Upstart Holdings (NASDAQ:UPST), a lending marketplace driven by artificial intelligence (AI), witnessed a remarkable surge in its stock value during the initial seven months of 2023. Despite the ongoing economic volatility, the company efficiently streamlined its operations, curbed fixed costs, and secured substantial long-term funding agreements, contributing to an increase in investor confidence and stock price.
However, Upstart’s positive trajectory took a downturn in August, resulting in a decline of approximately 52% in its stock value. Factors such as lower-than-anticipated Q3 guidance, challenges in the loan funding market, and profit-taking following the stock’s substantial rally have collectively exerted downward pressure on its shares.
In light of this significant pullback, it is prudent to assess whether investing in UPST at its current valuation is a viable option. To make an informed decision, let’s delve into Upstart’s business model and revenue generation strategies.
Understanding Upstart’s Business Model
Upstart functions as a marketplace that offers lending partners, including traditional banks, a proprietary AI-driven loan origination platform. Lending partners have the flexibility to retain loans aligning with their risk profiles and business objectives. Additionally, loans not retained by lending partners are sold to institutional investors. Moreover, Upstart retains a portion of loans that aren’t held by lending partners or sold to institutional investors.
As of June 30, originating lending partners retained 38% of loans funded through the platform. Institutional investors acquired 50% of loans through loan funding programs, while Upstart’s balance sheet financed the remaining 12%.
Upstart generates revenue through partner fees for utilizing its platform. The company also earns from borrower referral services offered to its lending partners. Furthermore, Upstart charges a servicing fee to the loan holder based on the outstanding principal over the loan’s lifespan and garners interest income from loans on its balance sheet.
Factors Favoring Upstart’s Positive Outlook
The latest earnings report highlights Upstart’s Q2 fee revenues at $144 million, reflecting sequential improvement. Notably, loan transaction volume across its platform surged by 30% quarter-over-quarter. The contribution margin stood at 67%, marking a 20% year-over-year increase. The company’s investments in loan processing automation and fraud detection models resulted in cost savings during onboarding and enhanced marketing cost efficiency.
Impressively, Upstart inked multiple long-term funding agreements worth approximately $2 billion, bolstering its business’s resilience and predictability in the coming months. The company’s initiatives to optimize fixed costs, expand its reach, and introduce new products contribute positively to its growth prospects.
Points of Caution
Despite potential improvements in Upstart’s top-line revenue and contribution margin, the lending market confronts challenges as financial institutions prioritize deposits and internal liquidity. While capital markets are gradually stabilizing, funding constraints persist, affecting originations, transaction volumes, and overall growth.
In the upcoming quarter, Upstart’s net interest income might decline due to higher discount rates and increased charge-offs.
Conclusion: Upstart Stock- Buy, Hold, or Sell?
Considering the hurdles facing UPST, a majority of analysts covering the stock maintain a bearish stance. Among the 13 analysts, seven recommend a “Strong Sell,” one advises a “Moderate Sell,” four suggest a “Hold,” and one offers a “Strong Buy” rating.
Furthermore, the average price target for UPST stands at $23.43, indicating an expected downside of approximately 28% from its present levels.
While Upstart is poised for improvement in key metrics due to an improved operational environment and cost-cutting measures, caution is warranted. The commitment from long-term capital agreements is encouraging. However, given UPST’s rebound in 2023, positive aspects seem to be already factored into the stock’s value. The uncertain macroeconomic landscape and tight funding market could exert pressure on Upstart, limiting its upside potential, and making it a stock to avoid at this juncture.
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Author Faith Yakubu 
