Either he’s playing with humble Monkey’s heart, or he’s a con-artist of the highest order.
We will shock the world
I always love Monkey’s posts, he is very wise. And great thread, I like chang’s dog analogy too.
To answer Monkey’s question, I think there is a place in between and why I would mostly attribute that quote as ‘noise’ and not place much import. When I first saw that tweet my first reaction was ‘oh that’s bullish’ too, but then there was something about it that made me feel uncomfortable. When I have a ‘gut feel’ I tend to think about why, until I understand it.
First, who is ‘we will shock the world again in 22’ addressed to? Is it to his employees perhaps (‘good job team, same again next year), is it to investors or to himself or to the world at large? Bear in mind what he and his employees might see as a ‘shocking the world’ might be very different to an investor’s expectations, for example how many banks they get to remove FICO requirements altogether (a major milestone) or partnerships with traditional banks or a Spanish language loan offering, improving more diverse representation in its loan originations, or expanding into new products, all could be perceived as ‘shocking the world’ to a founding CEO, without tangibly driving much incremental contribution to the top line (in the near term anyway). Or could he just be trying to mitigate the damage on the share price? What ‘shocks the world’ is perhaps very different in the eyes of an investor or a CEO.
I had noticed pre and post Q3 earnings several bullish intonations from Dave Girouard as well. Doubling down on the hyperbolic notion of AI being the most transformational change to lending in its 5000 year history, however accurate, while the share price trades at a near 70% discount to its high might hint at a cognitive dissonance and not to place much weight on media-speak.
What I would say though – if he really is confident of the shocking the world in 2022, he doesn’t have to wait long to prove it. Show it in Q4 with your FY22 guidance. It’s as simple as that, until then – it will go down in my book as bravado. Until proven otherwise.
Without a clear view of auto contribution yet, anything $1.1bn-$1.4bn would seem to be a plausible range for FY22. I’d suggest management might guide a bit below that, if they do a FY guide at all. But what more statement can you make to the world heading into 2022 than guiding $1.5bn+? That would shock an investor’s world, certainly. Otherwise you’re just setting yourself up for a fall.
FY22 Auto dependency
You only need to look back to Upstart’s S-1 to see one of the biggest challenges they will face in maintaining their growth rate over the next year or so:
Further, we believe our growth over the last several years has been driven in large part by our AI models and our continued improvements to our AI models. Future incremental improvements to our AI models may not lead to the same level of growth as in past periods. In addition, we believe our growth over the last several years has been driven in part by our ability to rapidly streamline and automate the loan application and origination process on our platform. The Percentage of Loans Fully Automated on our platform was 53% in 2018 and increased to 70% in 2020. We expect the Percentage of Loans Fully Automated to level off and remain relatively constant in the long term, and to the extent we expand our loan offerings beyond unsecured personal loans, we expect that such percentage may decrease in the short term. As a result of these factors, our revenue growth rates may slow, and our financial performance may be adversely affected.
If we can assume that at a 15% market share in their personal loans portfolio and various macro-challenges coming including higher interest rates and presumably higher default rates, it seems likely that Upstart will need auto loans to drive much of its growth next year. This might result in a reduction in automated loans % (a continuation of the drop to 67% from 71% in Q3 due to ‘fraud issues’), therefore lower conversion rates, a prolonged sales cycle with auto dealerships and lower margins. Lower rates of automation and consequently lower conversion rates from auto will challenge the growth rate on a total level. With pressure from sub-prime borrowers on deal sizes, more reliance on personal loans will come from new bank partners which typically have a long onboarding process:
Our sales and onboarding process with new bank partners can be long and typically takes between six to 15 months. As a result, revenues and results of operations may vary significantly from period to period. Prospective bank partners are often cautious in making decisions to implement our platform and related services because of the risk management alignment and regulatory uncertainties related to their use of our AI models, including their oversight, model governance and fair lending compliance obligations associated with using such models. In addition, prospective banks undertake an extensive diligence review of our platform, compliance and servicing activities before choosing to partner with us. Further, the implementation of our AI lending model often involves shifts by the bank partner to a new software and/or hardware platform or changes in their operational procedures, which may involve significant time and expense to implement. Delays in onboarding new bank partners can also arise while prospective bank partners complete their internal procedures to approve expenditures and test and accept our applications. Consequently, we face difficulty predicting the quarter in which new bank partners will begin using our platform and the volume of fees we will receive, which can lead to fluctuations in our revenues and results of operations.
Our financial results could vary significantly from quarter to quarter and are difficult to predict.
Our revenues and operating results could vary significantly from quarter to quarter because of a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful.
With an unpredictable and slow onboarding process for new bank partners, how much of Upstart’s personal loan growth is actually underpinned heading into FY22? This is why, in my mind, the reliance is on Auto (and Q4 will be important for management to set that expectation).
Any more insight on the time-frame on Auto roll-out then heading into 2022?
CEO, Nov.17th Citi Fintech Conference:
"Yes. I think any time we’re entering a new space – and this is really our second, is there’s a period of R&D and getting the grounding in place. And so it will move at a pace. And then certainly, there’s inflection points where the conversion rates start to move up, the model start to get better and that certainly was our history in personal loans, and I would expect it to repeat without question in auto and probably on a more compressed time frame. We’re not really starting from scratch, but we are entering a new market.
So as you said, it’s a very large market. It’s probably 6x or 7x larger than the personal loan market. But there’s a lot of problems we have to solve. So I think we’re just getting in there. We expect to become material for our business in 2020 – sorry, 2022. And so we’re, kind of, planning on that. And I think the teams are making fast progress, both on the refinance product and on the purchase product.
I would say our expectation on unit economics over time will be not dissimilar to our personal loan product. We create as much value in the sense of having smarter pricing and a better process. And we don’t necessarily want to extract more value than we need to. So I think you can expect over the long haul, that they are larger loan sizes generally than a personal loan, but the percent take maybe less. So it’s hard to say in the long run.
But generally speaking, I would say, we feel very confident that our value-add in this ecosystem is at least as good as it is in personal lending. So there’s every reason to believe the unit economics will be not dissimilar.
And as you solve that, you can get that rate way up. And it’s worth noting that 70% sounds like, oh, well, how could that be when you’re only solving such a small fraction of error? And it’s because, remember that the people who get that fully automated experience are converting twice as much as the people who don’t. And so there’s a – the rate at which you’re getting people the fully automated experience is going to be at the front of the funnel is a lower number than the back, which means as the opportunity is much bigger than it would look like from that 70% number."
Hmm. Considering this conference was mid November, I would expect slightly more conviction in auto loans than ‘we’re kind of planning on it being material for 2022’, unless he is being severely understated. Which is certainly at odds with the ‘we will shock the world in 2022’ comment just a month later.
On the comments of valuation, I agree that trading at ~10x sales the risk reward is much more favourable than it was at 30x forward sales a couple months ago, but I would caution about the notion of 10x sales being ‘cheap’ for Upstart in the current climate (especially when the only comparative is last year since IPO). Why 10x? Why not 5x? I would not model multiple expansion into any forecast. We know the value of SaaS and recurring revenue and why you might pay 30x sales for a Crowdstrike vs some non recurring alternatives for example, but for Upstart you’re paying for 10x sales for a company where its personal loans total addressable market is only 6x its current revenue run-rate: and it won’t ever get 100% market share. So the reliance is on auto and other products.
(I know this sounds like a bearish Upstart post, but I am actually a bull and I have an overweight position, for many of the reasons cited on the board before. I’m trying to offer more balance and to place more focus on the risk, rather than just the reward. I tried to express this in a message to another board member on portfolio management when the share price was trading $340 up to $400 a few days later, pre-Q3 earnings:
“So take DDOG and Upst for eg, both faced retracement in stock price ahead of accelerative/catalytic underlying biz fundamentals & soft YoY comps (perfect combo), after earnings, and seemed obvious to build positions at the time. Apps feels like sits in this bracket ahead of next couple of quarters - the market dislocation. So have been better with position sizing aggressively when feel reward > risk in those circumstances (doubling/tripling/quadrupling allocations in all 3 on initial retracement). What I’m still struggling with though is position sizing after the market has caught up. Eg upstart now is 27% though I have trimmed ~4%, and I recognise valuation is stretched, the risk reward now seems skewed too vs few months ago. The noise around it makes me feel uncomfortable too as awareness this plays into psychology and have seen how quickly a market darling is dropped from the investosphere… it makes sense to me building up big positions when market dislocation, but now everyone on board feel exposed - even though I like the biz and what management doing, and sure catalysts eg auto coming up. Need to hold LT perspective to justify such an outsized position now.”
I had a cognitive dissonance of my own, the story or thesis hadn’t changed, but the risk reward had.)
Now the market is looking at Upstart with uncertainty and it’s up to management to provide clarity.
In comparison, Bill Stone (Digital Turbine CEO) recently and clearly laid out his 3-5 year plan when investors started to look at the company with uncertainty over its acquisitions (https://discussion.fool.com/digital-turbine-apps-a-working-thesi…). I don’t expect Upstart to have visibility to offer the luxury of a 3 year target to the market (though they will have internal targets), but there is value to the Apps CEO’s often understated bullishness. He and his team might not be a former President of Google Cloud, one of Peter Thiel’s 20 under 20 fellows or creating complex AI/ML models to revolutionise 5000 year old industries – but what he does do is under-promise and over deliver and they are relentless with their execution. ”We do what we say and we say what we do”. What more can you want from a CEO?
We need Dave Girouard to be a cold blooded killer as a CEO. Who executes, executes, executes. Who goes out there and kills the opportunity and lets numbers speak for themselves. So far you can’t fault their execution but it’s continuity and clarity that investors expect now. By delivering, he can prove his words of ‘shocking the world’ are not just bravado. All eyes on Q4.