Capital allocation -- what a company spends its money on -- is one of the most critical jobs a CEO has. In his book The Outsiders, William Thorndike makes a strong case that it may be the single biggest factor in determining long-term shareholder returns. It is also often overlooked.
Shareholders of Upstart (UPST -1.97%) are paying closer attention these days. Many are scratching their heads as they process two seemingly contradictory pieces of information. While the CEO and other executives have been unloading shares, the company could be about to start buying them. It's confusing on the surface. But does it make more sense when each action is examined by itself?
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When companies buy and sell stock
Many investors were confused and a little dismayed when Upstart announced a share buyback program in February. The announcement came on the heels of fourth-quarter revenue massively beating analyst expectations. Given the results, a buyback seems especially out of character for a small company growing so fast.
That most recent quarterly revenue was more than triple the same period in the previous year. Conventional wisdom would have Upstart investing every penny into expanding its business. After all, it created and sold shares last year in addition to taking on debt that could be converted into more shares in order to invest in growth. But those actions make a little more sense in context of the share price.
The secondary offering was in April 2021 at $120 per share while the debt was raised in August, convertible at $285 per share. Through those actions -- and a stellar year of operations -- the cash on Upstart's balance sheet had grown 290% to almost $1 billion by the end of last year. Furthermore, the shares were trading below the April 2021 price when the repurchase authorization was announced. That's despite a more than doubling of operating profit. From the corporate perspective, that makes opening the door to stock buybacks entirely reasonable. But what about the CEO's selling of shares?
When executives buy and sell stock
The Securities and Exchange Commission (SEC) created Rule 10b5-1 to allow insiders at publicly traded companies to sell a set number of shares at a set date in the future. In theory, it results in planned sales that prevent insiders from taking advantage of non-public information. However, there are gaps such as the ability to have multiple plans and the cancellation of preplanned sales when an insider wants to hang on to shares.
So far this year, Upstart executives have been heavy sellers of the stock. In fact, not a single transaction has been made in which an executive spent money to buy stock since the initial public offering (IPO). Any increase in holdings has been the result of grants. There are a lot of reasons to sell. So investors can't read too much into any particular transaction. That said, CEO Dave Girouard's transactions began in September, when the stock was peaking above $300 per share. They have been relatively consistent since as the stock fell 75%. In March alone he has sold more than $20 million worth.
| Period | Shares Sold | Percent of Stake* |
|---|---|---|
| IPO to August 2021 | 0 | 0% |
| September 2021 | 137,498 | 1.2% |
| October 2021 | 137,498 | 1.2% |
| November 2021 | 137,498 | 1.2% |
| December 2021 | 137,498 | 1.2% |
| January 2022 | 91,664 | 0.9% |
| February 2022 | 91,665 | 0.9% |
| March 2022 | 126,789 | 1.3% |
Data source: SEC filings; *Calculated using end of previous year's shares.
What it all means
Girouard was awarded 53,000 shares in early 2021 and about 34,000 last month. The grants were worth $6.7 million and $4.4 million, respectively. That doesn't count the stock options. While he still holds more than 10 million shares -- about 12% of the share count the company estimates for the first quarter -- the current pace would see that evaporate in about seven years. I don't expect that to happen. But it gives some context about the pace of sales.
Taken together, I see nothing improper despite the seeming contradiction of the buyback program and Girouard's (and other executives') stock sales. But I will be paying attention to how consistently these monthly transactions occur. One thing is crystal clear: Upstart executives are cashing out.
While Girouard began selling when the stock spiked higher last autumn, he has continued even as the shares now rest below pre-autumn levels. It makes sense for a founder to diversify his wealth when he sees it jump tenfold in less than a year. But the benefit of using company funds to repurchase shares while continuing to sell your own is less obvious, especially after those shares have lost three-quarters of their value.
