Another deep dive on Pagaya (PGY), an Upstart competitor

The Seeking Alpha writer I referred to in earlier posts has come out with another article on Pagaya which I believe will be accessible to all. It’s hard to believe that this little-known company with a market cap of just $853 million is the largest issuer of consumer-backed asset-backed securities.

Despite all the enthusiasm over Upstart and AI, Pagaya, which has managed to grow revenues by more than 50% y/y in a rising interest rate environment where lenders are extremely cautious, is still a secret.

The Seeking Alpha writer, who is a lecturer at Stanford’s Business School, has clearly done his homework, including meeting with company management and one of their early-stage investors. Here are a couple of passages I find especially compelling

there are dozens of oddities and quirks to Pagaya that I believe contribute to its mispricing. I love this, because I look at it as a “Moneyball” scenario, where assets are mispriced for irrational reasons. I think those factors are still in play, but will fade into the background in the next 12 months

The debt markets love the Pagaya product, they’ve analyzed the defaults, the risks, and are happily buying billions of dollars of these securitized loans. They are saying, loud and clear, the Pagaya AI works and I’m willing to risk billions of dollars of investment capital to trust the AI. Meanwhile, the equity market struggles to allocate $10 or $20 million dollars into the company’s stock. I’m willing to bet the debt markets are right by purchasing Pagaya’s securities, and that the equity markets are wrong (to be ignoring PGY or pricing it this low).

I think there a couple of catalysts that could cause a pop. one being this article, which just came out, another being scheduled conference appearances by Pagaya today and next week. The website doesn’t list information about how to listen to the conferences. I wrote to IR but haven’t received a response.

Full disclosure: I have about a 25% stake in Pagaya. I know that’s too large and will begin trimming back to 20% very quickly.

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20% is still a huge allocation to any company, but in my opinion especially this company…and I’ll try to explain. I’m really not sure if any of this will be helpful to you, but here are some things I’ve learned over the last several years. I’ll admit I’ve only spent a few minutes looking at this company and haven’t read the Seeking Alpha article. This isn’t meant to be expert analysis – it’s meant to challenge you to answer these and other questions regarding your largest (and outsized) position.

  1. Back in 2015-2016 when I was just starting to focus on stock picking, I was very often guilty of trying to hit 3 or 4 home runs with one swing of the bat. That looked like buying tiny tiny companies hoping they would explode higher, or buying companies with a lot of revenue that seemed to be not getting the credit they deserved (low P/S ratio and/or low PE ratio), etc. Often after a lot of opportunity cost and sometimes some large losses, I usually learned why these companies were valued the way they were. That’s what Pagaya feels like to me. (You can read through my 2016 portfolio reviews if you want to see some of mine.)

  2. Lending businesses (Upstart too) are transactional (scaling won’t really help on a per transaction basis), so if they aren’t profitable now, how will that change?

3. Last year in Q2 they guided for $725m revenue for the FY. They reiterated this in Q3. Then for the FY they missed the guide and they only hit 685m. Why? Edit: never mind about this one, they didn’t miss their guide.

  1. Although you note their ~50% growth last year, guide for this year is for 20% [Edit: Make that 10%] revenue growth and they didn’t raise it in Q1. Is the thesis here that growth will accelerate? Because of AI? If so, why are they only guiding for 10% revenue growth?

  2. This company came public through a SPAC and there is probably a reason why. Perhaps that’s not a disqualifier, but it’s at least a yellow flag and I would give it some thought and investigate it.

All this said, I strongly commend you for sharing your portfolio and I believe that is the first step to really honing your stock picking and portfolio-building skills. Your portfolio review shows me you’re serious, and that’s why I replied here. I hope my challenge is helpful. Your own writing about your portfolio will be even more helpful in time…as long as you’re open to updating your beliefs and changing your mind often, you’ll do really well.

Bear

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Hey Bear
They didn’t miss the guide, their guide was total Revenue expected to range between $700 million and $725 million, and then their FY 22 was 748.93m.

Because companies in the same industry are facing the same problem, UPST is experiencing a more severe decline, while PGY is able to maintain growth. Considering the normalization of future loans, I would consider allocating 7-10% to both UPST and PGY.

Here, it is mentioned that they can lower the conversion rate during economic downturns to cope with challenging economic conditions. When the economy is doing well, it can increase the conversion rate to accelerate revenue growth. We see a similar situation with UPST. However, one advantage that PGY has over UPST is its long-standing partnership with institutional investors, including the extended collaboration with GIC until 2028. The reason why institutional investors are willing to collaborate with PGY might be due to its lower default rates and higher returns.

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Wow you’re right. So I guess that means the guide is for just 10% revenue growth this year. :grimacing:

Bear

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That’s a more reasonable allocation, but I don’t want to try to play the credit cycle. I think it’s fair to ask: can’t you do better than cyclical companies that will only grow (and profit) under certain conditions? I want to find extraordinary businesses that control their own destinies as much as possible.

I know Upstart was founded by some extraordinary people, and maybe Pagaya too. But even if they’ve created something extraordinary, the cyclical industry it’s in makes investing difficult, as a lot of people realized in late 2021 through 2022 with Upstart.

Bear

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Hi Bear (and ChangHsieh)–

I really appreciate your taking the time to look seriously at PGY. I read your comments last night and I will confess they cost me some sleep.

I think the point you made that made me especially anxious was the “why aren’t they profitable now” question–not because I felt it was unanswerable, but because I didn’t know enough to ask the question myself before making such a huge allocation.

First let me answer that question. The answer for Pagaya is that they bought a property management company. For Upstart (where I have a roughly 5% allocation), the reason they swung to a loss is because they had to adjust the fair value of loans they hold on the balance sheet. This isn’t/won’t be a problem for Pagaya, which doesn’t hold loans on the balance sheet.

As to the exchange between you and ChangHsieh, I am definitely making these investments in UPST and PGY on the view that their businesses and share prices will rebound enormously when the lending environment improves. I would love to invest in companies that control their own destinies, but I haven’t been able to find any that aren’t priced for perfection, and owning companies that are priced for perfection and seem to control their own destinies hasn’t worked out very well for most of us over the past year and a half.

All that said, this discussion has been very helpful to me, because it has helped me realize that my portfolio allocations don’t align with my macro outlook. I need to emulate you and hold more cash–or at least investments that are less volatile. I guess my view on PGY is that the downside is 80 cents and the upside is limitless, but that view has also gotten me into a lot of trouble. So again, many thanks to you and ChangHsieh for your observations.

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You could say the upside on every stock is limitless…so I’m not sure that means anything.

And you should think of the downside as 25% of your portfolio. “80 cents” doesn’t mean anything.

I could point to short term examples like Samsara where it is working, but probably the better thing would be to zoom out and look how well it’s worked over a longer period. It’s worked well for me, but Saul has more experience still, and he’s never been afraid to pay up for quality.

In my experience, cigarbutt investing (paying a great price for a meh company) is a lot harder than paying a reasonable price for a great company.

Bear

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I wasn’t planning to respond because I didn’t want to get into a debate over the merits of cigarbutt investing versus the type of investing we talk about here. However I did remember something that I thought worth sharing. I once subscribed to a cigarbutt investing service that blew my mind in 2020 & early 2021 with the returns it produced. They were comparable to what we saw here during the same time period. But the returns ran into a wall at some point and the service shuttered. But one of the stocks we owned for a time in the very low single digits was none other than AEHR.

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UPST and PGY are both early players in the game. Both companies are affected by the high proportion of personal loans in their revenue, resulting in significant revenue fluctuations. However, PGY has the advantage of collaborating with institutional investors, which helps reduce the volatility of their revenue compared to UPST.

Both companies are clearly affected by the economic cycle, so to mitigate the volatility, they are expanding into other areas of products. The future revenue volatility may not be as drastic as during this current period of tightening.

From my perspective, looking at the next few years, it is inevitable that interest rate policies will be relaxed, and the companies do not face bankruptcy risks. The current valuation is highly attractive compared to the projected growth rate for next year. Therefore, I am willing to allocate a portion of my portfolio to these cyclical companies.

Regarding Samsara, I believe it is a good company, but the current price is not reasonable. I used to think that valuation was not important, but now I try to find companies that have reasonable valuations and are great. I can allocate a very low proportion of my portfolio to a company when its valuation is expensive for observation purposes.
However, I try to avoid allocating a significantly high proportion when I consider the valuation to be expensive, unless I have very clear reasons telling me that the current valuation is a temporary issue (SNOW, NET, UPST).

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Well, Bert Hochfeld has just released a public article about PGY on SA. It’s quite positive, but comes with several caveats, not the least of which is that the float is so small that institutional investors simply won’t take a position. While the company has a lot going for it, attracting investors in light of illiquidity should not be ignored. Here’s a link:

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[quote=“brittlerock, post:10, topic:93302”]
Bert Hochfeld has just released a public article about PGY
[/quote

I had heard of PGY, but as Bert suggests, it was hard to look after the UPST experience. While I was lucky to have escaped UPST with a decent profit, though not near as much as i would have made had i sold in October, 2021, i never had full confidence in the UPST CEO and that declined considerably in late 2021/early 2022. He’s probably the biggest reason Google got behind MSFT in the Cloud.

But given Bert’s analysis, I spent a few hours yesterday looking at the leadership, after a few minutes with the numbers. i am very impressed with Gal Krubiner and his most serious Board that includes none other than Harvey Golub and Avi Zeevi (Chairman). Wow! Golub, former CEO of American Express, and Zeevi, a very senior Venture Fund Group CEO, are near giants and seem heavily involved and invested. Impressive. Krubiner is a more interesting leader than Girouard, IMO.

Nevertheless, there are risks here and I opened only a 1% starter position as I get to know the company better.

There are a few wonderful opportunities in SPACs which are very out of favor with stocks all beaten into the ground, perhaps deservedly so in many cases, but creating exceptional buying opportunities in a few cases.

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I’m glad you got something out of the article. There’s a ton of risk with PGY. IMHO the biggest problem is the tiny float. Bert wrote in the article that he spoke with their IR. Basically, they don’t need additional capital, at least not in the near term, so it’s very unlikely that they’ll have a secondary offering.

I took a position, but very tiny, just enough so that I’ll pay attention.

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This is getting more and more attention. Another writeup came out on Friday and it seems to be what’s driving the stock today.

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I don’t have an opinion on Pagaya one way or another; I have no position. But every so often it’s worth remembering that this board is viewed by thousands of people and that many here have their own stock services and have connections to others who do as well.

That makes it at least possible that Pagaya is getting “more and more attention” elsewhere because we started talking about it here. Bert wrote it up because a subscriber asked him to look into it. I subscribe to Bert’s service, and I bet others here do, too. I’m not the one who asked, but it’s possible someone else here does and asked the question after seeing the initial post on this board.

Bert mentioning it was then brought back to our attention here, and now someone else has picked up coverage. And of course there’s a direct connection from this board to TMF, who hosts us.

I am not saying any of that is improper, or even overblown. Small companies dream of getting attention in front of large audiences and bravo for them for getting it! I just want to caution that the mere fact of a tiny company mentioned here getting “more and more attention” is something a board of this size and influence can almost create on its own, regardless of a company’s merit or lack thereof.

If all the extra coverage is good, then we’ve provided a great service to the company and to those who post, analyze, and read the coverage here. Find the hidden gems–great! But we can also become an echo chamber, where insightful coverage can morph into hype if we’re not careful. With greater reach comes greater responsibility, imo.

Instead of just “Hey, look, someone else is talking about this company!” it might be helpful to say something like, “Here’s another mention of x company that x introduced to us. Here’s what stood out to me in this other analyst’s coverage.” That could help us stay on track to do what we do best–fully examine the companies brought to our attention–and not fall into the hype trap.

JabbokRiver

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@JabbokRiver42 I read the entire 74 page very detailed write-up about Pagaya linked by @philiproth. I am confident that this deep dive had much more to do with the sudden interest in Pagaya stock than the musings on this board.

Not to diminish the value and even widespread influence of Saul’s Investing Discussions, but I doubt that what has been written here had nearly the impact that Lake Cornelia Research report had. I think this is especially relevant as the interest in Pagaya’s best known competitor, Upstart has shown new life. The general interest of investors has been sparked by the emergence of AI. Obviously, AI assisted lending has benefitted from that.

I can spare you the time of reading the report (though I encourage you to do so if you have nay interest in this area) by reporting that the main take away from the report, IMO is that Pagaya has a more robust business model than Upstart. One needn’t get mired in the weeds as to which company has better AI, as if there were a way to determine that.

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So the market has only been open an hour and Pagaya is up 8% on double a full days volume. :thinking: i cannot find a news event or peer news event(UBNT) is on a normal volumn course. Anyone else have a clue?

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It is my understanding that the largest user of PGY’s technology is SoFi, who reported results this morning and is up ~23% right now. It could be a lifting effect from that.

Rick
No position in SoFi or PGY

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Muchos Gracias! Makes sense now.

As someone who has spent considerable time analyzing Upstart and highlighting issues about that company on this platform, allow me to briefly interject to advise anyone considering investing in Pagaya to thoroughly comprehend the complexities inherent in its business model. Similar to Upstart, Pagaya lends to individuals whom banks are reluctant to lend money. Like Upstart, Pagaya relies entirely on the market to fund such lending endeavors, essentially functioning as an unregulated shadow bank.

The risks associated with this business model are manifold. They include:

  1. The availability of funding and the intermediaries facilitating this funding.
  2. The presence of borrowers willing to accept exorbitant interest rates to obtain loans.
  3. Legal constraints on interest rates for consumer loans.
  4. The regulatory framework permitting the operation of such businesses.
  5. Fraud and litigation risks

Of course, their models have to also provide superior analysis justifying the 10% fee Pagaya imposes on its loans.

While this might appear to be a straightforward business model, it is, in reality, incredibly complex, as most financial companies are. Our experience with Upstart should serve as a cautionary tale. This is NOT just a company with a good AI model that is being sold to interested companies. This is a shadow bank that lends to margins of the society using money from fickle and demanding investors. Only time will tell whether this business model is viable long term as a standalone business. My personal feeling, based on 20+ years of experience in the financial sector, is that it is not.

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I should say, since I was the one who brought this to the group, that my enthusiasm for PGY has soured. I don’t think it’s all that complex and I don’t think UPST is either. The issue with PGY is the ownership structure. Until that is addressed, I don’t expect this stock to do any better than UPST, AFRM, ENPH, SOFI or many other stocks that are very dependent on where the market thinks interest rates are going. Nonetheless, PGY keeps putting up solid numbers, and I do believe interest rates are headed lower this year, so I still own around 3%. Very unlikely I’ll add, though.

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