LendingClub's (LC 3.81%) stock price has ballooned by almost 50% since the digital marketplace bank released its second consecutive terrific quarterly report last week. For the third quarter, the company took in diluted earnings per share of $0.27 on total revenue of roughly $246 million. Loan originations, its main revenue driver, topped $3.1 billion, even during a period when consumer activity was disrupted by a surge in COVID-19 cases.
The results beat not only analysts' consensus estimates but also the company's own guidance, and management revised its full-year guidance upward. It's easy to see why investors have driven LendingClub's stock up by more than 340% this year through Wednesday's close. But I still think the stock is cheap and can definitely double again from here.
The new model is humming
Earlier this year, LendingClub closed on its acquisition of the branchless Radius Bank. That deal made LendingClub one of a very few fintech companies to hold a bank charter -- and acquiring one of those is not easy.
The bank charter enabled LendingClub to change its business model and has made its powerful lending machine much more profitable. It can now use cheap deposits to fund a portion of its loan originations, and it no longer has to pay the extra costs associated with having outside banks originate the loans. Then, management made the smart decision to retain 15% to 25% of loans the company originates on its balance sheet to generate monthly recurring interest income.
Image source: Getty Images.
The result has been a powerful machine that in just two quarters' time has generated a combined $450 million in revenue, largely from $5.8 billion worth of loan originations. LendingClub has also grown members from 3 million at the start of the year to 3.8 million at the end of the third quarter -- ramping up its marketing efforts while also generating repeat business from previous borrowers.
Retaining loans on the balance sheet is an incredibly smart move in my opinion because, as management has previously noted, these loans are three times more profitable to the company over their lifetimes than those that are sold to banks and investors. These borrowers are steadily making loan payments on relatively high-interest rate debt; the average yield in its unsecured personal loan portfolio was close to 16% at the end of Q3. Look how quickly revenue from retained loans (net interest income) has ramped up since Q1.
Image source: LendingClub Q3 investor presentation.
Is there risk associated with holding loans on the balance sheet? Yes, of course -- borrowers could default. But because it only intends to hold on to around 20% of its total loan originations, the company is able to retain loans from prime and super-prime borrowers. LendingClub also sets aside a provision to cover potential losses each quarter.
It's still undervalued
Today, LendingClub has a market cap under $5 billion. Some of its competitors are popular fintech companies like Upstart Holdings and SoFi Technologies. All of their business models are slightly different, but in general, they're all in the business of using machine learning and big data to streamline online lending, and they all go after installment loans, particularly LendingClub and Upstart. Here are their earnings results and projected results for the past two quarters.
| Company | Q2 Originations | Q2 Revenue | Q2 EPS | Q3 Originations | Q3 Revenue | Q3 EPS |
|---|---|---|---|---|---|---|
| LendingClub | $2.722 billion | $204.4 million | $0.09 | $3.106 billion | $246.2 million | $0.27 |
| Upstart | $2.800 billion | $194 million | $0.39 | N/A | $215 million* | $0.33* |
| SoFi | $2.946 billion | $237 million | ($0.48) | N/A | $255.6 million* | ($0.14)* |
Source = Company financial statements, analysts' estimates. *=consensus estimate
One thing to keep in mind when looking at the table above is that SoFi's originations include mortgage and student lending, so they aren't actually originating more installment loans than LendingClub or Upstart.
Now, let's take a look at the consensus estimates these lenders for 2022.
| Company | 2022 Revenue (Estimate) | 2022 EPS (Estimate) |
|---|---|---|
| LendingClub | $1.12 billion | $0.92 |
| Upstart | $1.07 billion | $1.66 |
| SoFi | $1.45 billion | ($0.28) |
Source = Analyst estimates
Estimates for all three of these companies could change as analysts absorb LendingClub's quarterly results, and they could also revise Upstart and SoFi's up or down based on their Q3 earnings reports. But based on results from the last two quarters and projections for next year, the undervaluation of LendingClub is fairly simple to understand. The company has less than a $5 billion market cap, while SoFi's market cap is roughly $18.4 billion and Upstart's is $25.7 billion. Yet the revenue and profitability figures of the three over the past two quarters are not terribly different, and LendingClub has ramped up its originations, revenue, and profitability incredibly fast. In my view, the significant gap between the market caps of these three companies is not justifiable.
Why LendingClub can double from here
I can understand that investors may not like the fact that LendingClub is retaining loans on its balance sheet and assuming the risk. They also might believe that its tech and data algorithms are inferior to Upstart's. I very much disagree with both points. But even an investor who does hold these beliefs could rationally see LendingClub as deserving a $10 billion market cap -- which would still be far below SoFi and Upstart.
Yet at Wednesday's prices, LendingClub trades around $47 per share with a $4.7 billion market cap -- less than half that level. Also, consider that LendingClub trades at only 4.4 times projected forward revenue. All of this leads me to conclude that LendingClub isn't getting enough credit, and it could double its stock price if it keeps producing consistent quarterly results.
