UPST Q3 and my thoughts

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All,

UPST reported recently, and while I thought it was a solid report overall, they fell short in a few key areas that have led me to reassess my position.

The Numbers (Q4 2024):

  • Transaction Volume - 428,056 loans originated, up 128% YoY with a 20.6% conversion rate (up from 16.3% in Q3). Total originations hit ~$2.9B, up 80% YoY.
  • Revenue - $277M total revenue, up 71% YoY. Fee revenue was $259M, up 54% YoY.
  • Profitability - Returned to GAAP profitability with $31.8M net income ($0.23 per diluted share) vs. a loss of $6.8M ($0.07 per share) in Q3 2024. Operating income was $23.7M vs. an operating loss of $45.2M in Q3.
  • Adjusted Metrics - Adjusted EBITDA of $71.2M (26% margin) vs. $1.4M (1% margin) in Q3 2024. Contribution profit was $147M (57% margin), up 44% YoY but down from 61% in Q3.

What I Liked:

  • HELOC Innovation - 20% of HELOC loans are now being approved instantly. That’s massive market potential if they can scale instant loan services in the HELOC space.
  • Algorithmic Discipline - Management attributed the slowdown to their algorithm detecting market weakness and tightening lending criteria. This is actually a positive sign for their bank and credit union partners. Showing caution over reckless growth should help them add more institutional lenders and gain market share long-term.
  • Valuation - It’s incredibly cheap. The run rate non-GAAP P/E is under 20 for a company growing revenue at 71% YoY.

What I Didn’t Like:

  • Decelerating Growth - Revenue growth slowed to 7.8% QoQ, and they’re guiding for just 4.0% next quarter.
  • Balance Sheet Concerns - Loan balances on their balance sheet increased rather than decreased. I was expecting improvement based on last quarter’s conference call, where they discussed reducing these positions. This quarter they acknowledged it’s a slow process given the loan sizes, but the trend is going the wrong direction.

Why I Decided to Sell:

The market and I clearly disagree on this company’s performance. I’m down 50% on this investment, and that disconnect has made me realize I may not fully grasp the lending/fintech industry as well as I thought I did. The market’s persistent negative reaction suggests I’m missing something important.

Rather than hold and hope, I’m trimming to a sub-1% position so I can continue following their story and learning, but with significantly less capital at risk.

Drew

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Part of the issue with UPST is its periodic need to carry loans on its books. In its heyday, UPST was purely a loan screening facilitator matching consumers with lenders. It was lining up to disrupt traditional credit scoring (mostly FICO) and saw considerable growth without exposure to any of the lending risk.

The moment UPST could no longer sell its full book of approved loans to outside lenders is the moment the business model changed. That made UPST more of a digital bank than a SaaS company servicing lenders. That increased risk rightfully makes it a riskier investment meriting a lower multiple. One of the lessons I learned from owning UPST is even though it was technically a B2B business, the fact its customers in turn serviced individual consumers made it more susceptible to the whims of the B2C lending market than I fully anticipated.

(Full disclaimer: though I’ve followed UPST indirectly since, I sold out fully after that first big miss in the Fall of 2021 and have never bought back in for the reasons stated above. I’ve come to believe that underlying dynamic is why the entire fintech sector seems so erratic at times, mostly recently my brief and unfortunately unprofitable dabble in SEZL earlier this year.)

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This is a good summary Drew. Before I add my thoughts, I want to quickly say why I own Upstart.

I feel they are a category defining company and will be one of the big players in AI based lending for years to come.

Their rating - has consistently been 4.9 in Trustpilot with 58k reviews. I have followed it for years and it has never gone down. Not just the ratings, but the kind of things people say on why they like Upstart is deeply emotional. I have never seen anything like that.

It tells me they have achieved a rare case of Product Market fit. In my opinion, it’s much more than using AI to give better loans. The even more important aspect is the speed of delivery that has solved a key pain point - the old process of talking to another human (banker), being asked back and forth for many documents and most importantly the element of rejection must have been a very painful experience for people. At least, this is what I infer from all the comments.

Q3 balance sheet concerns:

I agree I’m also concerned with the $200M increase in balance sheet loans. Their explanation was it’s a unique timing where three of their new categories are exiting R&D at the same time (Auto, HELOC and small dollar). I went and looked at their commentary from last Q to see if they’re shifting the goal post. It seems to be the case, timeline is still Q4 primarily but moving into 2026 now. It’s the main thing to watch. If they shift timeline again next quarter, I’ll be concerned and reduce my position. They have kept their promise on using their own balance sheet for R&D and move to third party capital with their core personal loan product, so they have history here.

2Q management comments:

”Yes, as I mentioned in the prepared remarks, a lot of the volume on the balance sheet today are from our new products. So our core business, I think, is well funded. Categories like Home and Auto are growing quickly. So it’s a bit of a good problem to have, sort of the original use case for the balance sheet, which is R&D and incubation.

In terms of time frame to get the flows moving to third-party capital, I think we’re looking at a time line that’s sort of roughly between now and the end of the year.”

3Q comments:
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”To reiterate, we are aiming to enter into a phase of reducing our R&D-related balance sheet holdings, which we anticipate will gain steam in Q4 and continue into 2026, and we would expect this revenue item to moderate as we are successful.”*

“We are very pleased with the progress of these efforts and believe that we are on a path to putting multiple agreements in place across all of these new product lines, which will set them up to further scale in 2026.” (Relates to agreement to move their loans of balance sheet)

“These are large deals, a multiyear time frame, and a large check size. So there’s a lot of diligence in these conversations and these processes, and they are not perfectly predictable in terms of timeline. But with respect to progress, I think it’s all going well. We’re excited about all of it.”

*Upstart is one of the stocks where I have had a decent history. My strategy is to always put protect the week of earnings (due to high volatility) and it helped me big time in 2021 and even last week. I got out in ‘21 and got back in May ‘24 at a ~$26 cost basis (the protective puts I do have raised the cost basis to ~$31).

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@drew1618t thank you for writing this up, I had it on my to-do list along with a few other holdings that I hope to get to this week.

I ended up trimming a bit due to the revenue miss and reduced guide, but currently still have it as a 5% allocation. After all, it’s revenue still grew at 71% YoY and is continuing to grow Net Income. They’ve stated the R&D loans will come off the books which if true, would be promising on multiple fronts. But I understand the distrust and they are certainly a candidate for me to trim further as earnings season progresses.

I too am not quite understanding the market’s perception of this sub-sector of the fintech market, which includes PGY that just had a very good report this morning. Both of these companies are growing both revenue and net income at a solid clip, and have a pretty strong narrative in an industry begging for disruption, yet continue to be valued like a bank.

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