Source: Beast Finance Author: Beast Finance
Summary:
(1) For the subprime mortgage market where Upstart (UPST) is located, the worst period may have passed, because the situation is improving.
(2) Upstart's higher profit margin in the most recent quarter is the result of improved retention and reduced competition.
(3) Although new financing has been obtained, the overall financing environment is still full of challenges.
(4) Upstart is a leading artificial intelligence loan company because it has data advantages, has also made huge investments in artificial intelligence, and has professional talents and technology accumulation.
(5) Although we are positive and optimistic about Upstart's long-term prospects, investing in the company at Upstart's current valuation still lacks a margin of safety.
The worst may be over for the subprime market
Upstart's management reiterated that while the past 18 months have been tough, they expect the worst may be over for subprime borrowers.
In particular, subprime borrowers have benefited to a greater extent due to the stimulus from the pandemic, leading to higher consumption, higher savings rates, and possibly an increase in some FICO scores.
The company's chief financial officer also acknowledged that they have been relatively slow to reset their sales model.
However, much has now changed over the past 18 months as companies have tightened their credit lines.
This means that about 60% of borrowers who could have previously been approved will not be approved under the new adjusted sales model.
In addition, Upstart's chief financial officer commented that he believes now is the time to be bullish on subprime borrowers, as the worst may be over for them. Given the mass layoffs at big tech companies, it could be a more challenging and vulnerable time for white-collar workers.
Increased retention, less competition
In the first quarter of 2023, Upstart's gross margin actually expanded by 160 basis points, or 12% sequentially. This is also twice as high as before the epidemic.
There are two reasons for the sharp increase in retention rates. The first is that the company has increased automation and aggressively adjusted the model, and the second is less competition in the secondary market.
As such, we believe we will see this continue in the near term as overall market risk appetite increases and more lenders return to the market, before rates eventually normalize to Upstart's historical average.
Leading AI lending firm
While most fintech lenders say they have built AI capabilities into their offerings in some way, Upstart is one company that has more advantages than most when it comes to AI.
The first advantage comes from the fact that it has invested heavily in its artificial intelligence and machine learning capabilities since its inception. In fact, Upstart may well have made its biggest investment yet in its own artificial intelligence and machine learning capabilities, resulting in a smarter lending model. Upstart's management team also knows that their strength and value lie in their AI technology, which includes their AI models, and as such, have invested heavily in AI and machine learning capabilities.
The second advantage comes from Upstart's huge data. In 2022 alone, Upstart's lending partners will disburse about 1.3 million loans. As we have analyzed before, data advantage is very important in the competition of artificial intelligence, because the higher the amount and quality of data a company has, the better the model training will be. The better the data, the more competitive the company will be.
Finally, Upstart also has the kinds of talent it needs to maintain its AI lending dominance. The data engineering and machine learning talent needed by the top AI lenders is scarce, so competition for that talent will be fierce. Upstart already has a head start when it comes to acquiring and retaining this talent to maintain its edge.
Financing environment remains difficult
While Upstart announced in the first quarter of 2023 that it had secured $4 billion in committed capital, management commented that the funding environment remains difficult.
While Upstart's funding situation has improved, consumer demand for loans still exceeds what lenders can supply. Furthermore, the ABS market remains subdued, and funding levels by regional banks are likely to remain low through the remainder of 2023 as they typically account for around 25% of Upstart funding.
Upstart is still in talks with various other financing partners to increase long-term capital financing for its business.
Upstart's near-term plans and other moves
In terms of financing, Upstart is not only negotiating with other long-term, committed capital partners, but also plans to use its better quarters to enter the ABS market in the short term.
In terms of the use of committed funds, Upstart's management expects to use the funds to fund about 50% of startups over time.
Valuation
At current prices, Upstart trades at 60 times 2024 earnings.
At this valuation, investing in the company still lacks a margin of safety.
The higher and richer a company's valuation, the lower the implied future rate of return.
Therefore, we will enter after the share price of Upstart falls further, which is more reasonable and has a sufficient margin of safety.
Conclusion
As an AI-powered lending company, Upstart is in a good position right now and ahead of the competition.
Moreover, while the worst is over for the subprime mortgage market, the funding environment remains difficult.
However, Upstart is also focusing on its business, as it has been investing in its technology, improving its processes and artificial intelligence models, and waiting for its business to bounce back when the macroeconomic environment improves.
As we mentioned before, we remain bullish on Upstart's long-term prospects, but investing at its current valuation lacks a margin of safety.