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Fair Isaac: A Good Business With A Wide Moat

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Crimac's Blog
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  • FICO is a good business that has been operating for decades.
  • The Scores business is a royalty-based monopoly.
  • The company has many growth opportunities.
  • Management is shareholder-oriented with strong buybacks.


Fair Isaac operates in two businesses: Scores and Software. 

The first business is called Scores and makes up 50% of total revenue. It provides scores that provide consistent/objective credit risk, and is widely used by major financial institutions in the US to make all sorts of consumer credit decisions. The score is a three-digit number ranging from 300-850. It is calculated by running data from the three US national credit bureaus (Experian, TransUnion and Equifax) in the company's algorithms. The resultant score is used by many banks, lenders, credit organizations and other institutions (insurers, retailers, telecoms providers, automotive companies, pharmaceutical makers, healthcare reorganizations and public agencies) which pay a small amount on a per score basis to know consumers' creditworthiness. As a result of the royalty schedule, distribution is straightforward with very minimal cost of goods associated with revenues. What is really interesting is the dominance of FICO’s scores. In fact, over 90% of the lending decisions made by major financial institutions are based on FICO scores. 75% of Scoring service is distributed B2B (through major credit bureaus), while the other 25% come from FICO’s B2C offering, directly to customers. The FICO Scores is the fastest-growing segment (over 20% per year), accounting for 50% of revenue in 2021 (growing from 41% in 2020 and 36% in 2019) and enjoys 85% gross margins so it’s the main driver of earnings growth.

The second business is called Software. It offers solutions and services that help customers automate and improve decision-making process to enhance business performance. The company's predictive analytics and decision management systems use big data and mathematical algorithms to predict consumer behavior. It consists of two reported segments:

- Applications makes up 40% of total revenue and offers pre-configured decision management software tools that are designed and tailored for specific business problems such as credit origination, marketing, fraud / security management, customer acquisition, etc. FICO operates in many large markets so the company still has a long runway for growth. The company derives revenue from software license agreements and transaction-based fees, so the company’s revenue stream is largely recurring with 25% gross margins. Applications is offered through the FICO Analytic Cloud or Amazon Web Services (AWS). 

- Decision Management Software or DMS makes up 10% of total revenue and offers analytic decision-making tools to help businesses create their own custom decision management application, automate and improve their decision making process. These tools are offered as on-premises software, or through the FICO Analytic Cloud or AWS. Even though this segment is developing and the client base is large, this segment is not profitable yet (-14% gross margins) but growing by 20% per year.

Monopoly in Scores

What I really like is the Scores segment. FICO scores have been the standard for decades and is a vital component of credit health. This score influences everything ranging from the amount of credit that's available to a person, and the terms that lenders may offer. Every single means of obtaining credit, whether for a credit card, an auto loan or a mortgage follows from the score. And this FICO score is used for 90% of all credit decisions and 98% of all mortgages written in the United States. Simply put, lenders want to know how much risk they are taking when lending out money, and Fair Isaac is the main decision to know that. 

So basically the Scores business is a royalty-based monopoly with more than 90% of the market share when it comes to consumer credit lending decisions. By being the industry standard, there are high barriers to entry for new companies that want to replicate similar services. And this segment has a tremendous pricing power runway as we will see in the Growth section.


The majority of the firm's revenue is generated in the United States (80%), followed by Europe (15%) and Asia (5%). FICO clients include two-thirds of the top 100 banks in the world, more than 600 personal and commercial line insurers in North America and Europe including the top 10 US personal lines insurers, 400+ retailers and general merchandisers, including one-third of the top 100 U.S. retailers, 98 of the 100 largest financial institutions in the U.S., 150+ health care companies and all the 100 largest U.S. credit card issuers and more. FICO’s solutions are used in over 100 countries and 90 of the top 100 largest U.S. lenders use FICO Scores.

In overall, the company has many attractive characteristics: a monopolistic position with pricing power, strong cash flow generation, high returns on capital, a strong brand with increasing switching costs and a long track record of returning significant amounts of capital to shareholders via buybacks.


Let’s see some numbers step by step. Here is a table with a lot of valuable information.

FICO has good fundamentals with consistent growth. In the past decade, the revenue (1) has doubled, net income (4) has quadrupled and EPS (5) have been multiplied by 5. But if we want to be objective, we must subtract the recent sale of the Collection and Recovery business in 2021 which has boosted earnings. So we must subtract $95M of net income and $3.23 of EPS, and in this case, net income has only tripled, and EPS has only quadrupled in the past decade.

The company has maintained its gross margins (2) above 70% and has slightly increased its operating margins (3) from 25% to 31%. You can see that profitability really increased since 2019 and we will discuss this in the Growth section.

The company has stopped paying dividends (6) in 2017 to focus essentially on shares repurchases. In fact, the firm loves buybacks and has reduced its outstanding shares (7) by 25% in the past decade. Finally, this asset-light business model has enabled FICO to generate a lot of free cash flow (8), which has been multiplied by 4 since 2012.

Graphically it looks like this:

Balance Sheet

The company has a leveraged balance sheet. As of September 2021, FICO has around 195M in cash (1), around $1B in long-term debt (4). We’ll note that most of their debt is long-term debt and the leverage ratio has recently increased from 1.62 to 2.07. With current assets (2) equal to current liabilities (3), the company has a current ratio of 1 so it can weather short-term events.

If we look at future maturities, the company must pay most of its debt after 2025, something it can do easily, so it’s not an issue for the moment.

Graphically it looks like this:


Past Growth

In ten years, the company has grown in a very nice way:

- Revenue has grown at a CAGR of 7.83%.

- Net income has grown at a CAGR of 18.54%.

- EPS has grown at a CAGR of 22.30%.

Some key elements have boosted growth:

Cloud: In the past, most of FICO’s management solutions have been delivered on-Premise, and the company lacked the agility to quickly develop its software. But in 2017, the company started to use Amazon Web Services (AWS) as a public cloud to have a global presence, scale, reduce cost, add velocity, security and compliance. So in the past few years, FICO has made more of its Software solutions available as hosted solutions through the FICO Analytic Cloud and AWS, with cloud bookings accounting for 41% of total bookings in fiscal 2020. As On-Prem-to-SaaS and Cloud transitions continue to accelerate and we get past the investment phase, the incremental margin will be higher on additional revenue growth, leading to sharp margin expansion for the next few years for the combined segment. The cloud is growing double-digit, and this transition will maybe make the DMS segment profitable in the future.

Pricing power: While the base volume of FICO Scores is tied to general consumer credit activities (growing slightly faster than GDP), this business has tremendous pricing power. Before 2018, FICO hadn’t changed Mortgage Score’s pricing in 25 years because Credit Bureaus prevented pricing increases. But in 2018, the company renegotiated with the credit bureaus in a way that would allow it to institute annual price increases above inflation, therefore getting their pricing power back. This lead to significant improvements in the profitability and sustainability of the business model at 100% incremental margin (first in Mortgage Scores, then Auto Scores, then Credit Card Scores). Since FICO Scores’ costs represent just a tiny fraction of the cost of an entire credit underwriting process (less than $1), there has been absolutely no customer pushback. FICO intentionally charges a fraction of the amount of the value that their customers get to ensure that they won’t lose customers. For example, if a bank or a customer wants to know its FICO score, it pays the credit bureaus $20 to pull the score. What FICO used to get was roughly 5¢ out of that, which is very low, and it allowed bureaus to have a huge margin. The company gradually raised prices in 2018, 2019, 2020 and 2021 so they can get roughly 50¢ now. They plan to continue these regular annual price increases at above the inflation rate for years to come. And if regulation doesn’t change, the runway for pricing power is extremely long. And even if FICO raises its price to $1, it still won’t be expensive for the bureaus.

Business model: Because of its asset-light business model, the company enjoys a good ROIC, which has recently increased a lot to 34% in 2021. ROE has also been very good for FICO, but is less meaningful as the company repurchases its own shares, reducing the equity to very low levels. Speaking of buybacks, FICO has long been a cannibal of its own shares which has generated signifiant EPS growth over the years.

Here are the ROE and ROIC for the past 10 years.


Also, the company enjoys very high margins. FICO’s gross margin overall is about 70%, which is pretty good. The scores business is about a 90% gross margin and the software business is about 50%. There is a growth opportunity is FICO gets its software gross margin up to 70% margin similar to other enterprise software companies.

Future Growth

International markets: Thus far, the company has only enjoyed tremendous success in the United States. Now the test to growth will be whether it can duplicate that success in a range of international markets. Some international revenue is coming in already, and almost half of Fair Isaac’s revenue from its software business comes from outside the United States (Canada, UK, Brazil, South Africa, Germany and France). FICO is currently trying to implement its scores in other countries:

In 2015, Malaysia's largest private credit reporting agency CTOS Data offers FICO Scores to all its clients. In 2018, FICO has acquired GoOn LLC, a leading credit risk management consulting firm based in Brazil. FICO is partnering with banks in places like Brazil, China, India and Europe in order to adopt FICO Scores.

If Fair Isaac can encourage international businesses and consumers to expand their usage of the FICO score, and work to make it as crucial as it is to American consumer markets, then the growth potential is massive.

I looked at how credit scores are delivered around the world. Some countries have their own rules and credit scoring system. Others like Japan and Brazil don’t have a formal credit scoring system. A massive growth opportunity lies in Brazil because since 2012, the country has been developing a credit scoring system with major banks and global companies like Experian and FICO.

The UK credit scoring system is similar to the system in the US, with three major credit agencies (Equifax, Experian and Callcredit) so I suspect FICO can grow its revenue in this region. Similarly, Canada has two of the US’s three major credit agencies (TransUnion and Equifax); Australia has Equifax and Experian among its four bureaus; India uses a TransUnion partner and Equifax among its four bureaus.

Application segment: Whilst FICO is best known for its Scores product, others segments are developing. Over the past decade, its Applications business, in particular, has become a more material part of the company and is growing by 50% per year. The group's software offerings are dominated by two products, Falcon and Triad, focused on fraud and customer management respectively. These well-established products account for around 50% of the Apps revenue base and can grow further in the future.

B2C opportunity: Right now, Fair Isaac has a substantial and long-standing business-to-business (B2B) business, providing FICO scores to companies, including banks, retailers, credit card companies, car companies, etc. A growth opportunity lies in the business-to-consumer (B2C) field, where Fair Isaac has just begun to ramp up its business and product offerings. Currently, consumers can monitor their credit scores via Open Access (since 2013) and receive instant alerts using myFICO which help prevent and detect fraud. This tool is getting traction. If the company invests in this field and develops new revenue streams, Fair Isaac can capture a much bigger piece of this market. Against its 90% market share for its B2B business, it currently has less than 5% of consumer business. So the growth opportunity is big.

The second and potentially more lucrative change is the development of deals with credit reporting agencies. For example, FICO signed a deal with Experian in 2014 to allow the agency to use FICO scores on its consumer-facing website in lieu of paying a royalty. Experian now provides FICO-branded scores direct on its own consumer sites (B2C) included in its bundled credit information service offered to consumers on the Experian site. FICO receives a monthly fee for each customer that is paying Experian for its scores. Subsequently, FICO signed other affinity and re-seller agreements, recently with American Express. This ecosystem will benefit FICO in the future and generate recurring revenue.

More recurring revenue stream: The company’s objective is to increase recurring revenue growth by at least 10%. For the moment they have not achieved that. But this is slowly increasing from 4% growth in 2020 to 7% growth in 2021. I believe management is working on this objective. They developed new financial metrics that provide more visibility into the recurring revenue generated by the subscription-based software and the retention and growth of the existing software customers. We’ll see if they manage to do it in 2022.


FICO’s management has a habit of underpromising and overdelivering revenue and earnings. It is extremely conservative on its Scores business, because they exclude benefit from special pricing. I like how they don’t feed Wall Street with high expectations.

In 2016, they guided to Scores growth of 3-4%, it achieved 16%. In 2017, they guided to Scores growth of 5%, it achieved 11%. In 2018, they guided to Scores growth of 5%, it achieved 29%. In 2019, they guided to Scores growth of 10%, it achieved +25%. In 2020, they guided to Scores growth of 10%, it achieved +24%. In 2021, they didn’t provide guidance, the Scores growth was +10%.

For 2022, FICO is guiding to 6% Scores growth. I wouldn’t be surprised if is another 15%+ revenue growth year for Scores.

As Charlie Munger puts it “Show me the incentive and I will show you the outcome.” In this company, the insider ownership is 3.3%, and the CEO owns 1.4% of the shares so that’s a correct incentive. What concerns me more are the long-term business metrics incentives for compensation: Adjusted Revenue (50%) and Adjusted EBITDA (50%). Not great, I’d prefer to have non-adjusted metrics like operating margins or EPS.

Now, let’s see who the CEO is.


William Lansing has served on the board of directors of FICO since 2006 and has been the CEO since 2012. 

Before joining FICO, he served as CEO and president of InfoSpace (2009-2010), and also as CEO and President of ValueVision Media (2004-2007). He was a partner at General Atlantic Partners (2001-2003), a global private equity firm. Prior to his work at General Atlantic, Mr. Lansing served as CEO of NBC Internet (2000-2001), an Internet media company and as CEO of Fingerhut (1998-2000), a direct marketing company. He has also been VP of Business Development at General Electric (1996-1998), COO at Prodigy (1996) and McKinsey & Company (1986-1995).

I don’t really know if his diversified background is a strength or a weakness for his role at FICO. I don’t know if he will hold this position a long time, or work for another company in a few years. He seems to be doing fine for the moment, as the business has grown in a nice way, in line with previous management.


Michael McLaughlin joined FICO as a CFO in 2019, as outgoing CFO Mike Pung retired after 15 years at FICO.  

Mike joined FICO after spending 12 years at Morgan Stanley, where he was Managing Director and Head of Technology Corporate Finance. During his 26-year investment banking career, Mike advised hundreds of companies in the technology, financial services and real estate sectors on a wide range of strategic and financial topics. He has extensive software industry experience.


In 2019, Claus Moldt, who joined FICO in 2016 as CIO, became the CTO. Claus has industry experience driving cloud adoption and he is helping FICO accelerate the transition to a platform-based, cloud-first company.

Capital Allocation

FICO's transition to a platform-first, cloud business has involved several years of heavy investment. For the moment, it seems to work. Customers want to accelerate their digital transformation, and use FICO's technology to facilitate the process. So FICO’s on-platform revenue has been growing at 50% for the past 3 years.

As part of their strategy, they undertook a deep and strategic review of the business in fiscal 2020 to help improve profitability and increase their ability to deliver on their strategy. They want to grow revenue from their on-platform solutions, favor software over services, improve recurring revenue streams, optimize pricing and manage operating expenses.

This strategy has already led to the closure of some under-utilized offices worldwide, and a decision to exit some operations. In October 2020, FICO sold its cyber risk score operations for $7M. In May 2021, it sold its Collection and Recovery business to Constellation Software for $93M.


Fair Isaac produces its growth through organic growth but also acquisitions. Over the last decade Fair Isaac has acquired 10 companies, most of which were bolt-on acquisitions in order to improve efficiency of already-existing segments. FICO’s doesn’t try do buy a new segment outright, they don’t try new markets blindly. Here is the list of the latest acquisitions:

Entiera in 2012 : a provider of customer dialogue management solutions, terms undisclosed. Adeptra in 2012: a cloud-based customer engagement and risk intervention solutions company for $115M. CR Software in 2012: a leading provider of enterprise-class collections and recovery solutions, terms undisclosed. Infoglide in 2013: a fraud detection, security and compliance company for $1M. InfoCentricity in 2014: a private SaaS-based predictive analytics software company, terms undisclosed. Karmasphere in 2014: big data analytics technology, terms undisclosed. TONBELLER AG in 2015: a risk-based financial crime prevention and compliance company, terms undisclosed. QuadMetrics in 2016: a US cyber risk security scoring firm, terms undisclosed. GoOn in 2018: a leading credit risk management consulting firm based in Brazil, terms undisclosed. EZMCOM in 2019: security access provider for $19M.


The company has a long history of buying back its own shares, with a historical annual rate of 4.41% after 2010. Since 2006, FICO has bought back 60% of its shares. This is great.

What is interesting is that management increased buybacks when the stock price dropped (2008, 2011, 2018, 2021). Sometimes they increased buybacks when the stock was cheap (2011 when the PE ratio fell from 23 to 12), sometimes they just boosted buybacks when it was expensive (in 2018 the price tanked but the stock was still overvalued at 43 PE). So it’s not a perfect buyback policy. I would prefer to see buybacks only when the stock is cheap.

The company has resumed buybacks in 2021 when the price and valuation dropped from 56 to 26 times earnings (they bought back almost 8% of their total shares) and announced an additional $500M buyback program in November 2021. In the Q4 conference call, management announced they see buybacks as the most attractive use of cash, and they expect repurchases to continue in 2022. Good sign for us long-term investor!


In 2017, FICO stopped regular cash dividend payments in favor of using its excess cash flow for share repurchases. "Our share repurchase plan has been successful and continues to be the most meaningful way to return excess cash to shareholders," said  Will Lansing.


FICO competes in many categories, the main ones are software analytics and scores. When we compare Fair Issac to other fintechs involved in credit scoring or business analytics such as Fiserv (FISV), ACI Worldwide (ACIW) and Jack Henry & Associates (JKHY), we see that no other company even comes close to Fair Isaac’s numbers. Their profitability and returns are way below FICO’s. They have fewer partnerships and a weaker scalability. And some of then use FICO to operate (for example Fiserv).

In the fraud space, FICO has a product called Falcon which is a market leader and has been around 30 years. FICO is facing some increasing competition from some smaller players specialized in fraud like Featurespace and Feedzai, but FICO was still able to win deals.

FICO is basically a high-margin monopoly with 90%+ market share in B2B credit scoring. Equifax, Experian and TransUnion are the leading credit bureaus in the United States and have a history of collaborating with FICO so I don’t see them as competitors. They can have an impact on the company though. For example, in 2006 they created their own brand of credit score, the Vantage Score, which is an alternative to the FICO score. Even though there have been some updates to improve the Vantage Score, FICO has maintained its dominant position over the years and its score is still used by 90% of all lenders.


One potential competitor making a lot of noise recently is Upstart. This high-growth fintech company wants to replace FICO credit scoring with a cloud-based, artificial intelligence lending platform. This platform aggregates consumer demand for loans and connects it to the network of Upstart AI-enabled bank partners. The revenue of the company is primarily comprised of fees paid by banks.

Upstart believes the FICO’s credit score is often not a fair judgment of creditworthiness, so it uses different metrics to evaluate a score. Unlike the FICO credit scores, which uses 5 metrics to determine creditworthiness, which are payment history (35%), current level of indebtedness (30%), types of credit used (10%), length of credit history (15%), and new credit accounts (10%), Upstart uses non-traditional variables, such as application interaction, bank transactions, cost of living, credit experience, education and employment experience to predict creditworthiness. 

Targeted Customers

Upstart focuses on a different kind of people. The CEO said that one unfortunate result of the Great Recession was a « seemingly permanent reduction in access to affordable mortgages to the average American. » Upstart believes that there is a huge fraction of these million people that are credit-worthy and deserve access to an affordable mortgage.

Upstart developed an artificial intelligence lending platform designed to improve access for the 80% of Americans that never defaulted on a loan but had no access to affordable credit because they have a bad FICO score. As a matter of fact, borrowers on Upstart must have at minimum a FICO or Vantage score of 600 as reported by a consumer reporting agency to start. A credit score in the 580-619 range is considered Subprime, so we can say Upstart targets the lesser risk portion of subprime borrowers.

Upstart also accepts applicants with insufficient credit history to produce a FICO score. For example, someone who has been working for 20 years and living in the same house for 20 years has stability and has the ability to repay the loan. But this person didn’t use credit throughout his or her life so he or she doesn’t have a credit score. This kind of people can turn to online lending platform such as Upstart. In this case Upstart looks at the person’s situation and establish the stability and ability to repay the loan. Upstart is good at attracting clients and giving them a second look to give them a loan. Something FICO doesn’t do now but can easily replicate in my opinion.

Partnering with Banks

One primary decision about Upstart's business model from the beginning is that the company rejected to become another online bank and instead of competing with banks, Upstart decided to partner with them. While some of the larger banks might decide to build their own AI lending platforms from scratch, Upstart management thinks there will likely be many smaller banks that will prefer to have a partnership with technology providers like Upstart that have an expertise in building an AI loan platform.

This innovative way of rethinking credit has resulted in rapid adoption from new clients. The company has tripled the number of partners from 10 in 2020 to 31 in 2021, most of which being small community or regional banks and credit unions.

Upstart’s revenues are primarily from 3 sources of fees, which can be either dollar or percentage-based depending on the contractual arrangement with the bank:

Upstart charges bank partners a referral fee each time the company refers a borrower who obtains a loan. Upstart charges bank partners a platform fee each time they originate a loan using the Upstart platform. Upstart charges the holder of the loan (either a bank or person) an ongoing annualized servicing fee over the lifetime of the loan.

Upstart boasts about increasing its conversion rates (the conversion rate is a measure of the effectiveness of Upstart's sales funnel in converting people who apply for loans to actually receiving loans). The better the company's AI algorithms are, the better loans get made. 

The conversion rate has increased from 14% in 2019 to 23% in 2021 (see below). One red flag here is that they cooked the numbers. They recently modified the calculation of conversation rate to remove what they « believe to be fraudulent loan requests » from the total number of rate inquiries received. Using prior methodology, the real conversion rate for Q3 2021 is 13.5%. I don’t know if this change in calculation is really alarming, or some ordinary problem.

CEO Dave Girouard said in Q3 2021 that the conversion rate for people with low FICO scores is “not always high”. In other words, the number of "diamond in the rock" customers is limited, even using Upstart's AI technology.

New Business Line: Auto Lending

In Q1 2021, Upstart announced that it has closed its acquisition of Prodigy which is a provider of cloud-based automotive retail software “by helping car dealerships create a modern multi-channel car buying shopping experience.” It has already powered 4,000 auto loans in 47 states. The auto lending market is six times the size of the personal loan market, so this is a good opportunity for the company.

They think the auto loan product should attract more banks to Upstart's AI platform, as they can approve more loans, have lower loss rates, and have a more profitable portfolio of loans in the auto loan space.

Upstart management believes the auto loan industry is ready for disruption because it has at least as much mispricing and inefficiency as the personal loan industry. Upstart believes it can deliver far more accurate pricing, instant approvals, and elimination of friction to the borrower in the auto loan market.

New Business Line: Business Loans and Small Loans

The company plans to develop a loan product for small business owners and a small loan product designed to help consumers with immediate cash needs. These types of loans usually consist of only a few hundred dollars and are often repaid within a few months. 

Upstart believes that with better technology, superior risk models, and a dramatic reduction in the cost of origination, they can build a better small loan product than the mainstream financial system.

What’s Next?

The next step for Upstart is the creation of a mortgage loan origination product over the course of 2022. Mortgage originations is a $4.5 Trillion market and maybe Upstart can operate in a small area of this market. Their mortgage TAM are their current partners (small banks and credit unions) who will start to use this mortgage product. So it’s a good thing but not that big a deal as the company pretends. I don’t think big lenders will ditch FICO in the coming years: their default rates are very low and they're quite satisfied with profitable quarters.

Why Did Upstart Stock Go Up?

Upstart has been one of the hottest stocks in the market since its IPO debut on December 16, 2020 with a 700% increase. There is a lot of hype around this stock which is obviously overvalued, because it trades at 30 times sales and 240 times earnings. The hype and the move upward were driven by strong fundamental performance.

Beside its superior AI technology, a reason for this impressive growth and profitability is that banks are under pressure both from the government and investors to help better serve low-to-moderate income Americans. This concept of financial inclusion is starting to become part of ESG goals for lending institutions and banks are rapidly beginning to conclude that Upstart's

can better determine the true risk of the borrower, thereby helping banks to better serve a wider demographics that includes both the underbanked and unbanked. I suspect that the new “small loan product” will likely be in high demand among banks that have ESG goals that support financial inclusion.

Similar Companies and Competitors

There are a large number of online lenders online but most of them target different types of customers from Upstart. Upstart specializes in lending to either first time borrowers or subprime borrowers, which generally turn out to be most often either Gen Z borrowers just starting out their credit history or younger Millennials. It generally offers loans in amounts between $1,000 and $50,000.

Some companies are considered to be Upstart competitors:

- Upgrade is probably the closest lender to Upstart. Upgrade personal loans require a minimum credit score of 620 to qualify. Upgrade will offer similar loan amounts as Upstart and have similar interest rates and fees. The difference is Upgrade offers the option to defer two repayments, change the due date or make a partial payment if the borrower is facing financial hardship.

- Avant offers personal loans to borrowers with a credit score of at least 580. So the credit score range is similar to Upstart’s but Avant will also lend to even the riskier portion of subprime borrowers. Avant offers loans as high as $35,000. The big difference with Upstart is that Avant loans can generally only be used for debt consolidation and emergencies.

- LendingClub (NYSE:  LC) is an online peer-to-peer lending platform and requires a minimum credit score of 660 to qualify. So this company is technically in competition with Upstart but competing in a totally different market segment.

- SoFi Technologies (NASDAQ:  SOFI) operates three business segments, which are lending, financial services, and digital banking on one app. SoFi is vaguely a competitor and its lending services target a different group of borrowers. SoFi requires a minimum credit score of 680 to be approved for a personal loan.

- Rocket Loans (NYSE:  RKT) loans to borrowers with a minimum credit score requirement of 640 and a minimum income requirement of $24,000.

Are these businesses a threat to FICO?

In overall, this increasing competition might get some adoption, but none of them has a groundbreaking strategy to replace Fair Isaac. Most of them use FICO to operate, and they are in a different business category so I don’t think they are a threat to FICO.

The fact that FICO has all these partnerships with financial institutions and bureaus for decades puts them in a protected seat. Also, they have the name brand recognition that everyone knows. It’s just easier for clients to use the reference. On the innovation side, we’ll note that FICO is competing vigorously in this space with updates every year. So I don’t Fair Isaac will stay behind long. They have a lot of resources to keep up with new innovation.

So Upstart is a fast-growing business with a technological secret sauce that can focus on a riskier segment of the population, but it is worth mentioning that UPST is still very new in the loan origination space and there are many risks to consider:

1) Customer concentration: In late 2021, only two customers accounted for 85% of originated loans (in Q1 2021 only one bank accounted for 60% of revenue). That is customer concentration risk to the extreme, and in order to succeed, Upstart needs to enter into many more new bank partnerships while maintaining existing bank partnerships. Banks are crucial in Upstart's business model and play two key roles, which are funding loans and acquiring new customers. The inability to attract new bank partners or the inability to maintain the number of loans would impact Upstart's financial performance. 

There are 8,000 mid-sized banks in the US alone that could use Upstart’s products. But there are a few reasons why they won’t. First these banks can develop a similar lending system. Second, these banks may want to preserve the relationship with their clients and not delegate to a third party: in this case banks keep all the profits. Third, small banks and credit unions are typically very conservative. All of this narrows the opportunity pool for Upstart.

The most recent commercial arrangement with their major client, Cross River Bank, began on January 1, 2019 and has a term of four years with an automatic renewal provision for an additional two years following the initial four year term. If Cross River Bank decides not to renew its contract, it would be a major loss of revenue for Upstart.

2) Channel risk concentration: The second major risk has to do with Upstart's ability to maintain or increase the channels through which the loans are sourced. Upstart's loan origination traffic mostly comes from loan aggregator Credit Karma (owned by Intuit) which generates most of Upstart's sales leads at the moment. This company generates fees from displaying Upstart's loans, while they charge nothing to their customers. 

3) Innovation: A third major risk for Upstart is that the company must maintain their biggest advantage: their platform. It offers banks a way to achieve higher approval rates on loans with lower annual percentage rates while also keeping default rates low. This requires constant investment to improve Upstart's AI algorithms to keep them ahead of the competition, while also dissuading companies like Intuit or large banks from trying to create a competing platform themselves. If the competition keeps up with innovation, then the company could lose its competitive advantage.

4) Cyclicality: A very similar company blew up in 2008. Marblehead was a company involved with student loans that helped both lenders and schools create more innovative and affordable education loan products. First, Marblehead used a similar narrative to Upstart, in that it claimed its AI algorithms could accurately predict student loan defaults through the use of AI and with the knowledge gained through the AI, they believed they could create better student loan products. Marblehead eventually collapsed during the Great Recession, partially because the company's AI algorithms broke down on the bad end of an unfavorable credit cycle. First Marblehead didn't go bankrupt, but things became so bad that the company eventually went private and exists today as a company called Cognition Financial.

A big risk with Upstart is that its AI algorithms might work extremely well during the good part of the credit cycle but there is a possibility that if the cycle reverts, its AI models might not work too well and could even be a disaster in making like First Marblehead was.

5) AI model failure: Upstart's algorithms being caught in a situation in which they do not work is a risk, no matter what the company's marketing says about how powerful its AI models are. The most recent example of a company in the fintech industry having its AI model fail is Zillow, who lost millions from its home buying product Zillow Offers. Zillow had often bragged about its AI algorithms being able to accurately assess housing prices and for various reasons, its program based on those algorithms did not work. 

6) No recurring revenue: Upstart's customers can cure their own poor credit standing. When they successfully repay their loan, now they have improved credit scores and can qualify for FICO loan with lower fees and interest. So Upstart has to attract new clients each year as it does not have reoccurring revenue. In fact, there is a strong correlation between marketing spending and revenue, with marketing accounting for 40% of revenue. People are not coming back as easily as expected.

7) No customer service: Another disadvantage of these online lending platforms is the lack of customer service. They might lack in the ability to handle all of the customer concerns, where a bank who’s been established for 100 years have done this often. Some Upstart customers can return to Upstart to borrow loans again, but the relationship between Upstart and its lending customers is transaction by nature.

8) Limited supply of borrowers: Upstart addresses an underserved demographic of subprime loan qualification. It is possible that Upstart had explosive growth due to pent-up demand, which is being satisfied now. 

Conclusion: To sum up, everyone seems bullish on the stock and thinks that the company can maintain its 300% growth for a long time. There is so much hype around the stock. Even thought it might work because of its innovative AI, I remain skeptical of FICO replacement. I think Upstart can become a big business but there are many uncertainties/risks, and its targeted market is smaller than expected.

Competitive Advantage

I haven’t found much information about software analytics competitive advantage, but FICO occupies either the number one or two position in each of their respective software application categories. Their tools are easy to use and the company invests a lot to develop an efficient platform. So I suspect FICO has a decent competitive advantage in this category.

I think FICO has a wide moat in the Score business due to its brand, proprietary data and entrenched role in modern credit approval processes. FICO is considered to be the gold standard for credit scoring and risk analytics with over 90% market share for the B2B scores market and counts 98 of the top 100 US financial institutions as well as 75% of the biggest financial institutions globally among its customers. It has retained leadership for three decades. 

As more banks use FICO's credit scores to make loans, consumers are forced to focus on their individual credit scores in order to qualify for a loan. With each incremental consumer added, the firm's data sets become slightly more robust. This produces a network effect. As more banks and consumers are added to the network, the network becomes more valuable to existing participants.

Everyone in the U.S. knows the FICO scores. Over the last 10 years, FICO grew its awareness from 30% to 90% in the U.S. without spending any money on advertising. In fact, the credit bureaus and banks basically advertise for FICO with their services. So FICO has built an ecosystem where they are spread to consumers or end-users through their clients. And this is really, really powerful. 

When a bank has a new client, it will refer to its FICO score and not another score. If the bureaus want to implement another credit score, lenders will most likely prefer FICO. Even though a generic score is a little bit cheaper, lenders still prefer FICO because they are used to it. Financial institutions don’t easily change between one bureau to another. That’s why they prefer to have FICO just because it’s already there. The setup is there.

The deep integration of FICO scores and products into companies' operations has raised switching costs. For nearly every financial institution, it does not make economic sense for them to switch to an alternate software provider as FICO's credit scoring system is the industry standard. As companies adopt more services using Fair Isaac's platforms, they become more entrenched with time. Companies generally do not want to risk lost data and productivity which leads to business disruption. An imperfect data migration could lead to huge amounts of frustration and business risk that would cause any company to think twice about switching from Fair Isaac. Due to this, I believe that FICO is likely to preserve its pricing power over the long term. 

Even though a client would like to switch from FICO to another platform, the scoring business enjoys high barriers to entry and no company has created a real threat in this segment. As we’ve seen in the Competition section, the credit bureaus (arguably the best positioned potential competitors) tried for some years to compete with FICO through the Vantage score. However, Vantage has failed to gain meaningful traction, and Experian’s deal to offer FICO scores on its websites in 2014 represents an evidence of FICO's continued dominance.

The FICO brand has even increased when the company decided to put the FICO score on the customers’ statement to bring them awareness. People can see their score and are accustomed to its name.

Also, the company regularly updates its scoring algorithms to include more factors and to improve probabilistic forecasting. Its tools are generally considered simpler and easier to use for clients without advanced quantitative departments. 


Failures in new markets: If the company fails to identify and penetrate new markets which it currently does not serve, its revenue growth may slow down. The company intends to grow its revenue by delivering its products through additional distribution channels and new countries. If the company fails, its revenue growth could be negatively impacted.

Cyclicality: No different than Moody's or S&P, FICO's business is naturally cyclical and tied to expansions in consumer credit. In particular, the more loans companies are making, the more credit checks are being done, and the more money FICO makes. So clearly FICO is poised to benefit greatly from the improving climate for automobiles, housing and business credit in general.

As you can see in the graph below, FICO has a history of going through extended multi-year periods of very fast earnings growth, alternating with moderate earnings growth declines. Their cycles seem to correlate roughly with the wider credit cycle, which makes sense for a credit analytics business.

So a risk arises if we are in the peak of the cycle. One can wonder where we stand in the economic and credit cycles.

Regulation: Because FICO is almost a monopoly in the scoring business, it worries the Department of Justice and Congress. As one example, the Federal Housing Finance Agency ruled in March 2020 that they must consider alternative rating systems like the VantageScore. After 9 months, this antitrust investigation went nowhere. In December 2020, no enforcement action was taken. As Fair Isaac continues to be a dominant part of the credit market, I suspect more investigation will appear.

Competition: There is always a disruption risk coming from new entrants or VantageScore. This risk is not alarming as FICO has kept his dominance for decades now. Upstart said their models need the FICO score, so companies like Upstart, Credit Karma/Intuit could expand the market and demand for the FICO score.

Government: There is a chance that the government wants to have the control over credit scores, and that any credit reporting transaction has to be reported to some government bureau. In this case, bureaus and FICO will get broken or can become public. This scenario exactly what China does. The Chinese government knows everything about you and decides if they’re going to give you a credit or not. In my opinion, this risk is low because of two reasons:

The people don’t want that the government knows everything about people. If the government needs, they can go get someone’s credit history. They have to go to a judge, to a court, they will justify it. They can get it, but people don’t want their information to be stored in a government agency. They trust more a private organization All the three bureaus have lobbyists. They are doing to do whatever they can to make sure that the government does not make it a low that you have to report everything to the same agency. So it will be difficult for the government to implement this.


If we look at earnings valuation since 2006, Fair Isaac has gradually been more expensive to a PE ratio of 57 in early 2021. The company has not been cheap often, and never in recent years. In fact, since 2013, the PE ratio has always been above 20. 2014 was maybe a good buying opportunity at 20 times earnings. But for the last years, the company has become very expensive, trading at 60 times earnings in 2019. 

The stock recently declined to a PE of 26. I would say that’s a not expensive nor cheap considering the good moat and earnings growth of 22%.

The Price to Free Cash Flow ratio has followed the same growing trend. Because free cash flow has substantially improved since 2019, the P/FCF has decreased from 48 to 25. Again, definitely not cheap but not excessively expensive. 

So valuation has recently gone down in 2021 because earnings have improved but price has also taken a hit as you can see below.

There has been a pullback of the stock since July 2021 due to concerns about increased competitive pressure from VantageScore and FinTech's proprietary score, and worries that traditional credit scores aren't going to play as much of a role in the future of consumer lending as they have in the past. 

Whether it is true or false, I think these narratives are overblown. Wall Street forgets that this company has been facing competitive pressure for years and that it operates not only in the score business, but in management analytics and fraud protection which can bring more revenue in future years.

In my opinion, the simple reason for the stock decline is overvaluation. At the beginning of 2021, the stock was trading at a PE of 50. That was very expensive. Now, with a 35% decline and roughly 30% earnings growth, the current GAAP PE is 26. 

So you may think it’s fairly valued. But if we subtract the recent sale of the Collection and Recovery business in 2021, we must deduct $3.23 from the GAAP EPS so the real EPS as of November 2021 is $13.4 - $3.23 = $10.17. And then the real PE ratio is $350/$10.17 = 34.4. Even though it’s less that the US Software industry average (PE ratio of 50), I think the stock is expensive for the moment.

I don’t think you can buy FICO with a big margin of safety. The best you could find is a “fair” price in my opinion. If you take the quality of the business, with its competitive advantage and growth opportunities in an asset-light business model with tremendous pricing power and regular buybacks, you can maybe pay a premium for this business. As EPS has been growing at roughly 22% for the last decade (maybe a bit less considering the 2021 sale), I believe buying in the 22-28 PE ratio range is not excessive, which would mean a price ranging between $224 and $285.

In the wonderful Gurufocus website you can have an estimation of the fair value of a business, which you can see in the chart below. 

So Gurufocus thinks the company is modestly undervalued. If the price continues to drop to the 300s range, it will require further attention. Long-term investors don’t want to overpay for a stock.


I like FICO. Its royalties business model and its leading market position in scores has enabled it to sustain highly attractive returns on capital and great earnings growth. Management seems capable with a habit of doing buybacks, so I believe the stock is a good pick for the long-term.


























































Analyst's Disclosure: I/we have a beneficial long position in the shares of FICO either through stock ownership, options, or other derivatives.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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