Transforming Finance: Lending Club's IPO

Aug. 4.14 | About: LendingClub Corporation (LC)


Lending Club has had consistent, strong growth in the number of loans issued since 2009.

Lending Club holds a competitive advantage over traditional lending institutions.

While I don't generally recommend initial public offerings, Lending Club doesn't seem to be going public as a way to raise money.

Context: Think about what do Borders, Blockbuster, and the Sun Times have in common. They are all information based businesses that have been displaced by the internet. Looking back at the story of the US economy during the turn of the century and most people will agree that the dominant trend will be the internet disrupting large, information based products like these.

As Lending Club's CEO, Renaud Leplanche, states in a Lending Memo interview:

There have been many examples of this happening before, whether it was when Borders could not react fast enough to Amazon or when Blockbuster could not react fast enough to Netflix and eventually went bankrupt. There have also been many attempts at companies trying to survive by spinning out low-cost operations... Despite their best efforts they keep the same culture.

The financial industry could very well be the next one up for a ride. Every interaction of the financial industry is currently being re-evaluated, from transactions with Paypal, to fundraising using Kickstarter and even currency itself using Bit-coin. The site you are on Seeking Alpha is itself is a perfect example of a crowd-sourcing financial advice, which simply couldn't have happened a decade ago. While I'm not totally convinced that all these 'innovations' will turn out to be genuine improvements, there is one that merits your attention. Partly because of its upcoming IPO, you should be thinking about Lending Club.

Lending Club is the current leader in the emerging industry of Peer to Peer Lending. This phenomena first emerged in the UK as a way to facilitate loans being made from one person to their peer, using the internet.

Peer to Peer Lending how it works

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Peer to peer lending is the natural development of applying the internet to finance. This is the emergence of an industry not limited to one or two companies which suggests to me that this is more than just a short term fad. Along with peer to peer lending, micro-finance organizations for charity like Zidisha have popped up using the internet to give individuals access to funding otherwise un-available in developing world. Out of this developing field two major players in the U.S. that have shown staying power are Prosper and Lending Club. In 2008 during the financial crisis, the SEC required these companies to register their loans as traded securities, and offer re-sale on a secondary market which ended up suspending new loans from being issued and forced the UK based company Zopa out of the US market.

After adjusting to the new regulations, both companies were able to resume issuing loans near the end of the financial crisis of 2008-2009 with Lending Club taking the lead as the largest, best run Peer to Peer Lender in the US. Lending Club had originally been formed by Renaud Laplanche in 2007 partly "after he became irked by the massive disparity between the 18% interest rate on his credit card bill, and the 1% savings rate at his bank." Leplanche then collaborated with Oracle co-worker Soulaiman Htite in 2006 and initially tried to issue loans through Facebook but later realized they would have to build their own platform.

Potential- Since then Lending Club has continued to issue more loans, gain financial strength as well as recruit prominent financial industry leaders to their Board. John Mack former CEO of Morgan Stanley and Lawrence Summers former chief economist at the World Bank, Simon Williams former Citigroup head of Global Consumer Risk are the more notable recruits.

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Probably strongest indicator of their success in the continued increase in number of loans facilitated which more than doubled from $600 million in 2013 to $2 billion in 2014 and they very well may keep on growing. CEO LePlanche says:

I feel that our competitive advantage compared to traditional banks is really long lasting because, again, it is grounded in technology and cost, not something they can react to. The amount of debt that American families are carrying is really huge, so the opportunity to make an impact and help people is really tremendous.

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2013 SEC Report; p.58

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Risk: Part of Lending Club's strength has been their conservative approach to the loans they issue by requiring a high FICO and other other metrics that make returns consistent and reliable. There will be a challenge to continue to maintain this high quality without increasing fees as they expand into other states and into larger business loans. The increasing volume of loans will likely add traffic to their website which will need to improve and adapt to remain easy to use yet able to handle new loan types and increased traffic. As the company gains greater visibility they will have to manage security and legal risks similar to large online banks.

As an investment, Lending Club has enormous promise and is growing at an surprisingly consistent pace, but it should also be remembered that it qualifies as a high risk start-up that has only 1 year of producing more money than it is taking in. This is an industry that 10 years ago wasn't even an idea and it has never paid a dividend and is untried in its long term performance. With revenue of about $100 million and net income for the first time becoming positive around $7 million in 2013 this company has a long way to go before living up to the $1.55 billion dollar valuation heaped on it via the $125 million investment by Google, $15 million from Kleiner Perkins and others. For the long term investor it will likely take years and overcoming large setbacks for Lending Club to be profitable for its investors. It is by no means a sure bet during a bull market in an economy artificially propped up by a massive federal stimulus.

Initial Public Offering's in general are not usually a great way to find profit, as Seth Klarman explains in "Margin of Safety":

Gone are the days when a new issue was a collaborative effort in which a business that was long on prospects but short on capital could meet investors with capital in hand but few good outlets. Today the IPO is where hopes and dreams are capitalized at high multiples.

Or as Warren Buffett has stated in different ways on multiple occasions:

It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors).

His own history speaks even louder as he grew his wealth without having to purchase an IPO. I also I remember a quote from his mentor Ben Graham (I think) where he quips that what IPO really stands for is "Insiders Play Only."

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Despite the typical IPO drawbacks, I think that for every 100 or so overvalued new issues there may a few good ones hidden in the mix if you have the if you have the time, acumen and patience to identify them. I think Lending Club is one of them if we can take LePlanche at his word, Lending Club isn't actually going public because they need the cash but only "to use it as an opportunity to raise awareness for the company."

Re-cap: Because Lending Club is run using the internet, it will continue to take market share away from banks, credit card companies and other traditional lenders by offering better rates to individual borrowers and lenders. Although Lending Club is a company organized around the internet and has a culture that will give them this competitive advantage, it is still an untried business model in an emerging industry. This company is not purely about making more money so much as participating in the greater cause of reducing people's personal debt and losing less money in unnecessary administrative and bureaucratic costs that have built up in older financial systems. I have used Lending Club's service as an investor for about 6 months and I think it holds real potential for making the world a better place because it will enable borrowers to get better interest rates and lenders to get above a 1% return on their savings.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have used Lending Club to invest in loans and will likely invest in the company when it goes public depending on the price.