There's no doubt about it: Rising interest rates and the waning of the pandemic have ravaged AI lending marketplace Upstart (UPST 0.59%). At its peak in late 2021, Upstart stock surpassed $360 per share, a price that valued the company at more than $30 billion. Since then, the stock has tumbled about 95%.
Upstart ran into major problems as economic uncertainty ramped up. It's had trouble unloading some of its loans, leading the company to start holding a substantial volume of loans on its own balance sheet. This exposes Upstart to interest rate risk. It has also seen loan volumes collapse as the economic environment takes its toll.
In the first quarter of 2023, the company made just over 82,000 personal loans, with a total transaction volume of $952 million. Those figures were down 82% and 78%, respectively, from the prior-year period, and down 46% and 36%, respectively, from Q4 of 2022. Upstart generated just $102.9 million in revenue, down 67% year over year, and the company booked a net loss of $129.3 million.
A massive rally
While Upstart's first-quarter results were not good in any sense, the stock surged 35% on Wednesday following the earnings report.
There are a few reasons why investors might have jumped back on board. First, Upstart's second-quarter guidance, while still terrible on a year-over-year basis, called for an increase in revenue and a big reduction in losses compared to Q1. The company expects to generate $135 million in revenue and post a net loss of around $40 million.
Upstart made substantial progress cutting costs in the first quarter, and that effort will extend into the second quarter. While spending on engineering and product development more than doubled, the company slashed sales and marketing spending. That effort drove total operating expenses down about 15% year over year.
Second, that elevated spending on product development is partly supporting Upstart's planned entry into the HELOC market this year. Breaking into the home lending market will expand the company's total addressable market. Currently, most of Upstart's loan volume comes from unsecured personal loans, and the rest comes from it testing the waters in the auto loan market.
Third, Upstart secured $2 billion in long-term funding for the next 12 months. Some of that funding is coming from existing partners that had reduced activity due to economic conditions, and the rest is coming from new partners that have never worked with Upstart before. These new commitments give Upstart an outlet for some of its loans, and they should make the business a bit more predictable.
Still a long road ahead
While the market reacted positively to Upstart's report in a big way, the company is still a long way from a full recovery.
For one, the performance of Upstart's loans is still a bit below target levels. The company's loans enjoyed substantial outperformance during the pandemic, but performance deteriorated quickly in 2021. The situation has improved since then, but the pitch for Upstart's services is just not as strong as it was a couple years ago.
Upstart's balance sheet has also worsened, and the company's continued cash burn isn't helping matters. It had $452 million of cash at the end of the first quarter, down from over $1 billion a year ago. Operating cash flow was a loss of $76 million in Q1. If Upstart can't turn around the cash flow situation quickly, the company may need to raise money in what will likely be a difficult environment to do so.
Upstart is valued at about $1.6 billion, putting the price-to-sales ratio based on the average analyst estimate for 2023 revenue at about 3. The company won't be profitable this year, although analysts are expecting an adjusted profit in 2024. Whether that materializes depends on if and by how much Upstart's loan volumes recover.
While Upstart snagging $2 billion in funding over the next year is meaningful, it's important to remember that even at the currently depressed level, it's doing around $1 billion in originations per quarter. In its heyday, the company was originating over $4 billion of loans every quarter. This funding isn't a drop in the bucket, but it's not the answer to all of Upstart's problems, either.
Upstart very much needs to prove that its business model can work in the post-pandemic, rising interest rate world that we live in. The company is making progress, but the turnaround is still in its early stages and is far from guaranteed to succeed. What's more, the level of profitability Upstart enjoyed at its peak is going to be tough to replicate given the state of the economy. With that in mind, Upstart looks like a risky stock that could pay off for investors if a lot of things go right.
