If you look at a chart of LendingClub(LC) stock over the past few years, you may think that fundamentals have deteriorated or stagnated since 2016. However, LendingClub's fundamentals have actually improved substantially. With the price lower than it was a few years ago despite these improvements, we believe LendingClub may be undervalued, especially considering its great business model and strong reputation.
Large market potential
Its no secret that the US has a debt problem. From student loans to credit card debt, US consumers frequently take on more debt than they can afford. With credit card companies and other lenders charging exorbitant rates, consumers are forced to pay massive amounts of interest.
Meanwhile, there are massive pools of capital floating around looking for investments that can generate consistent returns. In the peak of this bull market though, solid high yield investments are hard to come by.
Enter LendingClub, which takes advantage of these massive pools of capital to loan to borrowers for everything from home improvement to debt consolidation to large purchases at much lower interest rates, allowing them to pay off the debt much more easily and cheaply. Investors, meanwhile, get a decent yield for lending to borrowers. The value proposition couldn't be more clear to both parties.
LendingClub's own research shows that the market for P2P lending available to them may be as much as $300-350bil.
These findings are supported by other sources. According to TMR, the peer-to-peer(P2P) industry is estimated to grow to 897bil by 2024 at a CAGR of over 48%. AlliedMarketResearch estimates the industry may grow to 460bil by 2022 at a CAGR of 51.5%. Although LC operates only in the US, the US is the 2nd largest economy in the world and will likely take a large share of the world P2P market.
On the investor side, LendingClub's own research again shows an enormous market opportunity, with potentially $38T of capital available for P2P lending. LendingClub, being one of the largest operators in this space, will most likely be able to garner a significant chunk of this capital due to their proven status.
2017 investor presentation
LendingClub suffered from a devastating scandal in 2016. Turns out, Renaud Laplanche, its founder, had sold loans that did not meet the buyers criteria and had several conflicts of interest which he did not disclose. The scandal caused a sharp drop in LendingClub's price, causing it to plummet as LendingClub began to lose buyers and had to ramp up internal security. In the end, Laplanche and several other executives were ousted from the company.
One of the best in this space
LendingClub has built up one of the best reputations in the P2P lending space after the scandal in 2016. On its own website, it boasts a 4.8 star average review score. In its Q4 2018 earnings call, management noted that they had hit an all time high NPS of 78, up from the 71 stated in their investor conference. This net promoter score is one of the highest among all companies and far exceeds the NPS of the average bank or credit card company (Major credit card companies have a NPS in the single digits while many banks have a negative NPS).
Most independent reviews online have also been very positive, giving LendingClub a 4-5 star rating. On consumeraffairs, one of the only sites LendingClub didn't receive a 4-5 star review, LendingClub beat out competitors SoFi and Prosper by a wide margin. Most of the complaints on that site about LendingClub seemed to be from people who didn't even use the service.
After suffering from the scandal in 2016, LendingClub's revenues and profits have dropped significantly. However, things have changed since then. New management and procedures have been installed and LendingClub is back to being a growth company. Revenues have increased back to 2016 levels and losses have been narrowed significantly.
New management have executed well, managing to exceed their own investor day targets set in 2017. Over the past few years, they have implemented cost saving measures that have paid off handsomely, as shown by the strong adjusted EBITDA margin growth.
Q4 2018 slides
Management has also done extremely well settling the SEC and DOJ lawsuits. Although LendingClub Asset Management was charged, the fact that the SEC decided not to recommend charges against parent company LendingClub is another testament of the culture of transparency that LendingClub embodies.
The only legal suit left to settle now are the FTC charges. We looked at evidence from both sides and we believe the FTC's allegations may be unfounded. Either way, on September 13, a judge told the FTC and LendingClub to try and settle the charges, so this problem will most likely soon be behind LendingClub.
Recession fears are unfounded
A frequently stated bear thesis around LendingClub is that a recession would cause P2P lending to die out as borrowers default. However, we disagree with this conclusion and would like to state the other side of the argument.
The simple reason P2P lenders won't die is this: "Credit card companies have made unsecured personal loans for decades and haven't gone bankrupt."
In the great financial crisis, the default rate momentarily peaked at 11 percent for a single quarter, but the credit card companies had 15 percent gross interest to cover those losses, leaving them with a 4 percent spread.
This means that if a recession does happen, all P2P lenders need to do is raise prices. Of course, that would translate into lower volumes, which could cause losses due to the high fixed costs. However, LendingClub has addressed this as well by outsourcing some of their business processes, which translate fixed costs into variable costs and gives them further resiliency over the economic cycle. With its current cash position and strong balance sheet, LendingClub should be able to survive for several years without any originations.
Furthermore, stress tests by LendingClub show that investors can achieve relatively high returns even in a downturn.
2017 investor presentation
US consumers have also improved their FICO scores since the Financial Crisis, as one report shows:
In 2009, 7.3 percent of American consumers had terrible scores, ranging between 300 and 499. Now that’s down to 4.2 percent. In 2009, 8.7 percent of consumers scored between 500 and 549; today, it’s down to 6.8 percent. Overall, fewer Americans now have FICO scores below 650 than in previous years. In 2009, just under 35 percent of consumers scored 649 or less; today, it’s 28.7 percent.
Most peer to peer lenders require high FICO scores, with LC coming in at a minimum 600. Many credit cards, meanwhile, have lower FICO score requirements. This is why I believe in a recession, P2P charge off rates will be lower than credit card charge offs, allowing P2P lenders to maintain a lower interest rate.
Lastly, according to LendingWorks, the fractional reserve lending system was what caused the crisis in 2008. Since P2P lenders lend out $1 for every $1 they receive, they will not be leveraged, not to mention there can be no “run” on P2P lenders as lenders cannot withdraw their funds for loans. This is because all funds will go to the borrower and the lender cannot force the borrower to pay off the loan. Only at the end of the loan term agreement will a lender reclaim its funds.
Competition has also been a major pillar of the bear thesis. With new fintech startups popping up, like Brex, this is definitely a valid concern. However, we have not seen any serious threats to LendingClub's dominance.
One could argue that Marcus by Goldman Sachs is a serious threat, but with Goldman Sach's low NPS(4) and the fact the fact that LendingClub has a much more streamlined process and a better reputation, we believe Marcus isn't a major threat, though it may take a significant share of the market. Goldman Sach's itself says it aims to get $1bil of revenues per year, which may seem like a lot but is only a small portion of the market.
Honestly, we don't see how Marcus can be a huge threat in the long term. Marcus may be backed by the capital reserves of Goldman Sachs, but its loan prices can be higher, according to anecdotal reviews, and LendingClub itself is back by large banks with huge pools of cheap capital, so we don't see how Marcus has a competitive advantage.
I was fooled by the positive reviews but they are just a predators. Despite what their marketing offer says, you WILL get a hard inquiry on your report. Just for fun, I typed in 12K to see what the interest would be and it was 24.99%! There is no way I would accept that! Then I received notifications that my credit rating dropped 35 points! At the time, it was about 750. Wow, I made a huge mistake but I'll get it back up.
Prosper is even less of a threat. It is much smaller than LendingClub and has a much poorer reputation, with its consumeraffairs score less than half of LendingClub's score.
Overall, although competition is serious enough to prevent LendingClub from capturing most of the market, it isn't really a major threat to LendingClub's existence. There is more than enough pie to go around.
Its quite hard to value LendingClub. Like most fintechs, it's losing money as it hasn't scaled enough to make a profit, yet high fixed costs means that operating leverage will likely help LendingClub increase profitability significantly as revenue increases. Therefore we'll use an adjusted EBITDA multiple to value LendingClub.
Most major tech companies trade at around 20-25x EBITDA and grow at similar rates to LendingClub, therefore we believe using them as comparables is warranted. Using this valuation, LendingClub would be valued at around $2.8bil, or around $6.60 per share, twice its current price. We believe this is fair given LendingClub's competitive advantages and dominant status in its market. We use adjusted EBITDA as a metric as net income eventually trends towards adjusted EBITDA for most tech companies as they continue to scale and as variable costs start to dwarf fixed costs. We believe net income will trend towards adjusted EBITDA for the long run for LendingClub. In fact, adjusted losses in 2018 are far lower than adjusted losses in 2017.
LendingClub has been beaten down too much. It trades at a lower price today than in 2016 despite the fact that its fundamentals have improved drastically. For a dominant company in this lucrative niche, we believe a market cap of $1.5bil is too little. LendingClub has significant upside from here, especially after it settles litigation from the FTC.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.