Chit Chat Stocks - Upstart (UPST) | Deep Dive

Episode Date: March 28, 2021

Upstart is a cloud-based artificial intelligence lending platform. The company connects consumers to banks that are willing to lend. Upstart is trying to revolutionize the old credit score system. Listen closely as Brad, Brett, and Ryan dive into what exactly Upstart does and how they may fair in the future. As always enjoy the show! Subscribe to 7 Investing with the code "CCM": https://7investing.com/subscribe/ Follow Brad and check out his work on Twitter: https://twitter.com/StockMarketNerd?s=20 Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to our Youtube Channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Email us: [e-mail] Timestamps Company Background | (2:26) Industry | (10:31) Management & Ownership | (12:31) Valuation | (15:35) Earnings | (17:36) Balance Sheet | (19:25) Our Analysis | (21:14) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now please enjoy this episode. Welcome in. This is the Sunday Deep Dive episode with Brad Freeman. He is joining us. I'm here with Ryan as always. I think you guys know that, but we're going to be talking upstart holdings.

Brad, we got to get an update. How is Michigan doing in the NCAA tournament? I know we're kind of getting down to it so yeah on to the sweet 16 um i do not think isaiah livers is going to play this weekend but he could always shock the world who knows all right well we'll be right we're florida state florida florida state yeah we're we're a gonzaga uh show here but our second um we'll be room for michigan a bit too i guess but it's a backup pick yeah so we're gonna have ryan introduce what upstart holding is before we do that we're gonna talk as always seven investing yeah how long until the new wrecks what oh gosh from here it would be only yeah when you're listening to this it'll be even less so you know this is the time to sign up if you've ever been

on the fence probably now you get ten dollars off if you use our code ccm at checkout that would be seven bucks if you do the monthly plan and then they give you a discount already on the yearly plan so you basically get a double discount if you want to sign up for a year really save money if you're trying to test out their service uh for a year because in reality if you just get one month it's not like you're getting the full breadth of the service uh but yeah sweet deal great performance they're crushing the s&p 500 uh so we need to find a way to rejuvenate our sales pitch i mean we've been talking about spice it up a little bit yeah i mean i'll just say it's a part of our research process we like to read what they write it's true and it's not like we

just blindly buy what they buy but you got to take it and be like all right that's a good idea And I'm going to research myself if I agree with everything they say. Inspiration. It can be inspiration. Yeah, for sure. But Ryan, you want to talk about Upstart Holdings? Yeah. So I've got their mission statement here.

It is to enable effortless credit based on true risk. And in quotes, I've got, we are a leading artificial intelligence lending platform. And so maybe we talk about this too much. but I'm beginning to question what AI means. It feels like any automated spreadsheet calculation is officially artificial intelligence. No, don't get me wrong. Upstart is, what they're doing is impressive.

Their numbers look good, yeah. But I think we need to temper what AI means. No, it just means one really, really big Excel spreadsheet. That's what I'm picturing. Just huge, just ginormous. I'm picturing all these like machine learning robots like stuff but it's probably just an automated switch anyway all right uh i know it might sound a little weird but it sounds like they actually what they're doing is working so their default

rates uh are lower than traditional lending and acceptance rates are higher um upstarts upstart approves 27 more borrowers with the 16 lower average apr which is basically their interest rate. And an internal study, which take that with a grain of salt, said that their system lowers loss rates by 75%. I guess the thing, the way to vet that is how many banking partners they get. Because in internal study, there could be some nuance to that that makes them look better. But if they're getting banking partners, then obviously their loss rates are lower. But there's essentially two parts to the platform. There's the front end, or what the partners and the customers are seeing. And then there's the backend. So I'll talk about the front end first.

Upstart connects banks and customers in kind of a unique way. So customers can come directly to upstart.com and they receive a $1,000 to $50,000 personal loan with APRs that range from 6.5% to 35% and banks will supply the capital. You can also go to a bank's website and use that as the top of the funnel, but it still gets, it's still powered by Upstart on the backend, if that makes sense. And it's basically the Upstart application, but just bank branded. But then on the backend Upstart's model, traditionally it's based on the FICO score. That's what credit worthiness was kind of determined by, which is in their opinion, an outdated model. And so what they use is at least a thousand variables, which is just columns on a spreadsheet essentially. And they use it to

target fee optimization, income fraud, identity fraud, default prediction, prepayment prediction. And 70% of this process right now is automated. So there's no need for documentation or a phone call. You just sign up and you can get granted these personal loans. But this is where it gets kind of interesting. So once you put in or you apply for this personal loan, then you get a bank partner that's willing to put up the front, the capital essentially. But the bank doesn't always have the capital to put up the full loan. I'm sure they do, but they might have sort of risk mandates required. So when that happens, the banks can access what is called the CRB conduit or the Cross River Bank conduit. This is basically an entity just designed to absorb the risk

or some of the risk. And it's responsible for 67% of the loan originations on the Upstart platform. And the way I understand the CRB network, and you guys can correct me if I'm wrong, is it's basically this network of institutional investors that are willing to fund these loans. So they'll get an institutional investor and they'll have something that says like, all right, this person is asking for $35,000 loan, 9% interest due in four years. Is that something you want to take. And the institutional investor will go, they get access to that through CRB. CRB will front it. They give the money to the bank and then the bank in coordination or collaboration with CRB fronts the money to the customer. I know that's a long-winded way of

saying it's basically diversifying risk across different entities. Are you describing a CDO? essentially it's not it's not a cdo uh but the deal with crb is set to end in 2023 but it can be renewed for another two years under the current terms uh upstart collects referral fees from its partner banks for each loan it originates which is basically i think it makes up 98 percent of upstart's revenue so for every um referral that they give uh or every customer they bring in borrower, the bank is offering them a fee. Essentially, it's essentially a commission. Yeah. I think I was looking at their S1. It would be less than 1% on the commission, but they also get the referral fees as well. I think it was like three to 400 bucks per loan.

So, I don't know. I really don't know how good that rate is, but yeah, they're getting some sort of 1% commission. But does that kind of make sense how the back end works? Yeah. They're basically the layer. And Brad, maybe you're thinking about it maybe in a different way. They're the layer between more and more borrowers and lenders. That's kind of, you know, that tech layer trying to replace the credit score. And they are, Brad, go ahead. Yeah, that makes sense. And the conduit thing, it sort of sounds like a clearinghouse to me just to ensure that

these loans are staying liquid and guaranteed. So, yeah, I think it was a good explanation. Okay. And on that front end, the customers, a lot of them go through upstart.com. But then if you go to the bank, the bank, it's kind of like Olo, which if you don't know what Olo is, they have an application that you can brand it to make it look like it's yours, but it's still powered by Upstart in this case. But I'll get into the history. They were founded in 2012 by three people. So Dave Gerard, Gerard maybe, I might be getting that wrong, Paul Gu and Anna Councilman.

So Dave's the CEO. He was the former president of Google Enterprise. And before that, he was a product manager at Apple. paul goo was a deal fellow which is like i don't know peter teal fellowship um and he actually has a really impressive background so i'm going to read this uh it says okay so he's the co-founder he's head of product and data science so it says paul leads the product and data science teams at upstart paul pioneered upstart statistical models to predict income and employment he has a background in quantitative finance and built his first algorithmic trading strategies on the interactive

brokers api at the age of 20 achieving a sharp of 2.03 i previously worked in risk analysis at de shaw group that's pretty good no i mean i joke yeah that's that's for that's where bezos went so obviously everyone there's the gold that's the golden uh the golden touch but i make i make fun of teal teal fellows because it's kind of a weird thing but if you get into that you're you're a genius and uh more on that he says during college paul led underwriting for two non-profit micro lenders in the u.s he has been recognized as one of the peter teal's 20 under 20 fellows forbes 30 under 30 and silicon valley's business journals 40 under 40 paul studied economics and computer science at yale um so yeah impressive impressive background i guess yeah but the other

founder went to google if he tells you i think paul goo might have come might have worked at google at a point as well but then anna councilman is sort of the customer facing side and she became Well, she came to Upstart, but before that, she ran the Gmail consumer operations. And they started lending originally by themselves, but early on, they realized it would obviously be better to partner with banks. And they went public in December of 2020. So they're brand new to the public markets, and they've had an impressive run. They have had a hot start.

Yeah. Brad, did you have anything else on there you might have? I mean, it's just crazy to hear their backgrounds. It's a really impressive team. Yeah. Again, we kid. They like to talk about how they worked at Google, but their track records are quite strong. And it seems like they got a good team over there.

But all hit the industry and landscape and competition. So they estimate from their S1 that from April 2019 to March 2020, now I think they did that because there's, you know, COVID screwed everything up. But there was $3.6 trillion in consumer loans originated during that time span. So that's about the annual consumer loans out there. Now, with their 1% tech rate, you can basically divide that by 100. And that's kind of what their revenue goal would be if you want to put a TAM on that. So the opportunity is not $3.6 trillion, but it's not small. But if they can just get 1%.

Just get 1% of the TAM, yes. Not really how you should think about it. But again, they're going after a large, large market. Competitors would be traditional credit bureaus. Think Experian, someone like that. people, you know, they're really competing with the FICO score because that's been the entrenched way that people get credit. And then the big banks could possibly be competitors too. I know they had a quote from their S1 outlying any risks that their business has. So they work with the,

you know, I think the big four banks, or maybe not all of them right now, but they said these four banks may attempt to build AI lending models over time once general market acceptance has been achieved so they're kind of saying look the smaller banks aren't going to be able to build what we have they probably won't but the big banks if they wanted to definitely could another competitor is probably sofi there's a lot of smaller ones square potentially square a little bit bank charter yeah i guess square and shopify now that you mentioned do the lending as well now that now that yeah i mean honestly this is a upstart as an upstart if they go into student loans is a bit of a threat to Nelnet. There's also Lending Club. They're a lot smaller than

there's person-to-person marketplaces. Again, a lot smaller. So, large market, but I don't know. They kind of have a unique value proposition right now because they came up with something new. We'll see if anyone starts trying to repeat what they did. But Brad, do you want to talk about management a little bit more? Yeah. So, Ryan kind of went over the executive team pretty thoroughly. So I'll go into ownership, institutional ownership, sitting at about thirty one point seven percent of the float. There's a very slow accumulation pattern taking place, which you would kind of hope to expect from a new IPO. And then just notable holders, the land of Dan Lowe, third point capital or third point ventures owns eighteen point two percent of the upstart float. He also has a board seat or third point has a board seat.

so it's so insider ownership is listed as virtually zero percent but i kind of think you can consider that 18.2 to be institutional ownership insider ownership based on the fact that they have board representation um but i believe we're yeah so there's it's listed at zero percent but but you i think we can consider it 18.2 so the founder ceo they he doesn't have any a large ownership stake or so so they can have they can have some options or warrants that haven't been exercised yet, but in terms of the pro forma share count float, they own about 0.3% of it. Wow. That's a lot smaller than I want to thought. Maybe they just wanted a lot of funding and they needed to get it. But it is important to note that they have pretty fat bonus packages

in terms of warrants and options. So that insider ownership, I'm sure it'll grow as they exercise and likely don't sell the entire package that they've been allotted. But as of right now, it's pretty low i wonder if the capital fronted for this was from someone else there seems were they the ones that kind of fronted all the capital you think uh some of it yeah yeah i would also worry a bit now it's just short-term worries it's really not something you should think about too hard but when the lock-up period hits third point's going to want to liquidate their stake because they got to pay back their lps that's going to be a lot of um maybe maybe maybe they're going to liquidate. I guess, yeah, you're not required to sell, but just traditionally the VCs

sell once the lockup period ends. We're not at that yet. So that's something to consider as well. Yeah. And I think also just based on the fact that the compensation packages are so heavily focused on derivatives and there's going to be a lot of, there's always a lot of insider selling from companies on the lockup expiring. And I think for a company like this, it's important to keep in mind that these executives have the vast majority of their net worth tied up to this company um they're still going to own a lot of it they're not as long as they're not just shipping off their entire stake like um like that uber founder did when he left the company or something like that uh i i i wouldn't pay too much attention to the insider selling that's probably coming in

the form of option exercises yeah it's not it's insider buying can be cool like to see But insider selling is usually just programmatic anyway. Yeah, and these were higher-ups at Google. They're not pressed for cash. They're not like – I don't think they're having any liquidity issues. Oh, who knows? Maybe they're spenders. Maybe not.

Maybe they're big spenders, but we don't want to get into that. I'll hit valuation. Market cap right now is about $9.3 billion. Ticker is UPST. However, for their first quarter guidance for fully diluted share count, Market cap is actually going to be closer to 11 billion. So again, there's going to be some share count headwinds. Make sure to look at that. Trailing price to sales is 40. So pretty, you know, you don't want to call it overvalued, but it's richly valued price to contribution profit. Now they don't give out gross margin. So I use this. I think that's the best or closest thing to gross margin that we could get, although it's probably including a little bit more expenses. that is about 88.5 again this isn't like a 90 gross margin business but it's still solid margins might be well gross maybe i think there's a difference between contribution there

is there is but they don't define gross and they had one line on their operating expenses that i thought could have been gross margin so i i'm not sure maybe over time gross margins could expand up super high but we'll see yeah they didn't put in gross profit but i mean when i think about it like what what's the cost of goods sold for them like cloud cloud computing fees i don't know i think it's the customer operations that they had on there but again i would look at contribution profit because that is similar maybe it can expand more but price to operating cash flow again it's high it's almost 300 but they're pretty close to break even no dividend um again expect share account headwinds and the share price is about 120 fun fact their ipo priced price was around

20 a share geez uh so it like doubled on its ipo day and now it's gone up 300 since so it is uh it's done phenomenally well yeah and uh investors it's also worth mentioning that there you see the trailing sales multiple of 40. i'm going to get into this in the earning but the forward guidance for sales is very different than the trailing sales. They're guiding for a strong growth, yeah. Right. So, in 2020, they had revenue of $233 million. That was up 42% year over year. They originated 40% more loans on the platform than they did in the prior year, which, unless there's some big pricing increase on the referral fees, expect those two to grow in tandem. And then

operating income was $11.8 million. Operating cash flow was $31.5 million. They've really been pouring a lot of money into the income statement because i don't know why not the a lot of it's on sales and marketing and i don't see that it feels like a naturally high margin business because there isn't it's not super capital intensive uh from what i'm thinking about right now as far as expenses go um but next year so they did 233 million in the last 12 months next year they expect 500 million in revenue. So they're jumping from 41% revenue growth to 102%, somewhere 110 maybe percent growth. And they expect a contribution margin of 41%. Weighted average shares outstanding rose about 4% over the last year, but it's going to look

very different next quarter coming off the IPO. But the earnings looked really good. And that's why when when you have a guidance it feels like they knew this guidance was coming i can't believe they priced the ipo at twenty dollars yeah i don't know whatever the bet i don't know it's crazy there's their finance department kind of screwed the pooch yeah investment backers came out very strong in this one bill girley bill girley is shaking his fist uh but twisting for the wind yeah yeah all right yeah uh brad you want to hit balance sheet and liquidity yeah uh the company has about 311 million in cash and restricted cash it's got about 177 million in total liabilities and it breaks that out to it doesn't call it debt but it calls it borrowings um so 62 million in

total borrowings um just to kind of dissect that a little bit it's got a 20.5 million uh dollar a fully drawn credit revolver. It's got another revolver worth up to $100 million that it's only drawn down $35 million of. It's paying a floating interest rate on that debt of LIBOR plus 3.35% to 4%. So really not anything ridiculous. That's pretty reasonable. Yeah, the balance sheet, I would call pristine, especially with the recent runoff in the share price and what the enterprise value looks like right now having 62 million in total debt i'm having 177 million in total liabilities it's really um they have a lot of flexibility there i think that's a strength for sure yeah they are good and they aren't fronting the capital they are the connector they're fronting

they only front two percent i was about to say so only two percent they originate so most if that grows over time you could probably expect uh some debt on the balance sheet to grow over time since they're lending that money as well. Yeah. And that kind of could be, you could argue that they could be a Trojan horse to the banks, you know, where they start out as just the connector and then over time slowly morph into the bank. But again, they don't have that advantage of, they don't have the assets on their balance sheet. They would have to take in a lot of debt. It improved their margins, but originating the loans is just adding another piece of risk there. Every FinTech company will become a bank.

Yeah, it's that joke that people made. I'm trying to become a bank, but that's only for people who watch Billions. Yeah, that's it for the first half. We're going to take a break, and we'll get to the second half of the show. Cox Panoramic Wi-Fi includes advanced security to help protect all your connected devices. You'll get real-time alerts. Oh, like this one, so you don't have to worry about malware. Or when your kid downloads a song from a shady link.

And now all your computer can play is... color where are you all blocked thanks to advanced security included with cox panoramic wi-fi advanced security must be enabled in the panoramic wi-fi app restrictions apply welcome back next up we have competitive advantages we'll kick things off with brad what do you got i would highlight just just the business model providing very asset-light scaling so with with their loans being not quite three quarters of the loans, but a very large chunk and close to three quarters of the loans being originated entirely autonomously, no human contact. I mean, there's a lot of optionality here to expand into different offerings, to expand with new banks and

do so without having just higher absorbent amounts of people like you see with traditional banks or traditional insurance companies um or other financial institutions so so i think there i do think that a competitive edge is is operating leverage kind of built into the model based on the fact that their artificial intelligence no matter how legitimate you want to think it is or isn't um it is providing them with the ability to more profitably expand that i think a legacy bank will yeah they don't why use a whole department where you can just have paul goo in his spreadsheet yes the it feels a bit if they can pull it off and scale like a visa or mastercard now that those are like the ultimate network effect operating leverage businesses but it feels

slightly similar to that i don't want to say they're ever going to be like that there may be flaws they may not have the competitive advantage but the the basic it's it's almost the reason i say that is because hubstart once this thing's going it basically has zero variable costs and that's why ryan was talking about how high margins how high their margins could be yeah uh potentially yeah and i'll get into my competitive advantage which is well i mean so there isn't when you think about the business they're just trying to make default rates as low as they possibly can and raise access to credit and so you're the only advantage you have is either the quality of lending or uh capital like having the capital

to lend or in this case being a low default rate connector um but i would say potentially being smaller helps so i guess if you think about the big banks like they can't really take as much risk uh and you don't have to go like if someone came up with the kind of model uh that paul goo came up with and they're on the bottom trading floor at some big bank or whatever like they have to go through a bunch of bureaucratic bullshit in order to get get that to the top or to get that implemented you don't have to go through that at upstart and that's kind of i mean that is i mean we see it in all industries when when i hate to use i hate to use the art quote but uh what is it creative innovative destruction or whatever disruption no it's

innovator's dilemma here where it's classic whatever that clay christiansen thing is um that everyone talks about where the big banks since them they have so much lending that they do and it's not just the big banks it's other large financial institutions they have it under a certain model and if they want to change that they got to change so many loans and how they originate that that's a bigger risk than upstart coming in here and doing it like this um it's hard to describe uh just audibly what the you know how how that gives them some sort of competitive positioning where you know they're not risking as much of their reputation because they're all doing it this way you know upstart is where the big banks they'd have to change so much um and

that's kind of why they're partnering with upstart focus like uh this is their main focus like it might not be for the big banks yeah well i think a lot of i think they're very focused on their default rates yeah but they haven't i mean they haven't implemented this all the variables that maybe i i that's what that's what upstarts argues and that's the big i guess we'll get into low lights it's kind of that is the question of competitive advantages we don't really know what's going into the the decision behind a behind lending at the big banks yeah it's kind of yes If I go score plus a few. Yeah, and I think we'll probably discuss that later,

but I'll hit mine before we move on. The data advantage, you know, they argue this a lot. I'm not sure I believe it is rock solid, but I think it's more plausible than like DoorDash claiming they have an AI advantage. When I see that in their flywheel, I always laugh. Prove me wrong, DoorDash, but they've accumulated, you know, Upstart's accumulated a lot of data.

They have a decade of training their model uh and their numbers look great the default rate looks a lot better they're giving out more loans to different people they're kind of disrupting the credit score i think uh and at some levels you know competitors could you know invest and copy this but not you know i'm not sure whether it's either they either have proprietary data or it's just tech expertise and that's an advantage either way but i'm not sure like could someone just invest a lot of money and copy this maybe and is it all branding? I don't know,

but that could be a competitive advantage for them. All right. Future growth opportunities, Brad. Yeah, the Prodigy purchase that they made or they announced in the last quarter provides some really interesting

opportunities to expand into auto loans. So I guess just the last or the proof of concept has come from the last couple of years of these lower default rates and lower APRs. And now they're kind of leveraging that proof of concept

into other large areas of loan origination. They're saying this could add another $92 billion in potential loans. I wouldn't consider that a total addressable market because, like Brett said, it's not $1 to $1 for every dollar. It's not $1 to $1 for every dollar in loan they're originating, but it is pretty exciting in terms of revenue optionality on top of the 62% loan origination CAGR they've got going for the last several years. yeah the the auto market if they get momentum there uh it seems like that they could do really

well seems like i i don't know yeah yeah and you kind of stole the and there was only that was the one i was going to use but i guess you could say why doesn't this apply to mortgages why doesn't this apply to student loans yeah do you want to say what prodigy is brad i don't know if you looked at what that was it's a little confusing but yeah so uh and i and i could be wrong but this is my understanding of it it seemed like it's very similar to upstart but just focused on autos pretty pretty strictly um so yeah that's my understanding if you want to add anything i think it also was supposed to maybe like a shopify niche where it helped people get like the the front end of their websites i honestly was confused looking at prodigy uh and they said it

wasn't material to revenue so i kind of ignored it but it's an interesting development uh that Yeah, it kind of seemed like they were. And I'm speculating here just based on listening to them talk a little bit. And I don't know a ton about the company or the management team. But based on what I know, it seems like they're going to keep this very private label approach for their partners. And I don't think Prodigy is going to change that. I just think it was their avenue into auto loans more capital, more efficiently from a capital perspective than doing it themselves. right okay ryan yeah like i said it just different uh lending areas so i guess mortgages uh student loans if you really really have that data advantage why can't it apply to other areas you know yeah you would think that's correct and they have to weigh whether they want to move quickly into these other spots uh to capture that market or uh move slower so they do it more properly because there's that threat of upstarts coming in and competing with them.

But I'll add my future growth opportunity. It is the Upstart Referral Network. They actually announced this yesterday. So not sure how big of a deal it is. I think they had it in a beta program, but now it's going to everyone. And it might be why the stock was up 6%. I don't know why it was up like 6%

and it might not be anymore, but it doesn't look crazy complicated, but it's a program that connects borrowers to lenders they want. So ones that either the borrowers want or customers that the lenders want and it has the potential to further entrench upstart as the layer between financial institutions and lenders if this can provide value without having any experience i'm not really sure what value it is so maybe certain banks have certain borrowers they like

certain borrowers have a preference to not go to other places they want to hit the local credit union or something like that uh so it's not going to be a big revenue driver but i think it just helps provide value to their customers. Yeah. I mean, think if you're an institutional investor or, uh, in that sort of CRB network, it makes sense. Like if you can get a really low default rate on an 8%, uh, consumer loan over the next three years, you know, when do you take it? Yeah, no, I mean, yeah. And it all comes back to, are their default rates good? Are they actually, uh you know uh what are they evaluating these people correctly yeah all right highlights on low lights brad uh what do you think so mine are very connected i'll start with the low light um

the competitive landscape is absurdly absurdly intimidating um every single big bank uh i mean the balance sheets are extremely healthy you've got you've got cash app you've got paypal using Venmo and now saying that they're going to expand that product offering significantly and it has a massive user base. But because of that, and this kind of relates to my highlight, I like the upstart approach. The private label, we're not going to try and displace you. We are going to try and facilitate business for you in a more profitable way. I think that's a really powerful model for a startup for an upstart like like this company is to kind of stake their claim in the industry without creating unwanted attention and without creating enemies that are going to want

to want to displace them that and i do own sofi and that's what i like so much about sofi's product um the private or just building companies um their own fintech apps and i think upstart's similar approach is really appealing in this space. So is SoFi a competitor to Upstart? I think you know it better. I couldn't really identify. Yeah, so SoFi, they do have some product overlap. Upstart is more focused on loans. And I don't know if they're going to really ever venture into equity trading or crypto trading or anything like that. But they do have product overlap. So if Upstart wanted to venture into student loans, and they would have a lot more product overlap.

But I think the biggest, I guess, yeah, the biggest commonality between these companies is their private label API builder for enabling other legacy companies to compete more effectively without having to do it themselves. Yeah, it comes down to the question that, okay, could Bank of America, PayPal, or Venmo,

and then Square or Cash App, is it more valuable for them or can they even build their own upstart competitor or is it better to just make them the, whatever, the layer in between them and their customers? And I think that's the ultimate question for this company. Yeah. I'll get into my highlights then. It's management is definitely a highlight.

They pass the test, basically everything. Like, go watch that video. They have it up on their IR page. And you can usually just tell early on when you kind of trust management. And they gave me the vibe that they're trustworthy. He also had good comments on SPACs. Someone asked him why he didn't go public via SPAC. He said it's like playing an entire video game, getting to the boss level, and then handing the controller to someone else.

I thought that was interesting. um i also think consumer lending uh is still sort of young i think that's a lending market that has room to grow as well um you're talking about the disruption of it because it's yeah i mean the market itself isn't young but it's getting sort of democratized in that access to capital is easier now for borrowers um but then low lights for me is whenever there's like these risk i said risk absorption funnels but where it's like entities behind entities taking the risk i always think of cdos and i always think there's room in there for someone to feel like there isn't as much risk as there truly is yeah um but i think they'd be able to snuff that out

and i'm kind of grasping for low lights at that point honestly the only potential low light is like why can't someone do this in house um yeah that's mine and i guess maybe there's margin of safety that they could be acquired uh this seems like a logical acquisition for a really big bank but yes yeah um i wouldn't i wouldn't invest on that premise yeah agreed agreed all right my highlights high margin model um they're taking minimal credit risk themselves now if their technology is making ends up not working for whatever reason they screw it up and 70 of their loans are automated so there could be a lot of screw-ups before people realize it and then the banks start losing money because of them they would i believe be very upset at upstart

but the industry seems like it needs disrupting the credit score uh you know the credit score whatever you think of it it feels like it needs modernizing i don't know uh i think the there's a win-win-win scenario here where i mean that the customer's winning where they're getting better loans at better rates the banks are winning because they're getting less defaults and upstart is winning because they're skimming one percent off the top uh i think there's a potential to build a mode here through high switching costs uh and maybe economies of scale i'm still hesitant on the the data economies of scale if you want to argue that but i think the switching costs probably are high low lights i hate ai black boxes and i say quote air quotes ai black boxes

because one it makes it so i can't understand it uh how are they able to acquire this data and why can't anyone else acquire it that is it the way they're manipulating it because if so maybe i don't know is it like is there a key person is it goo that you know if they lose that feels like the biggest competitive advantage of the whole business is goo i know but eventually he's going to eventually feels he can't rely on some employees to just carry you maybe he can but as an investor it feels a bit risky and i don't know why he'll fella i guess don't doubt the teal fellows uh i think in the short run stimulus might hurt them people might not need as much to borrow um and the need for constant improvements it feels like an industry sort of

like cyber security where basically everyone's just going to compete and compete and compete and start building better models means r&d might have to stay high means they might have to lower their rates that's just kind of some of the risks i've been thinking of i don't know i said a lot of things maybe you guys have any any thoughts or disagree on anything there they look there's a there is a ton to like about the business right now there's just a little bit of uncertainty around and correctly i think they should be sort of discreet about what they're if i mean if this ai really is their advantage like you don't want to just give it away but i always have a hard time throwing money at an algorithm without knowing why it's like advantaged versus competitors it's

like if there's the coca-cola secret formula but no one could taste coke you know i don't know brad any any thoughts before we hit the final question i think the them maintaining that that that um default rate advantage and the apr advantage is going to be how how they prove to the world that this is real. And I think as long as that is able to be a noticeable edge for them, I think they'll be able to compete effectively. All right. Well, more or less interested, we'll start as always with Brad. I got to go more interested. Anytime I see a company post the kind of quarter that this organization posted, the kind of revenue beat and the guidance rates that they gave, um it was it was pretty incredible pretty eye-opening i'm like i'm glad we we dove into

this one and i think it is it is going pretty close to the top of my watch list after this episode all right that's exciting right yeah i'm for sure more interested as well this feels like there's just there's so much to love about the business and obviously 11 billion dollar market cap right now you're asking a lot yeah fully diluted um yeah and the the thing is it seems like a really high price it could be the right price there is a little maybe i'm wrong in forecasting their growth from here um because and that's my only hesitation is it's hard to forecast that growth you don't know what competitors look like i don't know the space as well it's not a product where it's not like autodesk where you know you're going to get a minimal churn on a

really important subscription something like that you have to you have to know the landscape really well so i'd have to learn a lot more behind that but yeah at the right price this is a business that i like yeah i agree definitely i'm sorry no go ahead go ahead one second um sorry to interrupt but uh ryan i think ryan brings up a really good point for anyone wanting to start a position i I think it makes a ton of sense to kind of tiptoe into this one and use the starter position approach like we talk about sometimes just to give yourself the freedom and the optionality to kind of, yeah, to be opportunistic if this $11 billion hefty price tag gets cut by any portion. So, yeah, I think I should have said that when I said more interested. If I were to buy a position here, it would be done very, very slowly and over a long period of time. Yeah, you got to think here, okay, if I'm buying enough shares, how comfortable would I be if this gets cut by 80%? Yeah, that's kind of what with this valuation is what you got to look at.

And pay close attention to whether or not they fulfill the guidance they issued because it was really, really, it seems like aggressive guidance from the outside looking in. But if they can generate $500 million in revenue for 2021, that's really impressive. Yep, I agree. I'm more interested in the business. I'm concerned on valuation. The thing I think about is, okay, if revenue slows, the business is still fine, but the market's going to reprice it so much lower. there's a lot there's not much of a floor here and i would be uncomfortable without knowing it's not a predictable enough business for me to want to pay a premium multiple and that's just kind of where i'm out on it yeah yeah but i know we sound like a broken record when we say like oh that's not predictable yeah but this is you know it is a young company and that could be as advantageous as it could hurt them you know if someone's able to copycat this um and those variables or the columns that they have in their spreadsheet are repeatable then maybe uh

maybe revenue growth won't double year over year for in perpetuity in perpetuity i would say that is not going to happen but that is the key it's a little bit uh it's it doesn't make logical sense at first but in companies that have such profitable business models better have some sort of defensibility because if a business is uber profitable then it's going to attract smart competitors maybe maybe that's why they didn't put gross margins on there but like not our gross margins are 100 but we don't want to tell you yeah i mean it's the whole capitalism's destructive like you know if you have a business model that people really want to be a part of you're going to attract capital towards it and you don't want you'd rather be in a business

that doesn't attract smart future teal fellows or stanford grads or whatever you know this is an industry that attracts people like that the smartest people to go after this and that's a lot tougher than a business like Sherwin-Williams, like paint. No one from Silicon Valley is like, let's disrupt the paint industry. But yeah, Braddy, anything else before we? No, I think it's an exciting company. It's an expensive company. And that, I mean, that always raises the stakes for them delivering on this guidance and for them continuing to be a very, very hyper growth organization. And like you two are both saying, the company can remain extremely healthy and growth can slow and it can still get a large haircut with nothing being

wrong with the underlying business so just good to keep in mind and that is you know if you've listened to the show for a long time you're like oh god you guys every single time it's oh great business bad valuation great that's how it always works listen i can't think of a really really good business that never received a haircut where there was a better entry point you just got to be prepared for that entry point. Patience. Yeah. Patience, patience, patience, starter positions. But overall, what I'd be, I wouldn't be surprised if this is the next, you know, Visa or MasterCard. I also wouldn't be surprised if it's not. Big words. Those are big words, but it sounds like if they're legit, it sounds like there could be some of that there. Again,

I don't think that's a high likelihood, but you know, I wouldn't, I wouldn't be surprised if they don't make it to something like that, but it seems like some of those factors that made those one of the best businesses of all time it could be here all right we could be eating our words in a few what's the uh what's the stock for next week yeah your turn i'm picking and it is going to be danaher i forget who recommended it uh but it's a name that gets thrown out a lot danaher danaher uh they have apparently one of the best management teams of all time uh i i don't remember who recommended it so i'm sorry i'm forgetting your name but we are going to be looking at them so yeah what do they do i don't know something about pumps american yeah so this will be fun

yeah we'll all go into the blank slate i got it company designs manufacturers and markets professional medical industrial and commercial products and services i guess that's not helpful there we go professional services all right i think that's gonna do it yep all right thanks brad for coming on thank you all for listening remember we are not financial advisors anything we say on the show is not formal advice or recommendation. Ryan and I are general partners at Arch Capital. Clients at Arch Capital may hold securities discussed on this podcast. Again, thank you all for listening. This was a fun one. We'll see you next week.