Bull markets and easy credit can obscure weak business models and companies bound to struggle in a poor economy. So is it any surprise that Upstart (UPST) , a consumer lender, looks to be roadkill as the economy weakens? The company's artificial intelligence-powered lending service is now in question.
But is there some hope for UPST as everyone considers it dead? Let's take a closer look.
The company went public in 2020 and bubbled up during the pandemic, rallying over 1,000% to over $400. The shares have since given back all gains, declining 93% in the last nine months. While it may be tempting to believe that after the massive decline the bear market has overly discounted bad news for Upstart, still the pain is likely to continue, save for a few dead cat bounces when recession fears abate.
On Monday, Goldman Sachs downgraded Upstart to a "Sell," with a $14 price target, down from $40. When the lead underwriter takes its target to the low on Wall Street, 50% below the current price, that's a flashing caution signal. I understand the contrarian urge when analysts become fully bearish after such an enormous decline and a 35% short interest. Yet, with closer scrutiny of Upstart's business risk, there's no clear buying opportunity at hand.
Goldman had been impressed with Upstart's speedy growth and around 9% penetration of the U.S. personal loan market through 2021, but sees the recent slowdown in origination and revenue growth as evidence of heightened competition and increasing funding costs for Upstart partners. Goldman believes this reduces visibility into long-term growth and share gains beyond 2023 that historically had justified UPST's premium valuation relative to peers. Goldman notes, "Slowing growth and reduced confidence in UPST's differentiation in credit underwriting likely will catalyze a further de-rating of UPST valuation to be more in line with its lending peers."
Last week, UPST previewed weak earnings to come, citing lending marketplace funding constraints as capital market partners pulled back funding due to concerns around the macroeconomic environment and rising interest rates. Two factors that led to Upstart's strong market share growth in the personal loan market -- robust funding from capital markets partners and a willingness to lend to underbanked and underserved borrowers that may have been unable to borrow from other lenders -- may work fine in a strong, easy-money economy. But, I feel that Upstart's resemblance to a subprime lender with tightening funding options, bodes poorly for underwriting growth and rising loan delinquencies.
Upstart was founded in 2012 and has yet to operate through a true recession business cycle. According to Wedbush, a firm early to warn of elevated risk in the business model, "The biggest risk to Upstart is its reliance on third-party funding, and this risk tends to become exacerbated during recessions and market turmoil, the beginnings of which could be in the process of unfolding."
Goldman's downgrade is clearly reactionary and seems late after an ugly early quarterly announcement and a stock that has already lost substantial value from the highs. Still, UPST trades at over 2.5-times book value, a considerable premium to lending peers and shares of Goldman (GS) , which trades at slightly under book value (see my recent column on GS). In a down-cycle market, lenders like Upstart often trade below book value as well.
Upstart was started by ex-Google (GOOGL) employees, and their technological edge in ranking the creditworthiness of borrowers may very well be industry-leading. But the company is not modeled as a seller of this technology; it's a lender and hence exposed to funding risks and recessionary conditions that lead to deteriorating borrower credit quality. Although the shares have pulled back to a more realistic valuation, nothing is compelling about the stock at this stage of the business cycle, even after a 93% decline.