To The Moon

Summary

• Upstart's recent earnings report is a mixed bag, with bullish aspects but also notable concerns.

• Investors are eager to take profits after the stock's massive run-up in recent months.

• The bear thesis, rooted in skepticism about Upstart's intermediary role and balance sheet, contrasts with the company's claims as a loan originator.

Michael Blann/DigitalVision via Getty Images

Investment Thesis

Upstart $Upstart Holdings, Inc.(UPST)$ delivered a very mixed set of results. There was more than enough for the bulls to be content with, but there was also one very strong blemish in the earnings report.

Given that the stock had already run up massively in the past several months, there were a lot of investors eager to take profits on the back of this earnings period.

Nevertheless, as I look ahead to 2024, I remain bullish on Upstart.

Rapid Recap

In my previous analysis titled Setback to Comeback, Rise Above the Noise I wrote,

Upstart financials are not great, but they should stabilize going forward.

Investing is not a hard science. Rather, it's more of an art. If all there was to investing was the ability to accurately discount cash flows, the best investors would be mathematicians.

Instead, I focus on Upstart through the lens of emotional investing.

I proceeded to say,

[Hiking interest rates] created stress in the economy and consumer paralysis. Not only were consumers put off from borrowing capital, but also, Upstart's financial partners were not eager to take loans onto their books.

So, Upstart was left with the loans on its balance sheet. And this led to its balance sheet bulging, and Upstart was forced to slam the brakes on its operations.

This is my critical contention, that investors staring down at the premarket reaction will not want to hear right now. Stocks don't go up in a straight line.

Everyone wants to pick up a bargain. And everyone feels exuberant when stocks rerate higher. And indeed, Upstart has massively re-rated in a few months' time.

Author's work on UPST

But this pace of re-rating needs to take a breather too. This doesn't mean that the bull case has stopped. All this means is that the market is now thinking what's next? And with so many investors jumping on the bandwagon in the past few months, plus countless options expiring post-earnings, there's bound to be tremendous volatility.

But the bull case isn't over yet.

Upstart's Bear Thesis

Upstart is a middleman that facilitates the origination of consumer loans. With tight lending conditions, this disruptive fintech is viewed with skepticism by banks. Here's a quote from the earnings call that echoes this sentiment,

[Signs of stabilization] despite [being] in an environment where banks continue to be super cautious about lending. Interest rates are as high as they've been in decades and capital markets remain challenged.

[...] Funding markets remain cautious and risk averse. Banks and credit unions are generally focused on deposits and liquidity, while capital markets are beginning to show signs of normalization.

And indeed, the bear thesis facing Upstart stems from concerns that investors have with Upstart's balance sheet. More specifically, the bear thesis points to Upstart's balance sheet as an indication that lending partners are distrustful of taking on Upstart's balance sheet loans.

UPST Q2 2023

As a reference point, Upstart's loans on its balance sheet were down 15% sequentially from Q1 into Q2, which isn't a significant dent in improving its balance sheet, given that this has been an overwhelming concern from investors.

But the real negative news that bears will have latched onto from the earnings call was this,

Just after quarter close, we completed a one-off $200 million ABS transaction, funded entirely from our own balance sheet. As you may recall, we traditionally sponsor ABS [asset backed securitization] transactions on behalf of our loan buyers who are usually the principal economic agents and loan contributors to the transaction.

In this case, we took the unusual step of funding a deal from the Q2 vintages accumulated entirely on our own balance sheet.

We did this both to reset the market understanding for how our more recent vintages should be expected to perform, as well as to serve as a visible signal to the market of our confidence in the adjustments that have been made by our own underwriting models and adapting to the new environment.

Again, for bears, this is just more fodder for a business that is still highly uncertain and questionable until proven it can thrive.

For their part, Upstart proclaims that it's a loan originator. While bears charge that Upstart as a loan originator should not have to hold onto that ''risk'' on its balance sheet. It's a catch-22.

While for bulls, this quarter is a watch-and-see quarter.

Revenue Growth Rates Will Improve

UPST revenue growth rates

Analysts were expecting Upstart to guide towards $155 million in Q3. Meaning that analysts, myself included were hoping that Q2 was the final horrendous quarter and that Upstart would be able to enter Q3 either with flat y/y revenue growth rates, or in the worst scenario, down single digits y/y.

And yet, as it stands right now, Upstart's guidance for Q3 2023 doesn't inspire much hope.

Nonetheless, I stand by what I previously wrote when I said that looking out to early 2024,

the comparisons with H1 2023 would be of a company that would be perceived to be ''back to growth mode''.

And at that time, investors would be saluting how Upstart is a turnaround in the making.

I believe this thesis makes sense. And on that consideration, I believe it's difficult for bears to latch on to any further negative aspects.

The Bottom Line

In evaluating Upstart's recent performance, it's clear that the earnings report presented a mixed picture.

There were certainly aspects to please the bulls, but one glaring issue stood out, causing some investors to capitalize on the recent stock surge.

As I cast my gaze toward 2024, my bullish sentiment on Upstart remains intact.

While the financials were far from stellar, I approached the analysis through an emotional investing lens, recognizing that market dynamics play a significant role.

The impact of higher interest rates and cautious lending practices created turbulence, reflected in Upstart's balance sheet expansion.

While the stock has experienced remarkable re-rating, it's crucial to acknowledge that stocks don't move in straight lines.

The bear thesis centers around Upstart's intermediary role in consumer loans, facing skepticism from banks in a tight lending environment. The recent earnings call highlighted continued banking caution, with funding markets remaining risk-averse, which bears construed as a lack of lending partner trust.

This dynamic has fueled the catch-22 debate between Upstart's identity as a loan originator and its balance sheet risk.

Despite the uncertainty, Upstart's claims of being a loan originator, as well as the prospect of improving revenue growth rates in the coming quarters, underpin my ongoing optimism for the company's turnaround potential.

Source: Seeking Alpha