At one point in late 2021, Upstart (UPST +4.32%) had a market cap of more $30 billion. After going public during the growth-stock bubble in late 2020, the shares soared more than 1,000% in less than a year. Boy, how times have changed for this artificial intelligence (AI) consumer lending platform.
As of this writing, Upstart shares are down more than 90% from all-time highs and are actually below its debut price. Its market cap has fallen to a measly $2.1 billion. Investors have all but given up on the company, with sales declining and profit turning negative in a post-stimulus-check environment.
But that doesn't mean the business has failed. Read on to see whether now is a good time to bet on an Upstart turnaround.
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Volume pullback, but stabilizing trends
Upstart went public at an opportune time. With consumers flush with cash from government stimulus checks meant to spur growth during the pandemic lockdowns, Upstart was able to work with lots of lenders and test its new AI-powered lending platform.
The company works as a middleman that sits in between a lending organization (such as a bank) and helps them underwrite loans for consumers, hopefully profitably. It wants to help companies move beyond the FICO score and improve overall yields, given its data-driven AI model. Revenue is earned as a percentage of loan volume, so the more volume lenders originate using Upstart's services, the more money the company makes.
The problem is, Upstart's loan volume has declined in recent quarters. In the second quarter of this year, the company's lending partners originated just $1.2 billion in loans, down 64% year over year. This caused fee revenue to decline by 44% to $144 million for the quarter.
The company was hiring ahead of this projected growth during 2021 and 2022, so this unexpected slowdown hit the company's profits -- and hard. Upstart had an operating loss of $33.3 million in Q2 2023, a swing from net income of $36.3 million two years ago.
The good news is, these volume declines seem to be stabilizing. Lending volume is actually up from $997 million in the first quarter of this year, indicating that Usptart may have hit a floor when it comes to volume declines. But the question is: Why did they decline in the first place?
I think there may be a couple of reasons. With interest rates rising, lending institutions have become more reluctant to lend, especially through unproven services such as Upstart. There were a lot of worries about the performance of the company's loan as they aged, with gross returns significantly underperforming target cash flows in recent quarters.
Can they find a niche?
The most important question for Upstart investors is, where will loan volumes go from here? The company has been signing on more credit institutions each month while also expanding into automotive loans, so there's ample opportunity for loan volumes at Upstart to grow if its bank partners want to use its platform. The problem seems to be that a lot of banks have lost confidence in the Upstart model.
This is why the most important thing for the company is to build up a track record of strong performance on the loans it helps to originate. Recent quarters have been strong, with the performance of its 2023 loans in line with target cash flows. This is a major improvement from the late 2021 and early 2022 period.
If the company can prove its AI-powered model works, banks will send loans its way. Until then, it looks like most banks are in a "show me" mode. The business model isn't broken, but don't expect loan volumes to grow at a rapid rate. Confidence from banking partners will take years to build.
NASDAQ: UPST
Key Data Points
The stock still isn't cheap
During the past 12 months, Upstart generated $538 million in revenue, for a price-to-sales ratio (P/S) of 4, close to double the S&P 500 average. What this means is that -- even with the stock down so much -- the expectations embedded in the company's share price are for strong margin expansion or above-market revenue growth (or both).
The company is losing money and seeing revenue decline, so there's a lot of uncertainty about whether this will occur. Investors don't want to buy a turnaround story at a premium price. Even though the business may be stabilizing, it's best to avoid Upstart shares unless you can buy in at cheaper levels.
