LendingClub (NYSE:LC) has great potential, but should only be considered by high-risk investors searching for high returns. I estimate LC will return to its IPO price of $15 and above over the course of the next few years as the company continues to prove its potential.
LendingClub Corporation went public in December of 2014, priced around $15 per share. The company operates as an online marketplace that connects borrowers and investors in the United States. Its marketplace facilitates various types of loan products for consumers and small businesses. It also offers investors an opportunity to invest in a range of loans based on terms and credit characteristics. LendingClub's customers include retail investors, high-net-worth individuals and family offices, banks and finance companies, insurance companies, hedge funds, foundations, pension plans, and university endowments. The company's mission is to transform the banking system and make credit more affordable and investing more rewarding.
Peer-To-Peer Lending Industry
The peer-to-peer lending industry is a newly created market that gives borrowers and lenders another ability to satisfy each others' needs without the use of banks. Banks have previously controlled this market as one of the only providers of such lending and borrowing services. However, banks are now faced with growing competition and a shift in consumer behavior from personal banking to virtual peer-to-peer business. This form of business was made readily available for consumers at the end of 2014 when LendingClub, the first of its kind, was able to perfect an algorithm that managed risk and regulated transactions between parties.
Favorably, the peer-to-peer industry is under a lot less government regulation than the banking industry because of the excessive federal policies that were put in place over banks after the 2008-2009 financial crisis. These policies regulate the banking loan system and make it much harder for banks to give consumers their desired loans. These same regulations however do not apply for peer-to-peer lending, and therefore many individuals who were turned down because of increased regulation now have an alternative marketplace to receive their needed funds. As LC was able to prove its capability, banks realized the potential threat of LendingClub taking over their market share, and invested in competing against it by partnering with companies that researched and developed their own peer-to-peer lending place. To be clear, the peer-to-peer lending process consists of matching borrowers of certain risk levels with lenders of certain risk tolerances. LendingClub, or any of its peers, do not actually issue any loans themselves and therefore bear very little responsibility. The key component for this industry is managing default risk by properly evaluating borrowers' capability of taking on debt.
Is LendingClub Undervalued?
As explained above, the peer-to-peer lending industry is a new form of business that is not heavily regulated by government policies. For this reason, many analysts are skeptical that government intervention will take place and begin regulating the peer-to-peer industry which would dramatically slow the growth potential and reduce revenue estimates for companies such as LendingClub. This assumption is currently priced into the market and is partially responsible for LC's currently discounted stock price.
Important to note, this assumption is also only based on speculation, and because of this, it is currently undervaluing LendingClub's potential. LendingClub's management team has done an excellent job working with the government officials through multiple Q&A meetings and ongoing progress updates to build a completely transparent business model that the government can easily understand and therefore trust without intervening. As of April 19, 2016, the government has taken no initiatives to interfere with LC's operations, and the management has openly expressed light concern for the possibility of a government regulation. Despite this, as seen in the chart below, LC managed to beat revenue estimates every single quarter and will continue to outperform analysts' conservative revenue estimates in 2016 as well.
The key driving factor for LC's success and government cooperation is and will continue to be the accuracy of the underlying algorithm controlling all transactions. This algorithm is responsible for controlling the default rate, which is the most important measure for a lending service marketplace. As a result of growing macroeconomic concerns, analysts question whether the algorithm will be able to manage worse economic conditions or will the default rate grow out of control. LendingClub has addressed this concern and publicly stated that it continues to make small precautionary adjustments so that it can guarantee that its algorithm can sustain an economic downturn without default rates growing out of control.
Currently, LC's default rate is in line with management's estimates and below analyst expectations because of their speculative concerns. In addition to the pessimistic ideas around the industry, analysts also over accounted for the growing competition that LendingClub is facing. They projected that LC was going to have to reduce its profit margins in order to better compete with growing competition. LC, however, actually increased its fee structure and overall margins while maintaining over 70% revenue growth year over year. LC was able to do this by building a trustworthy name that lenders feel more comfortable getting loans through than other competitors. The chart below shows LC's earnings estimates compared to those that analysts predicted. The outperforming trend is going to continue until analysts better understand this industry and more importantly LendingClub itself. The misconception that currently exists is resulting in conservative growth estimates that are forcing artificial concern and causing LendingClub's stock price to currently be undervalued.
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Growth Into 2016
LendingClub has outperformed analyst expectations for the past year and will continue to post high revenue growth and higher profit margins in 2016 as well. In 2015, LC accomplished a loan origination growth of 82%, signifying the increasingly growing consumer demand and supply for peer-to-peer borrowing and lending. Operating revenue increased 93% year over year, and this was a direct result of a slightly increased fee structure that LC deemed appropriate. LendingClub evaluated the average return of its platform to be 7.8% for the average consumer, and therefore felt increasing its fee structure was suitable given the high average returns. The high growth in loan originations despite the increased fees is a good sign that consumers had small sensitivity to changes in the fee structure because of the high average returns. By increasing fees, LC was able to improve its revenue yields by over 5% and improve contribution margins to 49% for the year. The chart below portrays the increasing contribution margin that LC has been able to accomplish through its operational improvements:
When accounting for sales, marketing, origination, and service expenses, LC accomplished an annual EBITDA margin of 16.3% for the 2015 year. Looking forward to 2016, LendingClub predicts continued success with a 72% revenue growth and an improved EBITDA margin to 19%. Management will continue to run the company as it has, and capitalize on the natural growth of this growing industry. The next product that is currently being perfected and soon to be released on LC's platform in 2016 is mortgages.
LendingClub's founder and CEO is Renaud Laplanche. Renaud was recognized on Bloomberg Markets' 2015 Most Influential List, an annual list that acknowledges 50 of the top leaders across technology, finance and politics around the globe. In 2014, he won the Economist Innovation Award in the consumer products category. He was ranked one of the top SMB CEOs by the Glassdoor Employees' Choice Awards in 2015 and was named the "best start-up CEO to work for" by Business Insider in 2014. Renaud has an MBA from London Business School and a JD from Montpellier University.
LendingClub's chief financial officer is Carrie Dolan. Prior to Lending Club, Carrie was the treasurer for Charles Schwab Corporation (NYSE:SCHW), a leading provider of securities, brokerage, banking, and financial advisory services to individual investors and independent investment advisors. Carrie also served as the chief financial officer for Schwab Bank, a bank she helped launch in 2003. Carrie was named one of the Most Powerful Women in Finance by American Banker in 2015 and named the 2015 Financial Woman of the Year by the Financial Women of San Francisco (FWSF).
LendingClub is managed by highly qualified individuals that possess both a high level of technological expertise and financial experience. Thus far, this knowledge has enabled them to stay ahead of their peers by consistently achieving high revenue growth and increased profitability. In addition to simplifying and creating more efficient operations, LC's management has proved that its decisions include the best interest of all shareholders as well as the company.
As of the fourth quarter of 2015, LendingClub announced that it plans on initiating a $150 million stock buyback program that will take place over the next 12 months. This is a possible indicator that the management also feels its company is undervalued below $8 a share and wants to capitalize on the short-term undervaluation. Currently, LendingClub has almost no debt, approximately $550 million in cash, and is looking for value-creating decisions such as this program. In addition to the share repurchase, LC's management has also expressed an ongoing interest in possible acquisitions. Though there are no known acquisition targets as of now, LC is financially strong and its management will not under-utilize its strong balance sheet. LC's management has proved and will continue to prove that its knowledge and experience will lead to value-creating decisions.
An additional fact that leads me to believe LendingClub has great potential is that LC is owned by approximately 76% institutions. This sign of accumulation at low prices is a good indicator of potential long-term growth ahead.
LendingClub is a great company under extreme speculation and hiked risk premiums that are currently devaluing the true potential of the stock. Investors should note that if these speculative concerns become true, then future expectations will drastically change. This risk, however, if not true, is providing a very successful company at an undervalued price. LC is projecting to continue to post high revenue growth in 2016 and improved overall margins for increased profitability. I recommend going long LendingClub at a current price around $8 per share and estimate an 88% overall return over the course of next two years as LC returns to its IPO price of $15 per share and above.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in LC over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.