Is Recent Fintech IPO Upstart a Buy?

It's been an exciting time in the IPO market recently, but most of the market chatter has been dominated by the big-name IPOs such as Airbnb (NASDAQ: ABNB), DoorDash (NYSE: DASH), and Palantir (NYSE: PLTR).

One interesting recent IPO that has been flying somewhat under the radar is fintech lender Upstart (UPST -0.58%). In this Jan. 11 Fool Live clip, Matt Frankel, CFP, and Industry Focus: Financials host Jason Moser take a closer look at Upstart and what investors need to know about it.

Jason Moser: 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?

Matt Frankel: Well, like you said, there 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 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 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.

Moser: Yeah.

Frankel: Because of their over a thousand data points, they are willing to look at consumers that have lower credit scores in a lot of other personal entries. 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 ratings. 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 be 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 (NASDAQ: ZM), but X-O-O-M, which is a financial remittance company that PayPal (NASDAQ: PYPL) 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 isn't anything new. Western Union's (NYSE: WU) 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, it's still on 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 makes 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 models. 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 S1, 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 companies 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. 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 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: Like the technology used is 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 Girouard, 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 on 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 $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.

Moser: Right.

Frankel: Right now, I guess, that 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 (LC) 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.