In this podcast, Motley Fool analyst Jason Moser discusses:
- Amazon (AMZN 1.41%) CEO Andy Jassy's annual shareholder letter.
- Why AWS isn't getting spun off.
- Amazon doubling fulfillment capacity in just two years.
- The company's approach to MLPs (minimum loveable products).
Jason is joined by Motley Fool contributor Matt Frankel to take a closer look at lending platform Upstart Holdings (UPST -3.65%), which is down nearly 80% from its 52-week high.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
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This video was recorded on April 18, 2022.
Chris Hill: What is the stock market have in common with a magician? They both use misdirection to distract the audience from paying attention to something more important. Details next, Motley Fool Money starts now. I'm Chris Hill and I'm joined by Motley Fool Senior Analyst Jason Moser. Thanks for being here.
Jason Moser: Hey, thanks for having me.
Chris Hill: For the past week, the dominant story in the investing world has been Elon Musk and Twitter. I understand why it's been the dominant story. But it has sucked almost all of the oxygen out [laughs] of the room, and things are being overlooked, and one of them is the fact that the CEO of one of the most important companies in America published his annual shareholder letter. The company is Amazon. The CEO is Andy Jassy. First time Amazon has an annual shareholder letter published by someone other than Jeff Bezos, and there are a few things I wanted to get to in the letter and the interview that Jassy did after it was published. But let's just start here. You read the letter, what was your headline?
Jason Moser: To me, the headline really simply is, "Hey folks rest easy." We got the right guy for this job. Anytime you replace a long-standing CEO and founder CEO at that, they are going to be big questions as to whether you got the right person for the job, and I think just judging by this letter, and judging by the interviews I've seen with Mr. Jassy through the months leading up to the letter. It just to me, it feels they've got the right person for this job. It's really funny, too. If you [laughs] are watching an interview with Andy Jassy, if you just close your eyes and just listen and don't look, I swear you think you're listening to Jeff Bezos talk. They are very similar. Not only in how they speak, but the actual tone, the intonations, the pauses, other than maybe that big laugh. I think that's quite essential Bezos. But it's just really funny. I thought about that and I close my eyes and I was listening to this interview. I thought man really sounds like Jeff Bezos, and I'm sure there's probably a little bit of nurture there and they've worked so closely together for so long. But yeah, generally speaking, I think they've just got the right person for this job.
Chris Hill: It's funny you say that about Bezos, cause yeah, I was thinking the same thing, well, if you just take away the laugh [laughs] and read a transcript, if you're just thinking of how would Bezos answer the questions in an interview, that sort of thing. I pulled a trick out of your bag and did a search in Jassy's letter for the word customer and Bezos famously saying we want to be the most customer-centric company in the world. The word customer appears more than 50 times. Jassy made his bones as the head of AWS. It's really no surprise that AWS is very front and center in the shareholder letter. But between the letter and this interview he did with Andrew Ross Sorkin on CNBC, I think one of the things Jassy did was simultaneously speak to the importance of AWS while quietly putting to rest any questions of whether they would spin it off, and I have to say as a shareholder, I like the fact that he views, whenever we talk about spin-offs, it's almost always accompanied by the phrase "unlocking value"
Jason Moser: Yeah.
Chris Hill: and Jassy's approach is anytime you're thinking about spending off, you have to answer the question, why would we do this? To paraphrase what he said, there's no compelling reason.
Jason Moser: Yeah, I think he's right. Generally speaking, I do love in the letter. He takes that moment to really nerd out on the AWS side, which is just, it's really neat to see because like you said that's how he made his bonds. He's been intimately involved with that side of the business really since his been there. That's what he has been responsible for. I just thought it was need to read through you can sense his excitement when he gets to talk about that stuff, and so I think that's really neat because AWS is going to be a pivotal part of this company's future. If there were any compelling reason, if you felt AWS was suffering under that Amazon umbrella and you felt there would be value to unlock by giving it its own path, yeah that's understandable. When you see spin-offs. Oftentimes it's maybe two parts of the business that aren't as complementary is maybe they once were. I would argue in this case, an AWS is extremely complementary to virtually everything that Amazon does because AWS essentially helps run the internet. It's not hyperbole at all to me to say that if Amazon closed its doors tomorrow, half the world would stop turning. It is that important of a business, and so when you have a crown jewel like AWS, you got to come up with a compelling reason to unload it, to spin it off, and I think he will be very protective of that side of the business in nurturing and give it all the resources it needs, and that's the beauty of Amazon's businesses. They are generating all the capital and resources they need to keep iterating and rolling, and that's exciting.
Chris Hill: A couple of things real quick. First, he address the fact that they've essentially doubled their fulfillment capacity in the last two years. In terms of their fulfillment centers, the hundreds of thousands of people they have hired. Any concern on your part that we've talked about stocks that basically pulled forward growth. Is there any concern on your part that Amazon has maybe overgrown in terms of its staffing and hiring or do you think, no, this is what they need to do?
Jason Moser: I think it's probably more what they need to do. I think you raised some really good points there in regard to growth. They referred to that a couple of points in the letter. Ultimately be talking about the North American and international consumer revenue ultimately realize the equivalent of three years of forecast growth in about 15 months into your point on the fulfillment centers. That was another passage that was really an eye-catcher.
Because he says, and I quote, "This growth also created short-term logistics and cost challenges. We spent Amazon's first 25 years building a very large fulfillment network and then had to double it in the last 24 months to meet customer demand." All along the way, as investors, as analysts, we've talked about these investments that Amazon continues to make in fulfillment. You're talking somewhere in the neighborhood of $50 million, they have to drop on just one fulfillment center, and were these wise investments, were these investments they needed to be making? It turns out, yes, now I needed certainly easy to argue that there was a lot of demand pull-forward and so maybe they had to go a little bit beyond what they were planning. Maybe they had to accelerate the timeline a little bit. But it's not difficult to imagine a future where that customer demand that they've realized over the last 24 months. It's not difficult to see that demand sticking and growing as the world continues to move online, and clearly Amazon is a global business making large investments in its international side as well. To me, perhaps there could be some timing issues there, but I think that works itself out over the longer haul, which is obviously how we view investing in these types of businesses.
Chris Hill: We also got some insight into how Jassy and his team think about new products. There is a section in the letter where he talked about MLPs, not master limited partnerships [laughs] but what they refer to as minimum lovable product, which I love this approach, which is essentially it doesn't have to be perfect, but it's got to be good enough so that we can iterate off of it.
Jason Moser: Yeah. It's got to be something, I like that they define, there's got to be a threshold there. This is all part of this framework that he laid out there in regard to iterative innovation. Amazon is known for never sitting still in laying out that framework in some of the components they noted that help them in that iterative innovation. I'll just read them off because I think they're really helpful. There's a lot here for investors really. It's not just in building a business. Look at this from the perspective of investing. No. 1, hire the right builders. No. 2, organize builders into teams that are as separable and autonomous as possible. No. 3, give teams the right tools and permission to move fast. No. 4, you need blind faith, but no false hope. No. 5, to your MLP, define a minimum lovable product and be willing to iterate fast. No. 6, adopt the long-term orientation. No. 7, and maybe the most important, brace yourself for failure because that's a given. It's going to happen, and I say it all the time as investors, when we make mistakes, you need to embrace that because if you can look at that for what it is, No. 1, we're always going to make mistakes as investors, but No. 2, they're the greatest teachers. If you can look at those mistakes as opportunities to learn, it just opens up a whole new world of opportunity.
Chris Hill: A last thing on Amazon. I believe, May 5, is when their earnings report comes out. We will get some insight into how consequential the recent price increase of Amazon Prime is going. We're not going to get a full quarter's worth of data until they report in the summer. How closely are you going to be watching that? Is that a concern at all for you? Where does that rank on your list of when Amazon comes out with their earnings report, this is where it ranks in terms of my own interest?
Jason Moser: For me a time ago it may have been a bigger concern, and in one of the lessons I learned along the way in following Costco and that's a business we like and we talk about a lot. But remember over the last several years, we've entertained discussions, does Costco have pricing power? Can they raise that membership fee and are people still going to pay it? We've seen through time the answer is yes. They can raise it incrementally over time, and as long as they continue to offer value that their members in turn value, then it mean they can keep on thoughtfully doing that. With Amazon, they continue to offer a lot of value through that Prime membership. I know that there are some criticisms as of late in regard to shipping and maybe people don't get things on time all the time anymore and two days turns into four. We as consumers have grown very impatient, we want everything now and Amazon's partly to blame for that because they have done such a great job in building that fulfillment network yet, and to me, it sounds like these investments that they're making in their Prime relationship are the sensible ones. They're continuing to invest in that same-day shipping and making sure that they can get items to us on the timeline as promised. As long as they continue to make the right investments in that Prime relationship and focusing on what people really care about first and foremost, which I think still for the most part, is getting your stuff in a timely fashion, then they'll be able to continue doing that. [MUSIC] It really is difficult, shipping and logistics and fulfillment. That's difficult work. But they've made a lot of investments along the way to really build out their capability, and I suspect that'll continue.
Chris Hill: Jason Moser. Appreciate the perspective. Thanks.
Jason Moser: Thank you.
Chris Hill: Jason's sticking around and he'll be joined by as long time podcast partner in crime, Matt Frankel. If you're a longtime listener, you know they love to dig into financial companies, and we got a question right up their alley. We got a review on Apple Podcasts from a listener with the screen name, Change it later now, who writes, "I'd like to hear a bit about Upstart Holdings. Seems like it hasn't been mentioned as much after it fell, but I'd like to hear about how rising interest rates in the US will affect them in the future." If you're not familiar with Upstart, it is a lending platform with the ticker symbol UPST. For a closer look, here's Jason and Matt.
Jason Moser: Hey Matt, great to chat with you again. I hope spring is springing down there in the lovely state of South Carolina.
Matt Frankel: It is and our pollen season is coming to an end, which is always good news. You [laughs] have to know how that is.
Jason Moser: Well enough about the weather. [laughs] We always appreciate listener questions and suggestions, requests for companies to dig into a bit for the show. With that in mind this week we're taking a closer look at Upstart. This is a lending tech company. It's very popular recommendation here in our universe. It's been an underperformer so far. I'm not sure how long that will last though. This is a pretty interesting business to say the least. I know it's one that you follow closely, too. So let's go ahead and begin the conversation with a simple question: What does Upstart do?
Matt Frankel: Yeah, and that's a simple question, but it's not so simple in a way because I remember we talked about Upstart when they first went public. We really didn't get the business model too much, we were like, yeah, subprime lender. It's historically a bad idea to invest in subprime lenders, to be honest with you. But they're a lot more than that. They're a technology company, they develop an artificial intelligence platform that aims to do a better job of predicting loan losses than the traditional methods, specifically the FICO score. They provide the system that will underwrite and approve loans and try to give people the credit that they should have. One of their big points is that the vast majority of people have never defaulted on a loan obligation, but less than half could qualify for lenders' best rates in most circumstances. There's a big disconnect there. So their system aims to solve that.
Jason Moser: If you look at what they do now it sounds like their customers, generally speaking, are lenders, is that right? Like banks and just lenders or are consumers customers of Upstart as well.
Matt Frankel: Yes and yes. Upstart doers partner with banks that make loans off of its platform and that generates fee income for the business. That's where the vast majority of Upstart's revenue comes from, like 95% of it. But if you go to upstart.com, you can apply for a loan and they do hold some loans on their balance sheet and make some of their money from interest income, but very little compared to the fee income. It's mostly a fee-based model. They mostly partner with banks to do a better job of underwriting loans for their capital.
Jason Moser: I'm starting to get this picture of a SaaS business more or less. But I want to make sure I understand this, because you talked about fee income. Is there a subscription side of this business that bank's pay a monthly subscription fee to Upstart for their services and then they benefit also from that services fee along with that or is this really just a services style business?
Matt Frankel: The majority comes from the fees they get for facilitating those loans.
Jason Moser: OK.
Matt Frankel: In 2021, you could see the increase in lending volume and the increase in fee income were really on par with each other. That just shows that their fees depend on how much loan volume is flowing through their network.
Chris Hill: Got you. They're going to be pegged then obviously to lending volume. We can talk a little bit more about that in a bit. But before we get there, we always talk about competitive advantages. What is the business's special sauce, what separates them from their competitors? I have a feeling, I know what your answer is going to be here, but what do you feel? What is it that separates Upstart from other companies in this space?
Matt Frankel: There are a ton of personal lenders. We've talked about that many times, that the industry is getting really crowded. If everyone from the legacy banks to new fintechs have personal loan products. They all use the FICO score to approve loans for the most part. Upstart is the one that doesn't use the FICO score, so they can make better lending decisions and approve people for loans that they otherwise might not have been able to, and even if they could have gotten approved elsewhere, get better interest rates. It's a better underwriting process. So it's a win-win for both the customers and for the banks.
Chris Hill: So making lending decisions based on data. If that sounds familiar, it should. One of the companies this makes me think of immediately is Block formerly known as Square. But Square doing such a good job and utilizing the data that they gleaned from their customers, the small businesses in order to be able to make loans to those small businesses. Now, that's small business focus, would you say Upstart is, generally speaking, primarily consumer-focused?
Matt Frankel: Yes. They're they're absolutely consumer-focused for now. That's a really good point that you brought that up because they say by the end of 2022, they're going to get into small business lending. For the time being, there not a competitor with Block or Square Financial Services as their business division is called. But they will be very shortly.
Chris Hill: Yes. The other thing I noticed too the most recent earnings call that just piggybacking on that small business factoid. I think the following year maybe 2023, they have aspirations to get into the mortgage lending business too, don't they?
Matt Frankel: If there's one area where subprime lending could be done better, it's definitely mortgages. [LAUGHTER] There's a market for it. In 2008, 2009, we saw that there was a market for subprime lending. It was just being done very poorly. If a company could figure out how to do subprime lending right, there's a huge opportunity there. But that's really Upstart's focus. They don't focus on "bad credit borrowers," but they don't focus on the prime borrowers either, they focus on that niche in the middle, that's really being underserved by the current system especially in mortgages.
Chris Hill: Yeah. One thing I noticed in that calls, well, they were talking about the business and the advantages that it has over others. Management noted that choosing not to become a bank was the right decision for them, it's central to their world view. They went in a little bit more in that it gives them really the greatest market opportunity. It gives them this large swath of consumers in need. It gives them the opportunity to focus on those consumers without necessarily sticking themselves with that bank identity. Because once you become a bank then you're competing with all these other banks. But if they're seen as bank agnostic essentially, that more or less opens up a much larger market opportunity.
Matt Frankel: Yeah. It makes you address full market literally every financial institution in the United States.
Chris Hill: Yeah. A lot of people tell me the credit-based economy, this is a valuable service they provide for sure. Let's talk a little bit about leadership here because this is a founder-lead business insiders own a good stake in the business as well. What's your opinion on leadership and anything that stands out?
Matt Frankel: The leadership makes me glad that they are being a tech company, not a bank, because it's led by a bunch of tech veterans. Dave Girouard the CEO, he was a former Google Executive and a Councilman, another co-founder that came from Google. Paul Gu is the tech guy of the trio of co-founders. All three are still involved in the business. All three have substantial ownership stakes. Three very passionate founders, they left very lucrative careers at places like Google to start this, and it's because they are really passionate about democratizing credit.
Chris Hill: Well, let's dig a little bit more into that fee-based income and how it's tied to lending activity. Because what we've seen, and obviously this is a business that its seen some high highs and it seen some low lows. It's down around 45 percent year-to-date. If you look even further out though, it's down about 80 percent from its 52-week high. This has come down considerably from just where it was here recently and I feel like probably part of that is going to be tied to that interest rate conversation. Let's talk a little bit about that because how big of a concern is that for investors? It feels like interest rates are really only headed one way. For those who haven't been paying attention, that's up. How much of a burden is that going to be for a business like this?
Matt Frankel: Interest rates they have the effect of, one; slowing down borrowing demand, and two; of increasing defaults on loans and things get a little less affordable for consumers. We really don't know though, and this is a big risk factor. This is what you're seeing priced into the stock. We don't know how Upstart's business would perform in a recession in a rising interest rate environment because it just hasn't been through one yet.
Chris Hill: Right.
Matt Frankel: This was founded around the time of the financial crisis. It's in its infancy the last time that defaults were elevated and things like that. We don't know what it would do in a full credit cycle. Now that it's not just the economy going straight up if you will, there's a big question mark in investors' heads as to what happens if this inflation and interest rates leads to a recession. So big unanswered questions is really tricky.
Chris Hill: It feels like we're getting ready to learn. It feels like we're getting ready to find the answer out here over the course of next year. Now with that said, this reminds me a bit. I know you are familiar with Ellie Mae, the mortgage lending tech platform. This just reminds me a little bit of Ellie Mae in that regard. Ellie Mae had a subscription dynamic as well as as-a-service dynamic. But we're always having that big question with Ellie Mae, how is this stock going to perform? How is this business going to perform in an interest rate environment where refinances start to take a hit? Will purchase mortgages be able to make up for that loss volume? We never really got to find out because Thoma Bravo acquired Ellie Mae a little while back. That was up $11 billion deal I think. I just see a lot of tones of Ellie Mae in this business, and then that's a compliment. I was a big fan of Ellie Mae as many may know. What's your perspective here on Upstart going forward? Are you a bull, a bear, or you're on the fence? What what's your feeling in regard to this as an investment?
Matt Frankel: I'm generally bullish. I like it a lot better than I did when it was a $400 stock. Because when you look at the numbers, these are not numbers from a company that has been beaten down like that. This is a business that's done exactly what investors wanted it to do. Revenues up 250 percent year-over-year, lending volume is $12 billion of annualized volume, that's multiplied several times over in the past year alone. Their auto lending business is getting ramped up, which was the big both thesis, because that's a big market. It's a much bigger market than personal loans. The business is profitable, it continues to be profitable. Margins have improved, and you really can't make the case that this business hasn't done exactly what investors should have wanted it to do. I'm generally bullish especially now that the stock has come back down to earth.
Chris Hill: Yeah. It feels like lending is always going to ebb and flow, but it's not going away. I think you're right. It feels like it's a business where management is doing what they say they are going to do. If you can ignore those external factors, maybe this is one of those windows of opportunity for investors who are willing to take the longer view. But Matt, I think that will wrap it up for us. Thanks so much for taking the time to join the show today. I know I am always the wiser for it, and I bet our listeners feel the same way. [MUSIC]
Matt Frankel: Yeah. Always glad to be here.
Chris Hill: If you've done a question you can include it in a review on Apple, you can also call the Motley Fool Money hotlines 703-254-1445. Leave us a message with your name, where you're calling from, and your question. Again, that number 703-254-1445. That's all for today, but coming up tomorrow. Conversation about financial advice on TikTok. 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 or sell stocks based solely on what you hear. I'm Chris Hill, thanks for listening. We'll see you tomorrow.