Bank of America, Jefferies Downgrade Upstart

Upstart Holdings, Inc. (UPST) is one of the hottest stocks of 2021, returning about 685% year-to-date. This is even after a recent sell-off that saw it retreat from a 52-week high of $400, to $322 at time of writing. The skyrocketing stock price has taken Upstart to a ~$25 billion market cap.

However, this outperformance is starting to prompt some members of the investment community to question whether Upstart is priced for perfection. I am neutral on Upstart. (See Analysts’ Top Stocks on TipRanks)

What is Upstart? 

Upstart debuted as a public company in December 2020, pricing its IPO at the low end of its $20-$22 range for a market cap of $1.45 billion. It closed the day with an almost 50% gain at $29.47 and it was off to the races from that point on.

The California-based fintech states that its “mission is to enable effortless credit based on true risk,” and describes itself as “a leading artificial intelligence (AI) lending platform designed to improve access to affordable credit while reducing the risk and costs of lending for our bank partners.”

Upstart says that it is solving problems for both banks and consumers because its “platform uses sophisticated machine learning models to more accurately identify risk and approve more applicants than traditional, credit-score based lending models.”

This AI-enabled model helps to combine higher approval rates with lower loss rates, which is a desirable mix for the banks that Upstart works with. As Upstart does not compete with banks, it partners with them and enables them to originate more loans using its platform.    

CEO Dave Girouard left Google in 2012 with a mission of using modern technology and data science to expand access to affordable credit. With a management team that has an impressive background, great growth numbers thus far, and operating in a business that combines two of the hottest themes of the market in 2021, fintech and artificial intelligence, it is no wonder that Upstart has been a hit as a public company.

It has been smooth sailing for the stock over the past 10 months, but some analysts are beginning to ponder whether the company’s valuation has become too rich.

Analyst Downgrades 

One such analyst who feels that Upstart’s valuation may have gotten ahead of itself is Bank of America’s Nat Schindler, who recently downgraded Upstart to Underperform with a price target of $300 on the stock.

In the research note, Schindler explains that he is still constructive on the stock and the long-term thesis is intact, but the valuation has become overextended.

Schindler wrote: “Current market price of $390 per share implies a forward sales multiple of 26X ‘23E sales, which is at a very large premium vs. peers. While we continue to believe in the longer-term upside potential and strong growth outlook of Upstart, we think near term upside has been priced in given current valuation.”  

Jefferies analyst, John Hecht, also downgraded Upstart from Buy to Hold several days after Bank of America, on October 26th. He echoed the same concerns about valuation, writing: “We believe the current share value reflects strong and successful market penetration in the personal and auto loan categories over the next few years.”

Bank of America also stated why it could be wrong about its downgrade. The note explains that if Upstart is able to successfully enter the auto lending space and take material share within it, this would be a huge total addressable market for Upstart.

Furthermore, success in this market would raise the possibility that Upstart’s AI-based system would establish the company as a  ‘Credit Model as a Service’ that could gain success in a wide variety of industries, including the mortgage market. 

While Bank of America acknowledges that auto lending is a big opportunity for Upstart, it also points out that there are higher barriers to entry as compared to the personal loans space.

There is more well-established and well-heeled competition in this space than Upstart currently faces. Jefferies agreed with this line of thought, stating that “While we believe UPST’s business model can lend itself to capturing a larger market share than traditional auto lenders, there is the difficulty of entering a new market from scratch.”  

Wall Street’s Take

Turning to Wall Street, Upstart has Moderate Buy consensus rating, based on three Buy ratings, two Hold ratings, and one Sell rating. The average Upstart price target of $325 implies about 1.1% upside from current levels. This is slightly higher than Bank of America’s new $300 price target.

Takeaway

Banks in the U.S. issue over $3 trillion in credit annually, so there is still ample runway ahead of Upstart, even after its impressive performance. With its great results thus far, the long-term investment thesis is intact, as the Bank of America note states.

However, the recent pullback of about 20% from its all-time high, combined with this downgrade based on valuation, means that there will probably be more volatility ahead. This is opposed to the relatively straight line up investors have enjoyed over the past 10 months.

At this point in time, I am neutral on shares of Upstart given the valuation and looming questions. I think it is a great business model with plenty of long-term growth ahead, but one that seems like it is running into some turbulence in the short term. If shares pull back further from here I would revisit this conclusion and possibly rerate the stock as a Buy.

Disclosure: At the time of publication, Michael Byrne did not own shares of Upstart

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