Here is what I use to calculate GAAP gross margin for UPST:
First, we shall take the data from official Q2 report: So GAAP GM = (193,946 - 24,164) / 193,946 = 87.5% (I think their Non-GAAP GM is higher but it was not reported and cannot find the clue)
Zoro – this is an important point, and perhaps this serves as an opportunity for us to clarify their contribution margin (GM), and how it differs to the more conventional GM that we’re used to.
Upstart’s S1 states that “we incur variable costs in the form of borrower acquisition costs and borrower verification and servicing costs…borrower acquisition cost and borrower verification and servicing costs are highly correlated with the number of loans transacted on our platform and trended upwards on an annual basis.A small number of loans were sourced directly through bank partners in which we received no referral fee and incurred no acquisition costs, this category of loans generated a 67% contribution margin…the rising level automation and continued improvements on our conversion rate achieved through our increasingly sophisticated risk models and our evolving channel mix have contributed to improving loan unit economics at a time. We further believe that bank-sourced loans can be an important driver of volume growth in the medium-term future; to the extent we are able to increase the number of loans sourced directly through our bank partners, our contribution margin would be positively impacted.”
So, a couple of takeaways from me, but I would appreciate a correction if my interpretation is not accurate:
(1) CM gives us the unit economics of their loan product, while GM provides a company’s overall economics
(2) Partnerships for Upstart are important not only because of the net new revenue creation, but also because their higher-margin nature. Plus the network effects that they create through the optimization of their machine learning models! So it’s like a triple whammy
(3) The power of their business model can be seen through their GM evolution. As Zoro stated, GM last quarter was 87.0%; yet GM was only 50.2% in Q2’20. Sure, that was peak Covid quarter, so let’s take last quarter’s revenue instead, which is 85.0%. That 200 bps improvement sequentially! And we clearly see the trend that their algorithms create on their financials – more loans processed scales revenue by an order of magnitude greater than their costs
Sure, we might not get some of the metrics we look for in this business model as SJO mentioned. And we’ve seen how their revenue can diminish overnight during an economic catastrophe. But it’s important for us to appreciate the differences in their business model so that we can better interpret new information (i.e. signing more bank partners, etc).
We could argue that it took a pandemic for the market to re-rate the multiples of cloud companies, as the world realized that they essentially are the central nervous system of the economy. Well, its clear that Upstart was heavily mispriced at IPO, and it make take quite some time for the market to understand how to value these sorts of businesses. Surely there will be similar companies to Upstart that will IPO in the coming years, and the more we learn about Upstart, the more prepared we’ll be to take advantage of the market’s underappreciation of their disruption.
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