Upstart Offering of Convertible Notes

Upstart Holdings, Inc. Announces Proposed Private Offering of $575,000,000 of Convertible Senior Notes Due 2026

https://ir.upstart.com/news-releases/news-release-details/up…

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Upstart is trading about 3% down in after hours, to about 194.xx. Is this a possible reaction to to sale the sale of convertible notes being considered potentially a dilution?

Yes. Possible. Remember, Mr. Manic S. Market (a) still likes to trade on valuation, (b) loves to take quick profits at any sign of sideways movement or an event he doesn’t understand, and (c) doesn’t care much about the strategic business case for this convertible note offering. Anti-Foolish, in other words. I don’t tend to wait on the fence for dips in price to add, but I can see how many here (such as the replier before me) might. The press release said, “The notes will be convertible into cash, shares of Upstart’s common stock, or a combination thereof, at Upstart’s election.” and noted that after covering certain costs related to such conversion, the proceeds will be for general corporate purposes. Sometimes that means stock-based compensation or option grants to officers, which as I see it is not wise use of capital.
But then I’m not a leader of a growing tech company either, so wth do I know? : )

-n8 (long)

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The press release said, “The notes will be convertible into cash, shares of Upstart’s common stock, or a combination thereof, at Upstart’s election.” and noted that after covering certain costs related to such conversion, the proceeds will be for general corporate purposes. Sometimes that means stock-based compensation or option grants to officers, which as I see it is not wise use of capital.

If there are to be stock-based compensation or option grants to officers, they will be non-cash expenses and thus there will be no impact on cash. The convertible notes and stock based compensation are independent of each other.

The issuance of these convertible notes looks to be built on the back of the 50%+ runup in the stock price this past week following the Q2 earnings release. It’s better to sell equity or raise capital via convertible notes when the stock price/share is at all-time highs rather than when the price/share is relatively low.

My curiosity on this capital raise is what are their plans for the cash? They are essentially doubling the cash on their balance sheet. Are they going to make an acquisition(s)? It isn’t likely a company builds up its war chest of cash “just because”.

Lee

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I am not sure I completely understand convertible notes so someone critique my interpretation here. Upstart could just issue stock. Instead, they are taking a loan which will at some point be paid back with stock (timing at their discretion). The value here would be that they can convert it at what they expect will be a much higher stock price in the future. This equates to no dilution now and much less dilution in the future than what they would have to do to sell stock directly now. [because you could use less shares to pay back the loan since they would be worth more presumably in the future]. Essentially, it is a vote of confidence in their growth.

Given no dilution now, this is a net positive for shareholders if you accept that them having more cash for growth is valuable. Is this right?

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"I am not sure I completely understand convertible notes so someone critique my interpretation here. Upstart could just issue stock. Instead, they are taking a loan which will at some point be paid back with stock (timing at their discretion). The value here would be that they can convert it at what they expect will be a much higher stock price in the future. This equates to no dilution now and much less dilution in the future than what they would have to do to sell stock directly now. [because you could use less shares to pay back the loan since they would be worth more presumably in the future]. Essentially, it is a vote of confidence in their growth.

Given no dilution now, this is a net positive for shareholders if you accept that them having more cash for growth is valuable. Is this right?"

I’m no expert, but I have read before that when a company chooses to issue convertible notes instead of doing a secondary offering of stock, that it generally means they think their stock price is not “overvalued” - meaning they think the stock is going a higher. If they thought the stock was currently overvalued, they would sell stock instead to raise cash.

I believe CRWD did the same thing in the last year. Their stock has done ok since then.

Long UPST. It’s now my second largest position after Bitcoin. It has passed my favorite - TMDX - which is now in the #3 position. I have not mentioned TMDX lately, but I’ll use this post to sneak in a comment about it. It’s up ~ 90% since I first brought it up to the board 15 months ago. It is about to receive (I believe - but not final yet) FDA approval for 2 additional uses for it’s product. They are executing well and about to enter the upslope of their “S” curve IMO in 2022. Check out the TMDX board if you want any more details. Also - don’t reply on Saul’s board about this company. Thanks.

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Is this a possible reaction to to sale the sale of convertible notes being considered potentially a dilution?

The reaction could be the superficial resemblance to a security that could result in death spiral financing:

https://en.wikipedia.org/wiki/Death_spiral_financing

Suppose a company gets funding where the lower the share prices go, the more shares the convertible is converted into. Then situations can arise where hedge funds want to hedge their exposure, and do so by shorting shares. But the farther shares fall, the more shares the hedge fund would get on conversion, so then they have to short even more shares to hedge, driving down the share price even more.

In weak businesses, this can help kill a company.

I think that outcome is extremely unlikely with Upstart because it isn’t weak and they have the option to pay off the debt with cash, complicating hedges based on shorting shares against the convertible.

But the after-hours reaction could be a knee-jerk reaction to the creation of a convertible security that bears think has the possibility of contributing to a death spiral.

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Hi Analog,

CRWD recent debt offering was not convertible debt, it was for $750mil of straight debt at 3% interest. But this is also a good signal that management thinks the stock isn’t overvalued. Or it would have just done a secondary offering.

Of the companies we follow here Cloudflare was the one who just took out $1.125b of convertible bonds with a 0% interest rate. The tradeoff is minor dilution at higher prices so the creditors get to participate in the upside on the stock with a conversion price of $191.34/NET share.

I am guessing UPST will pricing will be similar with a near 0% rate and higher conversion price whenever we see the pricing details.

Bnh

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I don’t think we have enough information about the terms of the note offering. We don’t know the maturity date, we don’t know the strike price, we don’t know the upper strike price for the capped call transaction. It looks like Upstart might try to protect themselves from dilution by buying call options up to some cap. Details to come out later.

A far as the use of the money, as Warren Buffet says, you can never have too much cash. And hasn’t Upstart made an acquisition in the past. I’m sure Goldman Sachs and Bank of America, their bankers, have told them they have institutional customers for $575MM if they issue debt rather than stock. They don’t have much debt, if any, on their books now. There are many institutional buyers including fixed income mutual funds that can only buy fixed income and they may want to participate and have Upstarts name on their books. And Goldman and B of A will love to keep showing Upstart deals for a potential acquisition where they can run the books.

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"The press release said, "The notes will be convertible into cash, shares of Upstart’s common stock, or a combination thereof, at Upstart’s election." and noted that after covering certain costs related to such conversion, the proceeds will be for general corporate purposes. Sometimes that means stock-based compensation or option grants to officers..."

If there are to be stock-based compensation or option grants to officers, they will be non-cash expenses and thus there will be no impact on cash. The convertible notes and stock based compensation are independent of each other.
and
My curiosity on this capital raise is what are their plans for the cash?

I apologize that the initial wording was not as clear as possible. My intended meaning was that their plans for the cash remainder, “General Corporate Purposes” can include future stock-based compensation or option grants to officers, not that the convertible note offering itself could result directly in such compensation/grants to officers. Yes, clearly independent things.

Are they going to make an acquisition(s)? It isn’t likely a company builds up its war chest of cash “just because”.

This is a great question that I didn’t see addressed in subsequent replies. I haven’t found good acquisition targets in my research of this company, but I’m no expert. If it is growth by acquisition they have in mind, raising cash for it instead of thinking of funding it with (recently-appreciated) stock would be a positive sign of leadership’s confidence, and possibly that such acquisitions would be on the smaller side. We’ll find out soon enough, of course. My own read on the motivation is “Flexibility for fast organic growth as more lending partners join”. I hear they’re doing a lot of hiring… (kidding, won’t go there) : D

-n8 (long)

hi,

i am reading the press release up and down and up again. but it doesn’t states when is the offering date. is there anyway of finding out? Keen to find out so as to be aware of when this cash amount from the bond be reflected on upstart’s financial statements.

My intended meaning was that their plans for the cash remainder, “General Corporate Purposes” can include future stock-based compensation or option grants to officers

In a word, no. Stock-based compensation is a non-cash expense for the company. One way to think about this is the founding of a new company. The founders often/usually get shares before the company has any cash. Another way to to think about this is if the company has $1M cash and issues $500k of options and stock grants the company will still have $1M cash after the grants are issued.

Lee

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