What happened
Shares of lending platform Upstart Holdings (UPST 1.69%) are starting the week of Nov. 7 the same way they ended last week: down. As of 10:53 a.m. ET, shares are down 5.1%, adding to last week's nearly 16% decline. That puts the company's shares down almost 21% the last day of October, and down 88% so far in 2022.
Today's sell-off comes ahead of the company's third-quarter results, which it will announce on Nov. 8 after market close.
So what
Investors are increasingly concerned about Upstart's business results in the quarter it will report this week and in future quarters. In a Securities and Exchange Commission (SEC) filing, the company disclosed that it had terminated approximately 140 employees who "help process loan applications" on Nov. 1. Furthermore, the company wrote that the move was due to the "challenging economy and reduction in loans" being originated on its platform.
This is a further sign of the trend in deterioration it has reported in recent earnings. Back in August, the company missed its own second-quarter guidance and set very low expectations for its Q3 results. It also pulled company guidance for the full year.
In 2021, strong origination-volume growth led to the company generating positive operating cash flow for the full year. But sharply rising expenses in the first half of the year -- and banking partners slowing their loan originations with Upstart because of concerns about how they will hold up during a recession -- combined to cause it to burn $320 million in operating cash through the first half of 2022.
Investors should also note that the bulk of its working capital is in loans held at fair value. Rising interest rates and potential poor loan performance could deteriorate the value of its most important asset. With less than $13 million in cash on hand at the end of Q2, Upstart is about to learn just how the market values the loans on its balance sheet that it doesn't have an agreement to sell already in place.
Now what
Upstart is potentially facing its "crucible" moment. The biggest long-term risk for the company is learning whether its risk-determination framework really is better than the legacy credit rating system. Going through an economic downturn, frankly, is the only way to find out in real time. The challenge for Upstart is getting through this cyclical downturn unscathed. Cutting costs is almost certainly necessary at this point, but the bigger issue could be revenue; its lending partners are seemingly becoming more risk-averse and originating fewer loans, cutting Upstart off from the cash flow it desperately needs right now.
While I don't think Upstart is on the cusp of insolvency, it certainly needs to raise capital, and there are very few good avenues to do that in the current environment in a shareholder-positive way.
Put it all together, and Upstart is a company with what could be a hugely disruptive product facing some serious cyclical headwinds. If its origination framework proves out, and it can get through the downturn unscathed, it could be a massive winner from here. But there are some big questions unanswered and not a lot of working capital to pay the bills on the balance sheet in the near term. Consider the risk and the reward before taking action on Upstart stock.
