Upstart Craters As Stimmy Bonanza Ends With A Shocking Bang
Upstart Holdings shares cratered 60% after the cloud-based “artificial intelligence lending platform” shocked markets by cutting full-year revenue guidance on macro uncertainties and a possible recession. The stock was last trading at $30, down from $80 yesterday, and a whopping $400 in mid-October.
UPST reported solid Q1 22 results, notably beating on transaction volume of $4.535bn, vs. Cons. of $4.036bn/$4.273bn, flowing through to better than expected revenue and profitability. However, management reduced its full-year ’22 outlook materially from previously issued numbers, now expecting revenue/adj.
EBITDA of $1.25bn/$187.5mm vs. prior $1.40bn/$238mm, with new numbers significantly below Cons. of $1.41bn/$242.1mm.
UPST’s Q2 2022 outlook also missed expectations, with revenue/adj. EBITDA of $300mm/$33mm below Cons. of $340.6mm/$59.2mm.
While the results were dismal, it is what the company said on its earnings call that has spooked investors with substantial carryover into the broader macro environment.
First, the company said that investor demand for loans dried up due to rates/credit move, forcing UPST to originate loans (with rising default rates) on its balance sheet that it couldn’t pass to its funding partners – something that shouldn’t happen for an automated platform/tech company (as Stephens UPST analyst Vincent Caintic warned “If UPST will use its balance sheet to support its transaction volume, then we will ascribe a balance sheet multiple”). And yes, as we have been warning for the past year, this is the hangover from the Biden stimmy bonanza. As the company itself warned, while government stimulus in 2020 and 2021 led to an artificially benign environment, all that has now “reverted abruptly”, and loan defaults are again spiking.
Second, as Alex Good points out, the problem wasn’t on the volume side: “The volume of loan transactions across our platform in Q1 was 465,000 loans, up 174% year-over-year and representing over 350,000 new borrowers”. However, management cautioned that adding another 3-5% of cost on the loans was slowing demand.
Instead, as noted above, the company insisted that problems were due to stimulus ending. “think the bottom line is when you go through a period where the government essentially pays everybody’s salaries for most of a year and then suddenly stops, it’s a pretty damn difficult thing to calibrate exactly right.”
Needless to say, that’s when the defaults start. But there’s more, because adding insult – or rate hikes – to injury, Upstart said that if rates keep going up along with spreads, consumers will reject financing and forbearance terms need to get harsher which will spike rates further, creating a toxic loop.
Echoing these concerns, Morgan Stanley writes this morning that reflective of their lowered 2022 growth outlook (and below-consensus 2Q22 expectations), management stressed the impact of higher funding costs on their growth algorithm, particularly as it pertains to APR offers. Estimating that average loan pricing on their platform is up ~300bps since Oct ‘21, management flagged consumer price sensitivity to rates as a deterrent to loan demand.
Further, given usury regulations and UPST’s ~36% APR cap, higher funding costs are likely to structurally limit UPST from gaining additional market share with lowerend FICO borrowers.
Bottom line, UPST’s 1Q22 print and outlook demonstrated the company’s cyclical sensitivities, both with regards to macroeconomic factors and interest rates, which are likely to reflect on growth trajectory over the medium term.
More concerning is what this means for the state of the US consumer, which is still largely (and incorrectly) viewed as strong. Recall last Friday we showed that credit card use by Americans soared the most ever in March!
Far from a bullish read – i.e., “consumers are so bullish about the future, they are maxing out their credit cards like never before” – what the surge in credit card use means, is that having long ago spent their saved Biden stimmies, consumers have no other place to source their spending (as the UPST results indicate) and are instead rushing to take advantage of still low APRs before the rates reset (much higher). Of course, those APRs will reset and the new rates will apply to the new, record, balances causing a sharp increase in mandatory interest payments.
The conclusion is that the US consumer is about to hit an epic brick wall, with spending about to crater, and sending GDP sharply lower (recall consumption is 70% of US GDP).
Going back to UPST, at least three analysts, including Citigroup, Piper Sandler and Stephens, downgraded the stock following its results. Here’s what the analysts have to say:
Barclays, Ramsey El-Assal (Overweight)
- Says the company had a “good” 1Q, though cyclical pressure has emerged “more rapidly than expected”
- Adds that Upstart faces a “rougher year ahead”
Citigroup, Peter Christiansen (Neutral, PT $50 from $180)
- “Upstart’s AI seems to outperform in stable-to-benign credit conditions, though it’s evident now the platform takes time to adjust to deteriorating macro”
- Wonders if outlook for Upstart was cut enough and says “negative trends will be difficult to refute”
Jefferies, John Hecht (hold, PT $65)
- Calls Upstart’s quarterly results better than anticipated, though the change to outlook and the headwinds the company faces will likely overshadow the performance
- Current macro headwinds and higher rates will “create hurdles” for customer approvals, in addition to having higher investor risk premium
- Notes that new growth for Upstart, which is expected to come from recently launched auto lending product, also faces headwinds
Piper Sandler, Arvind Ramnani (Neutral, PT $44 from $230)
- Says the company faces a “perfect storm of headwinds,” including rising loan rates due to more challenging conditions and a larger loan balance that’s increasing risk exposure
- While guidance has been cut, the risks remain, and in the event of a recession or increase in delinquencies, there is further risk to both revenue and margin targets
- Despite the expanded outcomes with increased risk, Upstart is still executing well and has a “strong” management team; macro headwinds abating is just one of the factors that could make the broker more constructive on the stock
Stephens, Vincent Caintic (Underweight, PT $28 from $124)
- “Upstart is originating loans on its balance sheet that it couldn’t pass to its funding partners”
- “If UPST will use its balance sheet to support its transaction volume, then we will ascribe a balance sheet multiple”
- Adds that the company should focus more on “shoring up its funding partners, and spend much less time on additional products like small-dollar lending and small-business lending”
Tue, 05/10/2022 – 13:00