Upstart Holdings (UPST 2.19%), a lending platform powered by artificial intelligence (AI), was a market darling in 2021 when interest rates were low. But rates then shot higher to combat inflation, turning Upstart's business and stock upside down. It remains more than 90% below its former peak, a deep hole that stocks often never recover from.
But a closer look at the company reveals clues that the tide could be turning. The business is still financially stable, and investors could soon see a more accommodating economy that might get Upstart back on its feet.
Here is what you need to know.
Bankruptcy? Don't count on it.
Upstart tells a great story. The company evaluates borrowers for loans using AI instead of a credit score. It has published data to support its belief that its technology is better at identifying risky borrowers, even among those with good credit scores.
It can approve borrowers at the same rate as a credit score with 53% fewer defaults, and borrowers enjoy a better user experience. Combine a good product with a multitrillion-dollar lending market, and you get a stock chock-full of potential.
But rates rose at a historically fast pace starting in 2022, which caught Upstart off guard. Growth stopped, revenue declined, and losses ballooned.
NASDAQ: UPST
Key Data Points
So, is Upstart on its way to bankruptcy? Not exactly.
The company has dramatically cut spending to slow its cash losses. From the fourth quarter of 2023 to the first quarter of 2024, liquid cash declined from $368 million to $300 million. The actual cash burn was less, but co-investment arrangements with loan buyers restricted additional cash.
Even locking up that extra cash, Upstart has enough to fund the business for at least four more quarters at this rate.
It currently has approximately $394 million in loan assets for in-house experimentation and another $530 million in personal loans that it became stuck with as interest rates rose. Management might be able to sell some of these for additional cash if rates fall enough to attract buyers.
To be clear, the company's financials aren't rosy. It has $575 million in convertible debt coming due in August 2026, which puts some pressure on it to get back on its feet in the next 12 to 18 months. Otherwise, circumstances could force the company to do something destructive to shareholders, like issuing lots of stock to raise money.
This will take several more quarters to play out. But today, Upstart is on solid footing.
Are rate cuts on the way?
Simply put, the company needs interest rates to fall. Lower rates make its loans more attractive to prospective borrowers. The business would then pick up again because it was very profitable when rates were low. Rates probably aren't going back to zero, but they probably don't have to for Upstart to feel relief.
Fortunately, momentum is picking up for a rate cut. The July inflation report showed that prices fell in June. It's the first month-over-month decline (deflation) since May 2020. And unemployment has risen past 4% for the first time since January 2022. These are concrete signs that the economy is slowing.
Data from CME Group's FedWatch tool, which monitors data from interest-rate futures trades, signals an 80% chance of a rate cut in September. That doesn't mean it will happen -- just that investors expect it.
Should investors buy the stock?
So, what's the pitch for buying the stock? It looks like the worst might be over.
Upstart's own Macro Index (UMI), which tracks how the economy affects its credit losses, has stabilized and notably declined over the past three months. In other words, the company's own data shows its business conditions are easing. Inflation is heading in the right direction, and rates might finally drop from their multi-decade highs. The rays of sunshine are peeking through the storm clouds.
Don't get it wrong: This is a slight improvement in a challenging interest rate environment for its business. There is also a ton of risk in the stock. Inflation could return, or the economy could slip into recession. Perhaps the Fed doesn't cut rates until later than expected. Any of these could stretch the company's financials to the limit.
So consider Upstart a speculative stock that investors should approach very carefully. But if this really is the start of a turnaround, the upside from here might be spectacular if things go as hoped.
