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Upstart: Riding the AI wave

Opdateret: 11. feb.


Upstart is a growth company whose competitive advantage is their AI model, which means they have been riding the AI wave lately. However, if you look at the numbers, it is evident that Upstart has faced its fair share of challenges since 2022. In this analysis, I will investigate whether the recent AI hype makes Upstart a compelling investment.


This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.


This analysis will be a bit different from what you are used to read in my blog. Upstart is a growth company that made their IPO in 2020. So instead of using the principles I have learned from my Phil Town workshop, I use the principles I have learned from the GOAT academy. I should also mention that most of the numbers I use in this analysis is from Finbox, which I believe is a great tool to get different numbers from various companies.


Before I begin the analysis, I should mention that I do not currently own any shares in Upstart. If you are interested in viewing the stocks I own or copying my portfolio, you can find instructions on how to do so here. I came across the company some time ago, as it grew from $120 to $390 in just 2,5 months. It has since dropped to $13 and is currently trading at around $60 as I write this. Hence, the stock is definitely very volatile, and you need to be able to tolerate that if you choose to invest in Upstart. If you want to purchase shares or fractional shares of Upstart, you can do so through eToro. eToro is a user-friendly platform, and you can get started with as little as $50.



Upstart is an American company that was founded in 2012. They describe themselves as a cloud-based AI lending platform. In short, they connect people who need a loan with lenders. Traditionally, banks used FICO requirements to calculate credit scores. These requirements were not only time-consuming, but they also resulted in a significant portion of the population being excluded from obtaining a loan. Upstart wants to change that by creating an AI model that takes into account requirements other than just the FICO score. As a result, consumers can expect higher approval rates, lower interest rates, and faster payouts, while the banks will benefit from gaining access to new consumers, reducing fraud and loss rates, and increasing automation in the lending process. Upstart mainly generates revenue from fees by acting as the intermediary between consumers and banks/institutional investors. In 2022, 90% of the revenue was generated through this method. It also means that Upstart holds approximately 10% of these loans on their balance sheet. Upstart is building its secret moat through its AI model. An AI model cannot simply be copied, as Upstart has a head start with a large amount of data points. Hence, I do feel that Upstart has a secret moat that will only become stronger in the future. Upstart started with consumer loans and expanded into auto lending in 2020. They plan to enter the home lending market in 2023.

Their CEO is David Girouard. He is also the co-founder of Upstart, which is something I appreciate, as founders are typically committed to growing the business. He has an MBA from the University of Michigan, and prior to founding Upstart, he held positions at Apple and Google. He has stated that the reason for leaving Google to start Upstart is that the finance industry has remained stagnant for decades. He believes there is a significant opportunity to utilize technology and data science to create something meaningful and unique. He also mentioned that he believes millennials have no particular affinity for banks. He believes that the next great financial institutions will have well-defined brands, similar to Nike and Apple. He wants to create that kind of brand with Upstart. He believes that customer experiences are what will drive Upstart's growth in the future. Borrowers are seeking a loan with the lowest possible interest rate and the easiest application process, and that is precisely what Upstart aims to offer. When asked how he motivates others, he said he hires self-motivated people. Once he shares the opportunity to build a lasting company that will change the world forever, it becomes easy. Another thing I like about the management is that the other two co-founders, Paul Gu and Anna Counselman, are still part of the company. Hence, I feel very confident that the management can successfully grow Upstart moving forward.

I believe that Upstart already has a moat that will strengthen in the future. I feel very confident about management as well. Later, I will use a discounted cash flow model to calculate a price for Upstart. But before I do that, let's take a look at some key financial metrics.



Below, we present key financial metrics from the past three years. Upstart was already profitable in 2020 when they conducted their IPO. They achieved impressive growth in 2021, increasing both their revenue and profit. However, 2022 was a challenging year. Upstart managed to achieve slight revenue growth in 2022, but the gross profit margin decreased by over 800 basis points. While the operating margin, EBITDA margin, and EBIT margin all changed from positive to negative. It affected net income, which was negative. Thus, Upstart went from being profitable in 2020 and 2021 to becoming unprofitable in 2022. While it is not something that you would like to see when investing in a company, it shouldn't necessarily keep you away from investing in Upstart. I will elaborate on this as I continue with the analysis.



Before we proceed with the discounted cash flow model, I would like to examine the risks and potential of Upstart. Macroeconomic factors. In 2022, we saw higher interest rates, and higher interest rates usually suggest less borrowing. We saw in the numbers above how it affected Upstart's numbers in 2022 compared to previous years. Furthermore, the economic environment also led to Upstart retaining more loans on their balance sheet. It means that Upstart is no longer receiving fees from loan sales, but it also means that Upstart is now responsible for these loans in the event of defaults. Upstart expects to keep up to $1 billion in loans on their balance sheet moving forward. Customer Concentration. Upstart has a significant customer concentration, as Cross River Bank originated 51% of the loans facilitated on Upstart's platform, and fees received from Cross River Bank accounted for 45% of Upstart's total revenue in 2022. The second largest customer originated 36% of the facilitated loans, while fees accounted for 28% of the revenue in 2022. Thus, 73% of Upstart's revenue is generated from two customers. If Upstart cannot maintain a healthy relationship with these customers, it will negatively impact their business in the future. Upstart needs to continuously improve their AI model. Upstart's competitive advantage lies in their AI model, and as we have witnessed, AI is advancing rapidly lately. Upstart needs to continuously improve their AI model at the same speed as their competitors to maintain the head start they have gained. Furthermore, if Upstart's AI model contains errors, it could significantly damage Upstart's reputation and hinder future growth.


There is also a lot of potential for Upstart moving forward. Expanding into new markets. Upstart started with personal loan originations, which, according to Upstart, is an $81 billion market. They expanded into auto loan origination, which is a $672 billion market, and it also has higher profit margins than personal loans. Now Upstart is expected to expand into $2,7 trillion home market when they launch a home equity product later in 2023. It will significantly expand Upstart's market potential. Upstart has high hopes for their home equity product, as they aim to offer online approval in 10 minutes and funding in 5 days, compared to the current 36 days it takes to receive funding. Business Disruption. Upstart is disrupting the loan business, where banks have used the more than 30-year-old FICO score to approve loan applications. Upstart's AI model has 53% fewer defaults at the same approval rate as large U.S. banks, while making 173% more approvals at the same default rate as large U.S. banks. It means that Upstart is approving more applicants with lower loss rates. Furthermore, 84% of the loans are fully automated, which means they are more cost-effective and faster. Returning to profitability. Management expects that Upstart will return to profitability in 2023. The path to profitability lies in cost reduction. They have achieved this by reducing headcounts by 30% and cutting other operating expenses, including office space. These cost reductions have increased their contribution margin to a record 58% in 2023. Furthermore, Upstart generates revenue from fees, which means that attracting new customers is a priority. Upstart has been successful in securing multiple long-term funding agreements in 2023, which will deliver over $2 billion to the Upstart platform in the next 12 months.



I have now investigated the financials, risks, and potential of Upstart. I will now examine the price by utilizing a discounted cash flow model. To do so, I will need some numbers that you can see below. The numbers are the 2022 figures, which I found on Finbox. However, I have determined the perpetuity growth rate and the discount rate myself. The reason I chose a 3% perpetuity growth rate is that it typically falls between the historical inflation rate of 2-3% and the historical GDP growth rate of 4-5%. I decided to choose the lower middle option due to the current market conditions. The chosen discount rate is 12%, which is typically between 9-12%. I decided to go with the higher rate due to current market conditions. Remember that all the numbers used in these calculations are in millions.



I also need to determine how much EBIT, Depreciation & Amortization, and Net Working Capital will change over the next couple of years. According to Finbox, Upstart is expected to grow their EBIT by an average of 71,6% over the next 5 years. Thus, I have decided to make the calculations using an EBIT in line with 2020 at 20 million and a yearly EBIT growth rate of 70%. I decided to go with a Depreciation & Amortization in line with 2020 at 2 million and a yearly growth of 70%, which is significantly lower than the average of 177,7% over the past 5 years. I have decided to use Net Working Capital from 2020 at 20 million and that it will increase will increase by 10% per year. I haven't found a smart way to share all my spreadsheet here, but once I did my calculations, I found that the intrinsic value of Upstart is $33.


I believe that Upstart is an interesting company with a good management. I believe their AI model gives them a competitive advantage as it is continuously being trained on new data. Thus, it isn't something that another company can easily replicate. Upstart has been hurt by the rapid increase in interest rates in 2022, as evidenced by their financial figures. If interest rates continue to rise, Upstart will experience more headwinds. Therefore, it is definitely something to be aware of if you decide to invest in Upstart. Regarding customer concentration, Upstart has mentioned their intention to reduce dependence on their largest customers. It is a positive indication that they have successfully secured multiple long-term funding agreements from other companies in 2023. I really don't like that Upstart has increased the number of loans on their balance sheet. I prefer Upstart to act as a loan seller and collect fees, rather than being a lender themselves. Hopefully, they will reduce these loans in the future. Upstart does have a huge addressable market, and if macroeconomics improve, Upstart could be an interesting investment. Personally, I would need to see how Upstart performs in 2023 before considering opening a position.


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