our personal finance page, Upstart loans with as low as a 580 FICO score, which is well into the poor credit range. They're targeting the overlooked consumers by traditional banks. They make personal loans of up to $50,000, they've made over 600,000 loans so far. They are growing pretty impressively. Their revenue grew 44% in 2020, which I wouldn't expect a lender to grow that much in 2020. That's pretty impressive. The thing that really stood out to me about that 600,000 statistic, 70% of the loans they close are fully automated, meaning that they'd have no labor costs involved in starting, and they just start by the algorithms that the company has developed since they were founded in 2012, so it's a pretty impressive company.
Moser: Yeah. This reminds me a little bit of a company from a little while back. We've talked about it here in there, a company called Xoom, X-O-O-M, not Zoom Video, but X-O-O-M, which is a financial remittance company that PayPal ultimately acquired. Xoom was a company, I think it was really a little bit ahead of its time almost, in that it was at the forefront of this AI powered finance model. Remittances aren't anything new. Western Union's been doing it for over 100 years. But they rested on their laurels, and Xoom got in there, and essentially started using artificial intelligence, and data points, and automation in order to make this an easier experience. Also, along the way, really, and this was a statistic that stood out to me with Upstart, in 75% reduction in loss rates in regard to those loans that they are lending out there. I think it's a testament to the power of all of those data points that you were talking about. Because that was an advantage that Xoom really built out, in building their risk model was ultimately building out these data points, that help them assess risks far better than these traditional players in that remittance space. Ultimately, what it resulted in, Xoom was really taking a lot of share, PayPal saw that, jumped in there, made the acquisition before they got too big. It made sense. It was a little better as listeners probably know. [laughs] That's OK, don't worry, we still own PayPal, so we got part of it there. But it just showed me really even back then, the power of using that data in order to assess risk better. It's not just lip service, it really does work.
Frankel: On that note, it's interesting to point out how Upstart makes its money. Upstart's not a bank itself like a lot of these fintechs. They partner with banks. Upstart gets referral fees. They use their algorithms to find creditworthy borrowers that the system has overworked, and partners with banks who make the actual loans, and Upstart gets a referral fee for its services. Upstart, it's not taking out a lot of credit risk, in other words.
Moser: Yeah.
Frankel: It's a fee income business model. They are connectors, they connect banks with customers that they otherwise wouldn't connect with. It's an interesting business model. They claim there are millions of potential borrowers that are creditworthy, but not by traditional FICO scores, and other bank metrics.
Moser: I think that's probably right. I mean, I think we've seen some adjustments to the FICO score in order to make it a little bit more modern, and account for today's consumer. Another company that we talked about on this show before, and a firm, I think John Maxfield and I did show a little while back when we went through a firm's S-1, and there was just an interesting data point in there that really spoke to how consumers view the state of finance today. It's really gone beyond just banks, and it's more about tech companies partnering with banks. Just some numbers behind that, a survey that was conducted by the Harris Poll back in 2020, way back in 2020, [laughs] said that 64% of Americans would consider purchasing or applying for financial products through technology company's platform instead of a traditional financial services provider. That sentiment rises to 81% for Americans aged between 18 and 34 years. There's data there that shows more and more consumers, particularly even younger consumers, really are trusting of a lot of these tech companies that partner with financial service providers in order to ultimately get done whatever they need to get done.
Frankel: On a similar note, that age group you were just referring to, a lot of them skewed toward being self employed, myself included. [laughs] I'm not in the 18 -29 age group anymore, that'd be nice.
Moser: No. [laughs].
Frankel: But I am in the self-employed group. That's a group that historically banks have not been very easy to deal with. I don't know if you've ever been self employed, but if you've got to apply for a mortgage, or a car loan, or something like that, there's a lot of jump or hoops that banks make you jump through. That's a market that this non-traditional credit model, by companies like Upstart, can really help solve.
Moser: Yeah, I've never been self employed, but I worked at Bank of America for a couple of years, and I was a loan officer there. I did go through the process of getting some small business administration loans done for folks who were self employed, 15 years ago, maybe even more. But even then, I was just astounded at how difficult it was, and you could see the frustration from the clients when they came in, and you had to call them back in, and we had to call for more documentation, and needed another signature. Technology then wasn't where it is today, so I can imagine that it really resonates with that younger consumer. Let's talk a little bit about what the advantages of this business really are. I think we've homed in on one there in artificial intelligence, and using data to make decisions. What else stands out to you about this business that makes it special?
Frankel: The technology used is the proprietary element of this by far, is that algorithm, the whole non-traditional risk model that they're doing, and the fact that they are willing to really bend on FICO scoring. A lot of other lenders, SoFi, which we're about to talk about in a few minutes, follows a non-traditional lending model, but also wants to pursue generally high credit borrowers. Upstart is really pursuing that. I'd call it the mid-level credit, like the people with fair credit that all the other companies are overlooking, and they tried to do that area of the market better than everyone else. So far, like you said, 75% reduction in loss ratios, it looks like it's working so far so that [laughs] technology is really that good. Then that's a big competitive advantage all by itself.
Moser: Yeah, it can be, and certainly it does seem like this is another business with, I don't want to say founders leading the way is necessarily competitive advantage, but it's certainly a sign that leadership is in the same boat as investors. This is a company, one of the co-founders, David Gerard, who's the CEO of the business and co-founder, owns I think somewhere in the neighborhood of 16% of the shares. It feels like this is a good management story too.
Frankel: To be fair, I'm usually more excited about a founder owned business years after its IPO.
Moser: Yeah.
Frankel: [laughs] Most of the big tech companies that have gone public recently, are founder-led. But that is a big advantage, especially when one of them still has a lot of skin in the game like that. The company right now has just under a $4 billion market cap. You said about a 16% stake. He could stand to make billions if this goes well.
Moser: Oh, sure.
Frankel: That's a big motivation. I know money is not the biggest motivating factor for everybody, but you got to think it's there.
Moser: [laughs] Money makes people do a lot of things. There's no doubt about it. Let's wrap up with some of the risks or things that we're just keeping our eyes on here. I think that with any of these types of businesses, particularly in this current market, the way IPOs have been received, at least in the near-term valuation, has to be at least a concern. Now, with that said, this is also a business that actually has recorded -- I can't believe it -- positive net income, this thing is actually profitable? [laughs]
Frankel: It is. At the same time, it's trading for about 20 times sales. Not earning, it's 20 times sales. That's a big multiple to pay. To be fair, it's not the only tech company with a high-value. [laughs] But I got to believe the biggest risk, it's not just valuation, it's got to maintain its growth, and there's a huge element of competition risk in this space. Right now, I guess, their biggest competitive advantages are proprietary technology. If they can address that area of the lending market, which is millions of people better than anyone else, they're going to keep growing like this. If someone else comes along and there's no shortage of alternative lenders in the market these days, that space is really blown up. It started with LendingClub about seven or eight years ago, and now there is, if you go to the essence page, we have reviews on a dozen of them. If someone else figures out how to address that market equally well or better, then you could see a lot of competition risks. It's not a no-risk investment and it's really priced for a lot to go right in the next couple of years.
Moser: Well, definitely one will enjoy following and covering here on the show for sure it's right up our alley. Let's pivot over to another business that plays, it seems, in the same sandbox, maybe a little bit of a different focus there on who they are lending to, but we're looking at SoFi, Social Finance, also known as SoFi, looking to go public here possibly soon through the SPAC vehicle. Before we get into SoFi real quickly, let's just give our listeners a quick rundown on how SPACs work. I know that you had a great conversation, not all that long ago with Dan Caplinger and you had gone over some of the basics here in regard to SPACs and how they work. Just for our listeners, give us a quick primer there on SPACs.
Frankel: The brief overview is a SPAC which stands for special purpose acquisition company. As the name implies, the special type of company [laughs] that it's formed for one reason, to acquire a private business and take it public. A SPAC goes public, it has no business operations when it goes public. It goes public, raises usually a few $100 million, then it seeks an acquisition target. That acquisition target gets that few $100 million plus some extra capital infusion, and in exchange, they combine these businesses, go public, under the SPACs, already a public entity. The idea is that it simplifies the traditional process of IPOs, the IPO roadshow, the need to hire new underwriters, things like that. By combining it with an already public company, it makes it easier for some of these companies to go public. That's why we're seeing this giant wave of SPAC IPOs. DraftKings was a big one last year, Nikola was a SPAC IPO, Opendoor was a very recent SPAC IPO. Virgin Galactic was another one. All these companies are electing to go public via SPAC and have some advantages, cost, and otherwise. The new one, SoFi, it's been agreed upon, so it's going public under a SPAC that you can buy on the market right now. The ticker symbol is IPOE, it's one of Chamath's SPACs. This is his fifth SPAC.
Moser: Wow.
Frankel: The first three were Virgin Galactic, like I just mentioned, Opendoor Technologies, which just finalized, and Clover Health, which just finalized. The fourth one, IPOD, is still looking for its acquisition target, and that's in the market right now. You can still buy that one pre-deal. It's trading at a huge premium because he's been so successful with the other ones. Then there's a sixth one, IPOF, which is the largest one so far. It's a $1 billion-dollar SPAC that is still looking for its acquisition target. IPOE, Social Capital Hedosophia V is the official name for it, but just call it an IPOE, let's keep it simple, they raised about $800 million and the various other investors are contributing another $1.2 billion to acquire SoFi, which is an online financial business. That's the brief overview of how SPAC works. We'll get into the actual business shortly, but that's the general idea of how this merger is happening. Another name for SPAC is a "blank check company." They raised all this money, the company has no operations other than having this giant bank account with money, and they're using it to take SoFi, which is a popular financial company, public.
Moser: SoFi is popular. It's been around for a little while, and it's interesting to see how these businesses evolved because it really started out as an alumni funded lending model that ultimately it was just helping students and graduates deal with student loans. It was something that was helping students deal with student debt, and it really has grown to be a full-fledged banking style operation here. I saw that SoFi, unlike Upstart, has actually gotten conditional approval for its National Bank charter application.
Frankel: So far, to my knowledge, Upstart has no desire to become a bank. SoFi is a lot more than a personal lender at this point. They applied for and received conditional approval, like you said, in October, they got conditional approval for a bank charter. If approved, they're going to be a bank. That's a big cost of capital advantage for a lender. If you can make your own loans and not go through an intermediary, that's one less person you have to pay, so it can save money. SoFi has a lot of operations. Like you said, they started as a community-based student lender, refinancing loans, issuing private student loans, they branched out into mortgages. When my wife and I were in the market for a second home, I got a mortgage quote from SoFi, they were the lowest when we saw. Then COVID happens, so we didn't actually do it. But [laughs] SoFi does have a big mortgage operation. We mentioned personal loans, the student loans, they just launched their credit card product on the lending side, they also have a high-yield savings platform, they have an investing platform where you can buy and sell stocks similar to Robinhood, I would call it, but honestly doing a better job of educating the consumer and really bringing the community into the investing process, not just trading. They have a robo-advisor, there's an insurance division that partners with other insurance companies to offer products to their members. They have 1.8 million members. I mentioned that Upstart has done a little over 600,000 loans in its history, SoFi has 1.8 million members and all of these other products. A banking charter really makes sense for them.
Moser: Sure. That's something they have to upkeep, obviously, that comes with responsibilities, and regulations, and ratios, and requirements. But as you mentioned, that can be a real source of capital, which is their business.
Frankel: Upstart is trying to become a financial technology company that partners with banks and just to help them do their existing business better. SoFi wants to be the bank of the future.
Another really interesting part of the business is the Galileo Financial that they acquired in 2020. They just paid $1.2 billion to acquire it. It's essentially a payment processing business with about 50 million accounts. [laughs] It helps businesses process checks and things like that. That could be a big part of the story, just the increased technology umbrella that they have. One thing that really surprised me about this SPAC deal is that the valuation really doesn't seem that insane. They're valuing SoFi at about $8.65 billion, including the $2.4 billion and new money that's coming in. When I mentioned Upstart, which is just a personal lender, just 600,000 loans, that's impressive, but comparatively, it's small. It's trading at a $4 billion market cap. SoFi, including $2.4 billion of new capital, is about $8.65 billion. That doesn't sound like too outrageous of a valuation with 1.8 million members, this proprietary digital payments platform that's been very successful that they acquired, they're expecting about $1 billion dollars of revenue this year alone. I mentioned Upstart's trading at about 20 times revenue, so far it's trading at about eight times revenue and that's including about $2.4 billion in cash. It's not a surprise that the shares of the stock took off after this announcement. That's why. It's because the valuation is lower than a lot of people thought so far it would end up going public for. The stock trades for about twice its par value, which implies a market cap of about $17 billion once it actually goes public. But it still sounds pretty reasonable when you consider what some of these other fin techs are trading for, considering just the wide scope of what they do.
Moser: Well, Matt, speaking of fintech and banking of the future and all that jazz, we've seen over the past 24 hours, we don't get into bitcoin very often on this show. It's not really what we cover here, but by the same token, we've seen bitcoin pull back considerably here over the last 24 hours. I think it's down somewhere in the neighborhood of about 20% a year. You have some opinions on the matter. Why don't you elaborate a little bit for us?
Frankel: Now you're going to make me be the bad guy again.
Moser: Well, I mean, I've got thoughts too, but I'm going to go ahead and let you start. [laughs]
Frankel: Well, for one, well, bitcoin is still several times more than it was at this time last year, so take it with a grain of salt. Bitcoin hit over $40,000 dollars a coin last week, and has since pulled back a little bit. Over the past 24 hours alone, it's down about 18%. Right around $32,800, right before we started recording this. Regardless of your opinions of bitcoin, this volatility first makes me tell you to be careful. It's a volatile asset. There are three arguments that I often hear in favor of bitcoin. II personally don't own any bitcoin. I've mined bitcoin. I actually mined about 12 coins in total back in the 2012-2013 time frame.
Moser: Wow.
Frankel: I wish I still had them. [laughs] Maybe that's a little bitterness coming through.
Moser: Possible.
Frankel: I understand the concept. I understand how it works. I understand the utility of it. There's three main arguments that I always hear when people tell me I should own bitcoin. One is that it's scarce. It has a limited amount, and you can't make anymore. My colleague, Sean Williams, has an article on fool.com right now that points out it would just take a majority of the bitcoin community to agree to raise that. You could make more bitcoin. I mean, a majority consensus is why we have things like bitcoin cash, the offshoot cryptocurrency. Not only that, I checked right before we came on here, there are 4,308 different cryptocurrencies that are officially recognized right now. [laughs] Of those, $270 billion of cryptocurrency value is not bitcoin. If bitcoin is getting too expensive and still valuable, people can just use a different one.
Moser: Sure.
Frankel: There's a reason that there's over $100 billion in the second largest cryptocurrency. I mean, the scarcity argument, I don't totally buy. No. 2, the argument that it's a store of value, like gold. For one, forget about the scarcity thing where you can't make more gold, but potentially there could be more bitcoin made. Forget about that. I don't want to store a value that can fluctuate by 20% in a day. That's not a stored value.
Moser: Yeah, I agree. I mean, I'm not interested in that.[laughs]
Frankel: My savings account is a stored value because its value doesn't fluctuate. I mean, you could say that inflation over time will fluctuate, but not by 20% in a day. This is why people, I think it was Venezuela that had a hyperinflation if I'm not mistaken.
Moser: Yeah. I believe you're right.
Frankel: That's why people were storing value in that currency, because it was very volatile and unpredictable at that point. The stored value I think I don't really buy at the moment. It's a volatile day when the U.S. dollar moves by 1% in either direction against say, the euro.
If bitcoin got to that level of stability, I might buy the stored value argument a little bit more. But for the time being, it's not a stored value. Argument three that I get, and this is the one that's going to make people really mad, is that there is no real use case for it. Okay, so let me give you one statistic. You can spend bitcoin at about 2,300 merchants right now. 2,300 different retailers. That sounds impressive, right?
Moser: I guess. But out of a total number of what?
Frankel: If you just look at businesses that have at least one employee, there are seven million small businesses in America.
Moser: Yeah, I was thinking that's where we are going.
Frankel: That's not a lot of penetration into the market.
Moser: No.
Frankel: Bitcoin's been around for a decade now. It's been pretty well known. Everyone at least knows the term bitcoin since about 2014-2015. It hasn't proven as a useful currency over the U.S. dollar, especially with all these fintech innovations that we're talking about. With contactless payments I can pay by just tapping my phone on something. I don't need actual U.S. dollars to pay in U.S. dollars anymore. It's become easy to transact in foreign currencies.
Moser: Yeah, absolutely.
Frankel: Which one of the biggest use cases for bitcoin as a currency is that it could be a worldwide universal currency. Now, it's easier than ever to switch from one currency to another. I don't buy the use case for bitcoin. I don't see widespread adoption happening. I mean, you could make the argument that PayPal and Square are onboard with bitcoin and PayPal has said that it wants to make bitcoin usable at its merchants. But I still don't see the benefit to converting my U.S. dollars to bitcoin to be able to use them on PayPal when I can just take my U.S. dollars and use them on PayPal. I don't see the use case that's going to appeal to main street. I get the early adopters who loved the technology and things like that. I get why they see a big use case at it, I really do. But I don't see it translating to widespread mainstream adoption anytime in the next decade or more.
Moser: Just a reminder for all of our bitcoin bull listeners, you can reach Matt on Twitter @TMFMathGuy. That's --
Frankel: I thought you were about to give out my address or something.
Moser: I was just kidding. No, I won't do that. Listen, just like I said, we don't cover a lot of bitcoin on this show because it stands on its own. It probably deserves its own hour. I think you make a lot of good points there and I'm sure there are folks out there who would take the other side of the coin, so to speak. I'm with you. I'm not saying there is not a use case. I'm not saying it's not special. Maybe it is. You know what? I don't care. That's what it boils down to, is I just don't care. My time is better spent doing something else. Focusing on what I do. I know what I don't know. I just don't know enough about bitcoin to really even care. I just leave it at that.
Frankel: Like I said, I'd make all those points with all due respect to the bitcoin fans, people who love the technology, I get it. I've mined bitcoin, I've used bitcoin, I lived off bitcoin for a day just to see if it was possible. [laughs] I get it. But I just don't see the mainstream case for it at this point.
Moser: Yeah.
Frankel: I say it with all due respect.
Moser: All due respect.
Frankel: That's not going to prevent a Reddit thread from popping up.
Moser: Yeah. You gave it the old Ricky Bobby. Man, all due respect. You said all due respect, man. I appreciate that. [laughs] Well, Matt, before we wrap things up here, we normally like to wrap our shows up with ones to watch for our listeners. This week, because banks are getting ready to kick off earnings season on Friday, we wanted to just go ahead and get your take on a couple of things you are watching here for banks this coming earnings season.
Frankel: My pick last week was Wells Fargo. I'm going to stick with that as my one to watch because they report their earnings on Friday, which is the first day of bank earnings.
I like Wells Fargo, especially as a gauge of what's going on in the banking sector, because they're the closest thing to a pure play just savings and loan of the big banks. The things I'm watching are the default rate. We're going to get the fourth quarter earnings. The last time we heard from Wells Fargo was the third quarter when the pandemic had not subsided, but it was definitely at a low. There was still some stimulus being pumped into the market. The unemployment benefits, in a lot of cases, were still going onto the third quarter, for example. Some stimulus ran out in the fourth quarter. I want to see how that's playing out. I want to see their expenses. The new CEO, Charlie Scharf, has prioritized expense reduction, saying he wants to cut I think $10 billion of expenses off the bank. I want to see any progress on that. Now that the bank is allowed to pay dividends and buy back shares, the Federal Reserve said banks can start doing this in the first quarter. I want to see any commentary toward when that might start to happen and to what extent. I'm not necessarily thinking Wells Fargo is going to pop on the earnings announcement, but there's a lot of details that are going to play into my investment thesis that I talked about last week.
Moser: Well, that sounds very good, Matt. I think that's going to do it for us this week. Listen, man, I appreciate you taking the time to jump on as always. It was a really fun conversation. I appreciate you digging into Upstart and teaching us a little bit more about that business. Let's not be a stranger, I look forward to seeing you next week.
Frankel: All right. I will see you then.
Moser: Remember, as always, you can reach out to us on Twitter at @MFIndustryFocus. Or you can drop us an email at [email protected]. As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy your or sell stocks based solely on what you hear. Thanks as always to Tim Sparks for putting the show together for us. For Matt Frankel, I'm Jason Moser. Thanks for listening and we'll see you next week.
