William_Potter
Elevator Pitch
I have a Hold investment rating for Upstart Holdings, Inc.’s (NASDAQ:UPST) stock.
I previously touched on UPST’s share price weakness and financial outlook in my earlier March 2, 2022 article. My latest update shines the spotlight on the further drop in Upstart’s stock price, and the change in the company’s prospects in view of its new funding approach.
Upstart’s stock is down by over -80% this year as a result of funding issues that have limited its growth. But I don’t view UPST as a buying opportunity, as I see its shares as fairly valued after reviewing its peer and historical valuations and considering the impact of Upstart’s shift to committed capital funding sources.
UPST Stock Key Metrics
UPST’s key metrics revealed as part of the company’s Q3 2022 management guidance were poor.
According to the company’s Q2 2022 earnings press release, Upstart had guided for a top line of $170 million and breakeven non-GAAP adjusted EBITDA for the third quarter of 2022. Prior to UPST’s second-quarter financial results announcement, Wall Street analysts were expecting Upstart to achieve relatively higher revenue and non-GAAP EBITDA of $262 million and $29 million, respectively as per S&P Capital IQ data.
The company’s Q3 2022 guidance translates into an expected -26% YoY and a -25% QoQ contraction in its top line. Also, Upstart was profitable at the operating income level in prior quarters, boasting adjusted EBITDA of $29 million and $5.5 million for Q3 2021 and Q2 2022, respectively. In contrast, Upstart’s management guidance points to the company delivering a non-GAAP EBITDA of $0 million in Q3 2022.
It is also worth noting that Upstart no longer offers guidance for full-year fiscal 2022. At the company’s most recent Q2 2022 earnings briefing, UPST mentioned that “it is prudent to limit our guidance for now to the coming quarter and withdraw prior full year guidance” taking into account “the volatility of the current funding environment and the difficulty in forecasting, the timing of changing macro sentiment.”
Separately, the sell-side analysts have become increasingly bearish on Upstart’s near-term prospects. 12 of the 13 Wall Street analysts covering UPST’s shares lowered their respective bottom line financial projections for the company in the last three months.
The weak third-quarter guidance that Upstart provided has been factored into the company’s stock price performance as discussed in the subsequent section.
Why Has Upstart Stock Dropped Over 80% This Year?
Upstart’s stock price is down by 85% in 2022 thus far, as compared to a -23% pullback for the S&P 500 in the same time frame.
It has become increasingly difficult and costly for Upstart to secure funding for its loans against the backdrop of rising rates and a weak economy. This has led UPST to cut its revenue guidance for Q3 2022, and it doesn’t come as a surprise that Upstart’s shares have dropped in tandem with much lower growth expectations for the company.
UPST had highlighted earlier at its most recent investor conference, Piper Sandler’s Global Growth Frontiers Conference on September 14, 2022, that “the bigger constraint on our business right now is the sort of anxiety of the funding markets and their willingness to fund loans.”
In the next section, I focus on Upstart’s plans to tackle its funding issues and how that will affect its prospects for the long run.
What Is UPST Stock’s Long-Term Outlook?
UPST’s long-term outlook will be influenced by the company’s efforts to make changes to its funding approach. In its second-quarter financial results media release, Upstart disclosed that it is “taking the necessary actions to build a more resilient and committed funding model over time.”
Upstart noted at the company’s Q2 2022 investor call that the company’s plans are to have “a significant amount of committed capital on board from partners who will invest consistently through cycles.” At Goldman Sachs’ (GS) Communacopia + Technology Conference on September 13, 2022, UPST highlighted that these new committed capital partners could be investors like “sovereign wealth funds, insurance companies.” More significantly, Upstart cautioned at the GS conference that there will be a “trade-off” with expectations that “committed capital will come at a somewhat higher cost.”
It is reasonable to expect that Upstart will be a company boasting more stable revenue growth at the expense of lower profit margins or weaker profitability in the long term.
Due to the lack of committed capital as part of its current funding approach, UPST’s top line in the short term is expected to be volatile. Based on the market’s consensus financial estimates obtained from S&P Capital IQ, Upstart’s revenue growth is forecasted to slow from +42% for fiscal 2020 and +264% for fiscal 2021 to +6% and +7% in FY 2022 and FY 2023, respectively. In the long run, when UPST pivots successfully to a new funding model that has a higher proportion of committed capital, one shouldn’t see such wild swings in top line expansion from year to year.
With regards to profitability, UPST has already acknowledged at the recent GS conference that it will have to pay a higher price to secure the relatively more predictable and reliable funding sources. This translates into expectations of a decline in margins and reduced profitability for Upstart going forward, as the company optimizes its funding model in time to come.
Is Upstart Stock Undervalued?
Upstart’s stock isn’t undervalued, notwithstanding the -85% fall in the company’s share price in 2022 year-to-date. UPST’s valuations have derated over time, but the stock is still valued at a premium to its peers.
UPST’s consensus forward next twelve months’ price-to-sales valuation multiple was 2.2 times as of September 27, 2022 according to S&P Capital IQ, and this is way lower than its historical peak price-to-sales ratio of 33.1 times recorded on October 15, 2021.
On the flip side, Upstart’s shares are relatively more expensive than the company’s peers. The market values LendingClub Corporation (LC) and OneMain Holdings (OMF) at consensus forward next twelve months’ price-to-sales ratios of 0.98 times and 0.88 times, respectively.
In my view, UPST’s shares are fairly valued. On one hand, Upstart’s current valuations have compressed by a large extent as compared to historical levels. On the other hand, Upstart boasts a higher price-to-sales multiple as compared to peers. Furthermore, the change in the company’s funding strategy could lead to lower margins for UPST, which warrants a valuation de-rating for Upstart to some degree.
Is UPST Stock A Buy, Sell, or Hold?
I rate UPST’s shares as a Hold. The company’s share price has been weak, as issues relating to funding have negatively affected its near-term revenue growth prospects. Upstart intends to rely more on committed capital funding sources in the future to deal with funding issues, but this implies that UPST will have to accept higher funding costs in exchange for greater revenue stability. I think that Upstart’s stock is at a fair valuation now, which warrants a Hold rating.
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