Lending Club, the largest peer lending platform in America, will issue shares on the New York Stock Exchange soon and the pundits are sure to offer up all kinds of predictions on how much the shares will be worth. Use this infographic and your own analysis for how much you think the stock could fetch. I’ve included more detail on my own analysis below the infographic.
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The peer lending giant announced earlier this month in its S-1 Registration with the Securities & Exchange Commission (SEC) that it would raise up to $796 million for Lending Club stock at a price between $10 and $12 per share. At the high end of the range, the company would be worth $5.6 billion on a fully diluted basis.
Putting a Price on the Future
Stock market valuation is not an exact science and can sometimes seem more like voodoo than a legitimate occupation. It is one of the few jobs out there where you’re actually expected to predict the future with a degree of accuracy. Take valuing Lending Club stock for example; from sales to management decisions and government regulation, the analyst needs to be able to somehow foresee how all these factors are going to translate to profits in the future. Needless to say, there are a lot of estimates that come into play.
Fortunately, there is a common process that analysts use to arrive at these estimates and a final target on the stock price.
While Lending Club is the first true peer lending company to issue shares, we can use other financial companies to value Lending Club stock. The table below shows data for stocks of companies in three comparable financial industries.
From a comparison of other financial companies, we can begin to draw a picture of what sales growth and profitability might look like for Lending Club stock a few years down the road. One note on the table: I have chosen to show the comparables’ margin on earnings before interest, taxes, depreciation and amortization (EBITDA) which is more commonly used for valuation but very similar to operating margin for finance companies.
Mid-size banks would seem a good comparison for Lending Club. Both make loans to retail consumers and small businesses but that is really where the similarity ends. Banks take deposits, invest those deposits in loans and makes money off the spread in interest rates. Lending Club does not actually originate its own loans and does not take deposits. Its revenue comes from transaction and servicing fees as well as management fees for fund accounts. Lending Club does not invest its own money in loans and takes no credit risk.
I’ve also included Business Development Corporations (BDCs) as a comparison with Lending Club stock. These companies collect investor funds to make investments in small and mid-sized companies, much like a private equity firm. They take business and credit risk when they invest or loan to these companies and generally pay out high dividend yields to their investors.
Although business models differ, I like BDCs as a comparison for Lending Club stock for their similar roles in picking up the slack of slower bank lending over the last several years. Increasing regulatory burden has limited traditional bank lending to consumers and businesses since the end of the financial recession. As regulatory oversight continues to change lending in the country, the distinction between BDCs and peer lending platforms may begin to blur.
Comparing Lending Club stock against other consumer loan companies would seem the natural choice but the publicly-traded companies are a mix of payday loan stores, auto financing and other specialty companies.
Encore Capital Group (Nasdaq: ECPG) is a pretty close comparable for Lending Club stock, especially in its earlier days as a buyer of charged-off loans. The company went public in 1999 with total revenue of $28.1 million and a compound growth rate in sales of 101% over the previous three years. The company had a operating margin of just 6.6% and was still unprofitable. By the third year after the IPO, the company had maintained a 47% compound growth rate in sales, increased its operating margin to 29% and was profitable. Even more than a decade after the company’s public offering, sales are still growing at a compound rate of 30% a year though the company’s operating margin has not changed much.
This is where it all starts! Analysts look at past growth, market size and growth at competitors to see where the company could go. Lending Club grew sales by 190% in 2013 and is on track to do it again this year. Loan originations jumped 192% to $2.1 billion in 2013 and the company originated more than a billion in loans over the three months to September 2014.
Even on that explosive growth, the peer lending space is just a fraction of the $3.3 trillion consumer loans market and has plenty of room to grow. The company has just started tipping its toes into the small business market and there is no reason to believe that peer lending cannot grow into other loan types as well, i.e. secured auto and home loans. According to the Federal Deposit Insurance Corporation (FDIC), there are more than $292 billion in commercial and industrial loans outstanding with balances under $1 million. The money raised in the IPO could go a long way to paying for growth projects as well.
The demand for investment in peer loans is being driven by rock-bottom rates on other fixed-income investments. Rates on even junk-rated bonds are yielding less than 6.5% with maturity dates much further out than the three- to five-years associated with peer loans. Regulatory burden is becoming so onerous on traditional lenders that many are investing in peer loans rather than make loans themselves.
The Lending Club stock registration does not specify what the company might do with the money raised from the public offer, potentially upwards of $700 million. The company only has $1.8 billion in debt, about a third of its capitalization, so I wouldn't expect it to rush to pay down leverage.
The company calls out expansion into other loan types and geographies within its growth strategy. With the boom in student loan debt past $1 trillion, refinancing loans would seem a clear choice for the company's expansion. Lending Club acquired Springstone Financial in April which opens up the market for medical expense and private education lending. While international growth may be further off, the peer lending movement has done very well in the United Kingdom which could be a first stop in the company's geographic expansion.
I would expect the company to continue to spend money on lobbying state governments to lift prohibitions on borrowing and investing. Five states do not allow borrowing on Lending Club and 12 states prohibit investing on the platform, though all but five allow indirect investing through a Foliofn account. For a detailed review of the two peer lending platforms, see Peer Lending Sites Reviewed.
I am estimating growth to increase through 2015 on penetration into new markets and loan types before slowing slightly. Still, a compound rate of 180% over the four years to 2017 yields $1.12 billion in sales with plenty of growth potential further down the road.
How well does management make money after expenses? Analysts compare current expenses with competitors to decide how much costs will increase relative to sales growth. Currently, Lending Club makes just $0.075 for every dollar in sales. That’s well below the $0.30 in operating income that other consumer loan companies make but mostly due to heavy spending on product development and other expenses. Management should be able to get a handle on these as the company matures.
Stock-based compensation jumped to $15.3 million in the first six months of 2014, leading to an operating loss. Almost half of the increase ($6.5 million) was due to the Springstone acquisition so not recurring. The remaining increase still represents an increase of more than 35% on the amount spent in all of 2013.
Heavy marketing this year has accounted for about a third of the increase in operating expenses. Sales and marketing expenses jumped 147% to $23.7 million in the first six months compared to the same period last year. Marketing expenses will likely be a significant expense over the next several years as the company grows.
I am estimating the company’s operating margin increases each year to about 30% in 2017, comparable with other consumer loan companies but well below the margin at Business Development Companies. Since Lending Club does not originate loans itself and may not need as much staffing as a traditional finance company, it may be able to reach much higher margins than traditional consumer loan companies.
Share Count and Dilutions
New companies don’t have the money to pay big salaries to their top talent so they give them stock instead. It’s a great tool for keeping the go-getters but also reduces the ownership share of each stock issued. Lending Club reports in its most recent S-1 registration that there will be 154.19 million shares outstanding after the IPO but excludes approximately 31.56 million shares related to stock options, warrants and other compensation. I have included these shares and increased the shares outstanding each year to account for future stock compensation and capital raising. This is a pretty tough one to estimate and could be off. At that level of shares outstanding, being off by even 20 million on your estimate is not going to affect the ultimate earnings per share as much as you’d think.
Just over 1.8 million shares were exercised by four executives in 2013 for a value of $5.3 million. The company allows employees to participate in its stock purchase plan at a discount of 15% to the fair market value.
Earnings per Share
The “Bottom-Line” and what you’ll hear reported in the media. Your ownership of stock entitles you to a portion of the earnings generated though you’ll have to wait for the company to start distributing the profits. More importantly as an investor in a new and fast-growing company is how much other investors are willing to pay for those earnings and the promise of higher future earnings.
Lending Club made a profit in 2013 though higher operating costs resulted in a loss for the first six months of 2014.
For comparison, shares of Encore Capital Group were priced at 24.1 times trailing earnings in 2004 for a premium of 27% on the valuation of the S&P 500. That was when the company was only growing sales at approximately 30% a year versus the high growth expected for Lending Club stock over the next several years.
My assumption for earnings per share (boxes and right-hand axis in graph) is built on an estimate for 12.5% net margin in 2014 increasing to 19.5% by 2017. This may prove low if management can grow sales while controlling costs but I like to be conservative in my estimates. My estimate for the stock price from $15 per share on the IPO to $25 per share in 2017 is based on higher earnings but a progressively lower price-to-earnings multiple. A price-to-earnings multiple of 28 times in 2017 is still relatively high but not out of the question considering the high sales growth the company could still be experiencing.
Risks to Lending Club Stock
A ton of estimates go into stock valuation, especially for a company as new as Lending Club in an industry as new as peer lending. I have based my own estimates for growth off of the company’s prior growth and the potential in the market. Estimates for profitability have been based off of margins achieved at other consumer loan companies and Business Development Corporations (BDCs).
Lending Club does not originate its own loans, instead relying on its agreement with WebBank. This puts it at risk of relying on one single originator or that it will need to seek other partnerships.
While the market for pure peer lending is dominated by Prosper and Lending Club, the company still has to compete with other firms providing loans from their own capital and with traditional banks. With the cost advantages to peer lending and its small share of the lending market, competition should not be a significant risk for the next couple of years.
Peer lending has largely escaped regulatory costs so far but there will likely come a time when agencies take a closer look at the industry. When this happens, Lending Club may either choose to accept higher regulatory costs or may restructure its business to further avoid them. Either option would likely change estimates for sales or profitability.
There's bound to be more analysis on Lending Club stock after the IPO and high uncertainty in key factors likely means that price targets will range by quite a bit. While I am positive on the long-term outlook for Lending Club stock, investors may want to be cautious about jumping in on the first day of trading. To avoid getting caught in the market's enthusiasm for new shares, set a maximum price at which you want to buy the shares. The price range set by Lending Club for shares is only slightly above a valuation the company received earlier this year and the stock is likely to jump on the first day.
If the price of Lending Club stock jumps past your maximum buy price on the first day. Be patient and consider setting a buy order for shares if the stock price comes down. We'll follow the stock along with the industry on this blog. Join our email list and stay up-to-date with analysis and commentary delivered straight to your inbox.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.