Upstart Stock Analysis 🦄Too late? $UPST Price Forecast

Upstart is a very fast growing fintech startup, and the stock price has gone parabolic. We're talking almost 1,000% in the past year... that's insane! Some think this is just the beginning for this disrupter, and there's more upside. Is Upstart really just getting started?

Business Model

Upstart is an AI lending platform – not an underwriter – that connects borrowers (mostly Gen Z) to traditional banks. They're essentially a merger of two traditional models... (1) affiliate model, where they're selling leads to the lender for a commission; and (2) qualifying leads with data analytics (i.e. replacing the FICO model). As fancy as this can sound, it's not super complicated or revolutionary... but it is a smart model and was very-well executed.

The company was founded by ex-Google executive Dave Girouard, and some its early investors include Eric Scmith ex-Google CEO and Mark Cuban himself. They nailed a unicorn with this deal! This is a lesson for any entrepreneur, the model doesn't need to be sexy... but the marketing does!

Upstart's "marketing" towards banks (i.e. their customers) and their investors is that they have a more accurate and efficient machine-driven method than traditional FICO credit scores.

FICO scores were developed thirty years ago by Fair Isaac Corporation, which incorporated 5 data points to determine a score from 300 to 850 to assess an individual's credit worthiness. This is widely used with credit bureaus and lenders.

Enter Upstart using 1,600 data points including education, job experience, geography, cost of living, etc. Basically FICO on steroids!

The product, based on their internal research (which should be taken with a grain of salt), but also based on logic makes sense, is more efficient and accurate vs. traditional credit scores. This is why they're able to originate more than 70% of their loans automatically – without human intervention.

I actually really like the product, as it solves a legitimate problem in the currently outdated underwriting process.

Revenues

Normally you'd just assume this company is unprofitable, and just burning cash. That would refreshingly untrue for Upstart. In fact, I don't understand why half  these startups burn through so much cash in the first place.

Upstart is currently operating at 50% contribution margin and near 20% net income margin – which just goes to show how good this business model is. 😍 I really, really like it.

Upstart's revenue is mostly made up referral, platform and servicing fees. The 3-4% referral fee is paid by banks for each loan referred through Upstart.com and originated by a bank partner. The platform fee is ~2% of the loan value a bank is charged once it originates a loan through Upstart's platform. They also charge an ongoing 0.5-1.0% servicing fee for servicing or managing the loan through its life.

In addition, Upstart earns a small portion of revenue from interest income and securitization of loan activities. This makes up only 3% of revenues.

Valuation

Oh... valuation... this is where the bubble bursts for me, unfortunately.

Unlike other bloggers and analysts and YouTubers, I share my financial models and assumptions to my premium email subscribers... so you can see and play with your own assumptions.

Basically, to get to the valuation we have today we'd have to assume that we've already priced in 2024 earnings of nearly $600M – more than 5x from today. At that the growth rates we're seeing, this doesn't seem completely unreasonable. But, these are some serious assumptions!

Based on their latest guidance, they're looking to close the year with ~$750M in revenue, which represents about 8% QoQ growth for the second half of 2021. Yes, there's a chance they beat this... but going off of their guidance, that's a significant slowdown in growth to ~35% annualized. Either way, you can't expect a company to be growing at 200-1,000% forever. Believe me, I've been there... and it's not sustainable and incredibly difficult.

If we assume they grow 100% next year, and then down to 50% growth in 2024 – with a 15% net income margin – that gives us about $600M of revenues. At a 50x P/E, which would be reasonable for a company still growing 50%, that gives us a price target of $380 – which is not even a 20% upside.

In order to compensate for the risk, I would need at least a 2x on the stock by 2024 – which means we need higher growth and higher margins. The million dollar question: "is this possible?"

Based on a total addressable market (TAM) of $719B loans originated between personal and auto, how much can Upstart capture? Let's assume local banks and credit unions control 15% of this total, and Upstart captures a quarter of that gives us a 3.75% penetration... but we've already priced them at an 8% penetration based on the price today (with their current revenue model generating about 7% of loans originated).

So, in order to buy in to the 2x case, we need to believe that Upstart will penetrate the large bank. I understand that Upstart's acquisition of Prodigy ("the Shopify for auto dealerships") helps it better penetrate the auto loan originations, but this is still borderline gambling for me. For me, we'd have to assume they'd also replicate in housing & mortgage loans.

Risks

1. Execution risk, which I just mentioned, is the biggest long-term risk. The bull case here for Upstart is already priced in with some insane assumptions and flawless execution.
2. In the shorter term, we have customer concentration risk. 85% of fees are generated from two banking partners. Cross River Bank being 62% and another bank being 23%. The concentration seems to be declining, and going in the right direction; so I think Upstart has a handle on this. They are very early in the game, so this is expected. But, nonetheless, something to be aware of.
3. Lead generation risk is also a threat. Right now, Upstart is spending close to 50% on advertising and lead generation. This is normal in the affiliate model, and its also risky because its typically from a concentrated traffic source. This is the exact case for Upstart, since 50% of its traffic comes from Credit Karma (which was recently acquired by Intuit).
4. Competition is a legitimate threat wherever there's money. We can't assume that no one will step in to get an easy 7% of loans originated with no risk. Many have called out SoFi, Rocket Loans, Lending Club and a few others as direct competitors but they're catering to different consumers with minimum credit scores in the 600s. Upstart is catering to Gen Z and a different audience, but that doesn't mean their safe. SoFi is vertically integrated and potentially a better fintech play at its valuation.
5. Regulatory risk is something I'm not aware of, but can come in to play... just something to be aware of.

Conclusion

Upstart is a great company, and they've done an amazing job at executing. They deserve all the credit for building a profitable and scalable company, that's ready to go to the next level. It is really early in the journey for Upstart, and with that comes risk. Though, comparing it to other SPAC IPOs and early ventures we've seen come to the markets, Upstart is definitely among the highest quality.

The potential for Upstart is huge if they can get solidify their position as the new-age replacement to FICO scores. That's a huge opportunity that opens up loan origination in all categories, including mortgages.

But, unfortunately, for me, the valuation is too steep right now. Should Upstart not blow past their own Q3 and Q4 guidance (because the price assumes it will) this would present some buying opportunities for Upstart. In hindsight, opening a position in the $100-$150 cost was the best risk/reward play.

Either way, I'll be cheering from the sidelines for whoever's on the ride!