Upstart (UPST 3.44%), the lender using artificial intelligence in its decision-making on loans, delivered strong results for the fourth quarter of 2021, sending its stock price soaring last week. But the company also delighted shareholders with the announcement that it had authorized a $400 million share-repurchase program.
The share buyback news came as a bit of a surprise because Upstart only went public at the end of 2020 and has been in growth mode ever since. Usually, companies in growth mode do not repurchase shares. They are usually too focused on investing in the business to grow more users and capture market share.
Let's take a look at why Upstart chose to repurchase shares and what it might mean for investors.
Volatility and valuation
Upstart CFO Sanjay Datta attributed the decision to repurchase shares to recent volatility in the stock. Since going public, Upstart stock has been on a roller coaster of a ride. It traded at roughly $44 per share on its first day as a public company and then rose all the way to nearly $400 per share last October. But over the last several months, the stock has taken a big hit along with most other tech and fintech stocks as inflation has surged and the Federal Reserve has changed its monetary outlook. The market has reset on news that the Fed will raise its benchmark overnight lending rate (the federal funds rate) multiple times this year and also may shrink its balance sheet at some point as well.
On Upstart's recent earnings call, Datta said the repurchase plan was linked to the volatility in the stock; the fact that Upstart is already profitable, which is rarely the case for a fast-growing fintech; and management's belief that the company is undervalued.
But even at current price levels, Upstart stock trades at about eight times projected sales in 2022 and roughly 56 times projected earnings. When Upstart traded close to $400 per share, it traded at about 40 times forward sales and 200 times forward earnings. I wouldn't exactly call 56 times forward earnings a light valuation, and by no means do I think Upstart belongs anywhere near 200 times forward earnings or 40 times forward revenue right now.
Upstart should focus on its core business
While the company is planning to raise expenses to do things like ramp up hiring in tech, I would rather see the company focus on its core business instead of repurchasing shares. Upstart's whole model is built on the belief that it can better assess the true quality of borrowers. The company has claimed it can produce 75% lower default rates than traditional bank underwriting. Ultimately, Upstart wants banks to use its underwriting models and drop traditional FICO scoring requirements. The company started with unsecured personal loans and then recently expanded into the auto lending space. Management has said it expects to expand into mortgage, small-dollar lending, and then small-business lending.
In recent months, Upstart has begun underwriting personal loans to borrowers on the lower end of the credit spectrum, which has resulted in some higher delinquency rates. Management has said this is to be expected in the beginning, but banks and credit unions are very conservative. If they get a sense that Upstart's underwriting is not working, forget about getting rid of FICO requirements; they will drop Upstart's platform.
Upstart recently disclosed in its annual filing that partner banks only retained 16% of loans funded through the platform, with the rest being sold to institutional investors. The company has been adding bank partners, and I am sure banks retained more loan volume overall than in 2020, but that number still leaves a lot of room for improvement.
Also, Upstart in the past has spoken about creating a small-dollar lending product that charges interest rates under 36%. These loans, frequently known as payday loans, commonly carry interest rates between 200% and over 600%, largely because they are so risky. This could be very difficult for Upstart to pull off.
Lastly, the economy is entering a completely different environment than it's been in for the past two years. Federal stimulus, low interest rates, and high savings rates have resulted in historically low loan-loss rates for the banking system for the last two years. That is expected to change as the Fed hikes interest rates, stimulus benefits fade, and savings rates run down. Management expects this, but Upstart needs to make sure its tech and underwriting models can hold up well and beat traditional underwriting models in more difficult economic conditions.
Is Upstart management overly confident?
What Upstart has done so far is impressive. But I feel like management is getting a little ahead of itself. Upstart CEO Dave Girouard on the company's recent earnings call said:
Upstart is now about the size that [Alphabet's] Google was when I joined that company in early 2004. So I've seen this movie before and hope to use what I learned there to build Upstart into the most impactful fintech in the world.
There's nothing wrong with confidence, but with cyclical headwinds coming, I feel like it's a bit soon to be making Google comparisons and repurchasing shares. The company is doing well, but there is still a lot left to prove.