To The Moon

$Upstart Holdings, Inc.(UPST)$ : The Catalyst Needed Fell Into Place

Summary

• Upstart reached a tipping point. Up until a few weeks ago, the business was still being speculated as potentially headed into bankruptcy. Even if the likelihood was small.

• However, right now, after the deal with Castlelake, Upstart is getting the lifeline it desperately needs.

• With bankruptcy concerns now off the table, Upstart can be valued as a going concern.

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Investment Thesis

Upstart (NASDAQ:UPST) business model passes a critical juncture. In the past several quarters, Upstart's business had suffered from two facets.

Firstly, the weak macro environment was killing debt holders' appetite for taking on Upstart's loan. And secondly, Upstart's balance sheet was rapidly growing and becoming restricted, which by extension was obliterating investors' perception of the soundness of its loans.

Essentially, there was a perfect storm of events that boiled up the perception that Upstart could soon be headed for bankruptcy. However, a watershed event that took place two weeks ago changes this dynamic.

The Key Transformative Moment for Upstart

Upstart is a loan facilitator. Upstart provides banks with insights into the probability of knowing whether or not a customer can be counted on to repay a loan.

Can Upstart's model work better than the alternative solution, the FICO score, from Fair Isaac Corporation (FICO)? That's the question. Or is it?

In actuality, I'm not convinced that this is the key question for Upstart. At least not right now. In fact, consider that up until now, there had been a massive shadow hanging over Upstart's business model.

More specifically, investors became highly wary of investing in Upstart. Why? Because investors became troubled by Upstart's inability to scale without massively burdening its balance sheet.

Consider this:

UPST Q3 2021

Above, we see Upstart's balance sheet in Q3 2021. Upstart held more than $1 billion of cash and equivalents and $650 million in borrowings, meaning that the business operated with a net cash position.

Next, fast forward several quarters to the end of 2022.

UPST Q4 2022

Here we see that Upstart's balance sheet now has more debt than cash. Meaning that as time passes, Upstart's balance sheet is becoming encumbered by its net debt position.

Finally, we turn to see Upstart's more recently reported results:

UPST Q1 2023

The business was at a crossroads. It simply could not scale without figuring out a way to clean its balance sheet.

However, two weeks ago, Castlelake reached an agreement to take off some of Upstart's loans from its balance sheet.

Keep in mind that at the time of Upstart's Q1 results, there had been some insights on the earnings call into the possibility of $2 billion of funding being structured. But at the time of the earnings, Upstarts was still light on tangible details.

Case in point, when Upstart was asked about the funding agreements during the earnings call, this is what Upstart's management stated

I would say Upfront each agreement is a bit bespoke, so it’s hard to sort of broadly generalize. [...]

All investors have a slightly different set of preferences and objectives, so it tends to be a bit different by a counterparty. They’re all currently focused on personal loans, so they’re sort of restricted to our core business. Beyond that, they tend to mirror our broader institutional programs.

At the time of the Q1 results, Upstart did not have in place the Castlelake agreement. Right now the Castlelake agreement is not for $1 billion of consumer loans or even the $2 billion earmarked, but a whopping $4 billion of "back book of loans and a forward flow".

In practical terms, I argue that this is the first step at a critical juncture that will lead other specialty finance asset management firms to embrace Upstart's loans.

The Bottom Line

I charge that when a business has the possibility of going bankrupt removed, there's a rapid rerating in its share price.

To that assertion, many investors will be quick to underscore that Upstart's share price is already up more than 100% since the start of this month.

And to that assertion, I would push back that there are many companies that are up significantly since the start of May.

Data by YCharts

Looking back to where the share price was in the past tells an investor nothing of where the share price is headed. I can't speak for Nvidia's (NVDA) bankruptcy risk. I could speak substantially about Carvana's (CVNA) though.

But going forward very few investors will consider Upstart as headed for bankruptcy.

Strong Investment Potential

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Source: seekingalpha