upstart (NASDAQ:UPST) recently reported excellent fourth quarter 21 results, showing strong momentum in its business, continued expansion into new areas and excellent execution of strategy by the management team. There are several key positive updates for Upstart in its fourth quarter ’21 results that I think are important to highlight to Upstart’s investors. I reiterate my price target of $238, which is a 55% increase from current levels.

investment work

I wrote a previous article about Upstart when I started the company, which can be found here. This is a summary of Upstart’s investment thesis, and these points still apply today, and there is additional evidence that the investment thesis is having an impact, as presented in the following sections:

1. Upstart’s superior artificial intelligence (AI) model brings real benefits to both consumers and its banking partners, and this AI competitive advantage will only improve and expand over time.
2. Capital Light model as an intermediary between consumers and its banking partners.
3. Upstart expands its Total Addressable Market (TAM) into the massive auto lending market and demonstrates a major market opportunity.
4. The margins and economics of Upstart’s units have improved and will likely continue that trend as automation and scale increases.

Rise to become the industry leader in AI lending

As of 4Q21, Upstart has 42 banking partners compared to the 31 banking partners it had in 3Q21. Additionally, it has 7 lenders that do not require a minimum FICO score, so it relies entirely on Upstart’s AI models. This was also the first quarter that Upstart achieved more than $4 billion in lending transactions on its platform. This is up from $3bn in lending transactions in 3Q21 and $1bn in lending transactions in 4Q20 a year ago. In my view, the ability to grow loan volume nearly 30% quarter over quarter and loan volume to four times last year demonstrates the rapid growth of Upstart’s platform and the strong value proposition it offers to customers.

Additionally, Upstart is currently a profitable, high-growth company with net income of $59 million in Q4’21, a 102% increase sequentially. With the profitability it is experiencing in its successful unsecured personal lending segment, it is positioned to invest significantly for the future by doubling its product development and machine learning headcount in 2021.

Additionally, I believe Upstart’s ability to grow rapidly and profitably speaks volumes for the competitive advantage and operational leverage Upstart has in a highly competitive industry. Therefore, I think Upstart is poised to become an industry leader in AI lending as it offers a tremendous value proposition to both its banking partners and its customers.

Strong implementation in the expansion of TAM

Management said that after completing most of the groundwork for the auto loan business in 2021, it is now increasingly confident that Upstart can excel in the auto loan business. As shown below, Upstart is currently in the personal lending space with a TAM of $96 billion. It’s moving more aggressively into auto loans in 2022, which have a TAM of $727 billion, almost 7x more than unsecured personal loans. Upstart CEO Dave Girouard repeatedly mentioned on the conference call that his goal is for Upstart to be a multi-product company and he hopes to be active in the small business and mortgage markets by 2022 and 2023, respectively be.

I think it’s really positive that the company has such ambitious growth plans while still being led by its founder and CEO, Dave Girouard.

In the auto loan space, Upstart’s management is optimistic that it will pick up momentum, having already forecast $1.5 billion in auto loan financing volume in fiscal 2022. Additionally, the team has made great strides as they have managed to triple the retailer footprint and the auto-refi funnel is now similar to that of 2019 for unsecured personal loans. Finally, 10 banking partners have signed up for auto lending on Upstart’s platform.

With the traction they are seeing in auto lending, management now has the confidence to unleash the AI ​​model and technological improvements to auto lending that will make it as successful as personal lending in the future.

Additionally, having found success in personal lending and also gaining a foothold in auto loans, I believe management now has the playbook to expand into different markets and build on its TAM expansion with similar strategies with unique optimizations for different segments .

Reinvest in new businesses

With Upstart’s advances in auto loans in 2021, most of it was funded entirely from its own balance sheet. This is currently the incubation period of its auto loan journey, ensuring its AI models work the same as they do in the unsecured personal loan segment. Once it gains confidence that the AI ​​models are doing their job and predicting risks well, and if there is sufficient volume in auto loans, this can then be transferred to institutional investors and banking partners, as the business model in unsecured personal lending envisages.

As a result, it is important to note that auto loans are currently at a rather suboptimal level compared to unsecured personal loans and this could squeeze margins in the coming year. That should improve in 2023, however, as auto loans transition to a similar fee model to unsecured personal lending in the next quarter and achieve similar or even greater size gains than current personal lending.

This explains the decline in the contribution margin from 50% in 2021 to 46% in the first quarter of 22 and 45% for the full year 2022.

In addition, Upstart continues to invest in expanding its technical workforce, which has doubled in the last year. In my opinion, this is one of the best investments Upstart can make, as the success of its business depends on its AI model, which in turn depends on it hiring the best computer scientists, data scientists, machine learning engineers, and product managers out there. I think Upstart has the right focus on people, which will add a lot to the company.

Clarification of misunderstandings about late payment

There was an article on a forum and by a Wedbush analyst that Upstart was seeing an increase in delinquency, although there wasn’t much information or context to back it up. This created some uncertainty about the accuracy of the Upstart model as it began to move into different segments of unsecured lending, ranging from prime to sub-prime customers.

CFO Anjay explained that this was due to a change in his credit mix as the credit universe expands. In this context, the absolute numbers of default rates increased, although these were correctly predicted and priced in by Upstart’s models. This is a unique feature of Upstart as the job of the AI ​​model is to price risk as accurately as possible and if that risk is priced correctly, even if we see rising defaults, these have been priced into the loan and are no problem with the model .

Viewed in this context, increasing absolute failure rates, correctly predicted and priced, is not a bug but is actually a feature of our platform and a trend that we expect to continue as we successfully advance our core business. As long as the company is forecasting the loans correctly and pricing the loans accordingly, that’s a good thing for Upstart.

As such, Upstart has no significant adverse impact on its credit volume or unit economy from these escalating defaults.

Start of share buyback program

Upstart announced a $400 million stock repurchase program during its Q4 ’21 conference call. This decision may come as a surprise to many investors, as it did to me listening to the conference call. This is because Upstart is still a relatively young company and in high growth mode, which means there should be plenty of opportunities for Upstart to reinvest in itself and consider acquisitions as well.

However, CFO Sanjay was quick to explain the thought process going into the share buyback program on the earnings call. It’s not actually a capital allocation decision, as Upstart’s management still sees plenty of growth opportunities to invest in for the future. Actually, the main reason for the stock buyback program was to be able to buy back Upstart’s stock when it was deemed undervalued by management. This decision was supported by the volatility in equity markets that we have experienced year to date and Upstart is in a unique position of profitability and therefore the ability to leverage this to the benefit of shareholders.

In my view, management is making the right move in initiating a share buyback program as it maximizes the benefits of its profitability to capitalize on the volatility in the market, and Upstart in particular, over the past few months. Management can better signal the market when it thinks its stock is undervalued and can then turn sentiment around to benefit shareholders.

Conclusion

I’m gaining more confidence in Upstart as it continues to demonstrate very strongly its value proposition to consumers and banking partners and highlights its unique competitive advantage in a competitive industry. This puts Upstart in a good position to enter new markets and new TAMs, establishing itself as an industry leader in AI lending across product lines. Additionally, Upstart’s continued investments in its business and focus on growth, revenue and profits make it a highly investable company. I’m sticking with my price target of $238, which is a 55% increase from current levels.