An Analysis of Lending Club’s $5 Billion Valuation

[Editor’s note: Many people have been discussing Lending Club’s somewhat lofty valuation so I thought it would be useful to bring in a valuation expert to do some analysis.  Ho Wan Lee, CFA, CAIA, is a senior associate in the valuation group of Arcstone Partners LLC. Arcstone specializes in the valuation of high-growth companies and complex securities. Current and former clients include some of Silicon Valley’s best known tech companies.

Note that neither Lending Club nor Prosper are clients of Arcstone, nor does Arcstone have privileged information relating to Lending Club, which is the subject of Lee’s analysis below. The analysis is the unique work of the author and is based entirely on information available to the public. Mr. Lee’s analysis is provided for informational purposes only, does not constitute an opinion of value, and should not be construed as investment advice.]

Lending Club (“LC”), the world’s largest online marketplace connecting borrowers and investors through its online lending platform, is expected to launch its IPO in the coming weeks. The amount of the raise and the IPO placement price are still unknown at this point in time, but according to an article in the Financial Times the Company is anticipated to raise more than $500 million with an implied valuation of about $5.0 billion. One question apparently on everyone’s mind is this: is a $5.0 billion valuation reasonable?

The Company has shown rapid appreciation in value over the last several years. It was valued at $3.8 billion in April when it acquired Springstone, a company that facilitates education and patient financing. So to begin, a $5.0 billion IPO valuation represents a 33.3% increase in value from April of this year, and an annualized increase of 88.2%. Certainly, some of this increase in value could be explained by what we valuation analysts refer to as a “liquidity premium”, which essentially reflects the increase in value when a stock is freely tradable. Moreover, comparing the implied increase to the historical increase in observed valuations of LC while still a private company, the jump in price does not seem outrageous.

Table 1: LC’s valuation over time

Lending Club Valuation over time

So that’s one way to look at the $5.0 billion implied valuation. What about valuation multiples? Looking at LC’s venture round pricings on a multiple of total originations, it has remained relatively consistent in the 0.8x – 0.9x range. If we assume a 0.8x origination multiple, a $5.0 billion IPO valuation would imply LC’s total origination of $6.3 billion as of September 2014, which is not unreasonable considering LC’s recent trend.

Table 2: LC’s Valuation/Originations over time

Lending Club Valuation-Origination Trend

(Origination numbers source: nickelsteamroller.com)

Now what about multiples compared to comps? Based on the Company’s revenue for the 12 months ending June 30, 2014, the $5.0 billion valuation implies an enterprise value (“EV”) to trailing revenue multiple of approximately 30x. In LC’s S-1 filings, company management identified a list of public technology companies as their compensation peer group, which they selected based on consideration of revenue, revenue growth, net income and market cap. It is important to note that these companies are not necessarily valuation comps as they were identified as compensation comps in the S-1. However, the peer group does provide insight regarding management’s expectations about the Company and provides a potential benchmark for LC’s IPO valuation multiples. To assess the implications of the estimated $5.0 billion valuation for LC, we consider LC’s implied revenue multiple of 30x relative to trading multiples of comps as well as their IPO multiples.

Table 3: LC’s executive peer group’s operating metrics and valuation multiples

(click on the image below to view at full size)

Operating Statistics

Table 4: LC’s executive peer group’s operating metrics and valuation multiples at IPO

(click on the image below to view at full size)

Lending Club Valuation Comps

As seen in Table 3, the implied revenue multiple of 30x for LC far exceeds the current trading multiples of comps, with only Workday coming close. Similarly, as seen in Table 4, LC’s implied revenue multiple of 30x is also substantially higher than the IPO multiples realized by the comps. From 2012 to 2013, LC experienced net revenue growth of 189.9%, which places it at the high end of the comps (the only company that had last calendar year growth at IPO higher than LC was MarketAxess Holdings, which experienced 233.9%).

One other notable metric to consider is revenue scale. Typically, revenue growth tapers as scale increases since it becomes harder to achieve further penetration as a company increases market share. Notably, for the twelve-month period ending June 30, 2014, LC has already reached a revenue scale of $147.9 million, which puts it at the higher end of the comp set at IPO for revenue scale; yet the Company was able to generate higher growth than all but one of the comps. Indeed, over the last several years, the Company was able to achieve substantial growth in revenue through consistently growing loan originations, as well as improving profitability. We note, however, that LC’s profitability actually declined in the year-to-date period ending June 30, 2014 primarily due to increase in compensation expenses.

Charts: LC’s operating performance pre-IPO

Data in the charts below were retrieved from LC’s SEC filings

Charts_LC's operating performance pre-IPO

Although LC was able to generate high revenue growth to date, in order to justify the high valuation, investors need to believe the Company will be able to continue attaining extraordinary growth (keeping a similar growth trajectory as in the past few years) and leverage its operating efficiency to achieve high profitability in the future. Essentially, the high valuation assumes LC will be able to achieve its mission of transforming the banking system.

Based on LC’s S-1 filings, the Company believes further expansion is achievable through:

  • Enhancing the product suite. The Company expanded into the small business loan market in March 2014, and has also branched out to education and patient loans with the acquisition of Springstone.
  • Widening the spectrum of borrowers served. The Company plans to extend the product offering to wider risk profiles to meet demand.
  • Entering into strategic partnerships with banks, asset managers, and insurance companies.
  • Continuing to invest in its technology platform and data sources to connect an increasing number of borrowers and investors, identify new borrowers, detect fraud and maintain the security of the platform.
  • Exploring international opportunities. The Company currently operates in the US, but intends to expand the platform to address similar banking system inefficiencies, market dislocations, investor needs and borrower dissatisfaction globally.

However, we believe the following are significant risk factors that could affect the Company’s success. This list is not meant to be exhaustive and additional risk factors exist, some of which are presented in the Company’s S-1 filing:

  • The Company may not be able to continue growing its loan originations and revenue in the future.
  • The Company may be unable to maintain relationships with issuing banks.
  • Increased competition may negatively affect future earnings potential.
  • The Company may be negatively affected by regulatory and compliance mandates.
  • Fluctuations in interest rates could negatively affect transaction volume.
  • Failure to maintain information security of the platform can negatively impact confidence in the business.
  • The Company had positive earnings in 2013, but incurred net losses in the six months ending June 30, 2014 primarily due to an increase in compensation expenses. Fluctuations in earning may continue to occur, and the Company may not be able to achieve profitability going forward.

So what’s the answer? What’s it worth? It ultimately depends on your assessment of the Company’s prospects for growth and profitability, as well as your perceived risk of the investment. To justify the estimated IPO valuation, it is clear that LC needs to continue achieving astonishing growth, which is however not impossible given its unique position in a huge industry and its impressive track record. How will the Street receive the Company? It will ultimately be priced according to the different valuations that market participants place on the Company’s stock. My guess is no better than yours.

I wish you good luck as you embark on your own analysis of this interesting company.

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JJ Hendricks
JJ Hendricks
Sep. 29, 2014 1:55 pm

Good read. I think it all comes down to the statement above, “LC needs to continue achieving astonishing growth”. If LC can continue their growth then $5 billion is definitely justified. Otherwise it is way over priced.

The company is priced for growth prospects, not current profitability, which is not consistent.

Plasticman
Plasticman
Sep. 30, 2014 7:32 am

I began in both Prosper.com and Lendingclub .com borrower-member loans shortly after I read a Barron’s Electronic Investor column titled “At Last a Bank of your Own” in 2007 when Lendingclub went into business. After checking Zopa’s success in England, a highly regulated economy, I decided to invest any income tax refund and give Pier to Pier Lending a try. I split my investment 50/50 between Prosper and Lendingclub. I lost my Prosper investment because Prosper was a poor collector and Lendingclub was contacting the borrower within 10 days after being late stating stating “You(the borrower) now owe 2 Payments the payment that was past due and the next payment that is due early. I know this because all collection contacts are recorded and each Investor member can look this up for each loan number in his account! I know that Prosper has done an overhaul on their system but since Lendingclub started I now have almost 30K loans and I,have never lost a Penny of Principal. Matter of Fact, Lendingclub states that No Lender with at least 800- 25$ loans has ever lost a Penny of Principal!
Q.E.D.Plasticman

Dan B
Dan B
Sep. 30, 2014 3:15 pm
Reply to  Plasticman

Uh huh……………So, Lending Club good, Prosper bad, I get it. But what has any of this to do with Lending Club IPO valuation? 🙂

A joke...
A joke...
Oct. 1, 2014 6:53 am
Reply to  Plasticman

“Pier To Pier” … Should be the name of Renauld’s yacht

Prescott
Oct. 1, 2014 4:51 pm
Reply to  Plasticman

Is that Prosper loss pre the relaunch? Everyone lost money there – there was a whole class action about it.. If it’s after I’d be curious to learn more about your investing strategy to learn how you lost money – it’s pretty hard if you’re not concentrated to lose money.

Observer
Observer
Sep. 30, 2014 10:13 am

Not looking at fwd (2015+) valuation multiples makes this analysis basically useless. This is not how the buyside values high-growth internet companies. Look ahead…not behind.

Prescott
Oct. 1, 2014 4:51 pm
Reply to  Observer

So your opinion is that this valuation is low?

Observer
Observer
Oct. 1, 2014 5:12 pm
Reply to  Prescott

No, the valuation is absolutely absurd.

Prescott
Oct. 1, 2014 5:39 pm
Reply to  Observer

I get you’re saying it’s useless. Imagining someone picked 5B out of thin air, do you think that’s high or low?

Observer
Observer
Oct. 2, 2014 8:45 am
Reply to  Prescott

high

LC is not a marketplace

glenn hodgeman
Oct. 1, 2014 9:51 pm

The growth opportunities for Lending Club seem large. From what I have read, they have lent $5bn in loans so far, the consumer finance segment in the US is $3.2 trillion, of which LC see their segment to be approx $380bn……a lot of upside if they can get that. However, I have 3 issues, why is it a company can originate $5bn in loans yet has still hasn’t made a profit. Secondly, the valuation multiples applied above for LC seem very high compared to their peers. Finally, the economic, political and market conditions at the moment are deteriorating, it is critical for the success of Lending Club IPO to have a positive investment environment, otherwise investors will sit on the sidelines and watch or it will be postponed.

NealS
NealS
Oct. 2, 2014 8:48 am
Reply to  glenn hodgeman

Future for LC is not limited to the consumer lending sector. Small business lending, real estate, you name it. If the current financial system has built-in inefficiency anywhere, it will be targeted by someone.

Tony Chen
Dec. 4, 2014 9:02 pm
Reply to  Peter Renton

Hi Peter:

Do you think Lending Club could tweak around with their investor management fee to boost revenues? I believe it is currently at 1 percent. How about 1.5? How would investors react to that?

Jonathan Palan
Jonathan Palan
Dec. 5, 2014 8:08 am
Reply to  Tony Chen

Tony – the 1% is the servicing fee on the retail side which strictly covers the costs associated with the business and also aligns your interest with the company – LC only gets paid if they collect your payment

On the institutional side fees have come down in a scaled manner with breakpoints, larger investors have smaller fees – think in the range of $5m, $10m and $25m as the breakpoints

This is not their revenue model – their profit is from the origination fee upfront – if it costs them $200 per loan to acquire a borrower, underwrite and originate a loan that generates $600 in revenue with SG&A at $100 – thats a trade anyone would do all day – it breaks down as such

$600 (arbitrary #) in revenues
-$200 in acquisition and underwriting costs
-$100 in SG&A
_______________

$300 profit per loan which is an insane margin and then all it needs is to scale which it is only at the infancy

What multiple would you put on a company that had this margin and was the leader in a $5.2 trillion market?

I think you’re going to see the range get raised and the company hit a $10 billion market cap day one of trading

Jonathan P
Jonathan P
Oct. 17, 2014 9:35 pm

Forget about true comps, lofty multiples, nobody has ever generated alpha by betting on multiple levels.

What’s crucial to keep in mind is the massive size of the market they are targeting and the value they have created with two very small products on the realm of financial products. A simple 3 and 5 year straight line amortization product – that is a basic as it gets and look at what they created.

This is a similar path to EBay, Priceline, Netflix – creating efficiencies through technology and lowering the costs – that’s all LC’s business model really is – nothing complex about it
Even in the unsecured consumer market they are a blip on the radar vs. the big concentrated players.

Even if they stayed soley in this vertical the growth potential is substantial but with verticals like Auto, Mortgage, etc completely untapped I would make a case for multiple expansion not compression.

Management has executed flawlessly in every aspect and there are significant levers left to be pulled for the foreseeable future.

Tony Chen
Dec. 4, 2014 9:20 pm
Reply to  Peter Renton

Hi Peter and Jonathan: I agree with the management statement. LC’s leadership has been slow and steady in their growth strategy and have gone somewhat against the startup culture of “fail fast.” I find that because of the heavily regulated nature of the securities industry, LC has had to play strictly by the books from the very beginning. This is somewhat in contrast to the meteoric rise of Uber and Airbnb both of which have had to adjust their strategies somewhat retroactively as regulators crack down.

My question to you both is whether or not Lending Club’s performance can sustain itself in the event of a prolonged economic crisis like 2007-8, in the event of significant round of widespread layoffs and slow hiring.

Jonathan Palan
Jonathan Palan
Dec. 5, 2014 2:37 am

HI Tony – good points and a valid question

While LendingClub did build it’s business during the economic crisis one could argue it was not at scale or resembled anything close to what the business looks like today – this is a fair a valid analysis

I will say that if you look at historical data and the breakpoints you will see that the consumer that represents LendingClub’s borrower base along with the combination of small monthly payments will lead to sustainable growth and asset performance on a RELATIVE basis

I am sure you will see some defaults spike, payments come in late and the velocity of the growth slow during a cycle however, relative to any other model out there it would outperform any way you slice the cake

Jonathan Palan
Jonathan Palan
Dec. 5, 2014 2:42 am

one more follow up and for full disclosure I am no longer an employee of LendingClub but am an equity owner and have a ongoing relationship with the team

The real mind bending growth story is something I don’t think much of wall street is even aware of – the white label initiative

LendingClub can go into any bank or credit union and strip out all of the costs associated with underwriting, originating and servicing while giving the asset side of the business full NIM exposure as well as scale and reach to a demographic they otherwise would never be able to obtain otherwise

Think of a “XYZ bank loan powered by LendingClub”

There is limitless iterations and permutations of that concept but to me, that is the true growth story to his company

We are only just starting to see the real power and leverage of the model

Jonathan Palan
Jonathan Palan
Dec. 5, 2014 7:55 am

you have to remember, you and I have made career bets on this model close to 6 years ago – most of wall street at least on the equity side is hearing the story for the first time – it takes a bit for the magnitude of whats been created here to sink in – I still loose sleep over the opportunities that can blossom in any vertical or distribution channel

No traditional finance company can come close to unit economics as LendingClub or other streamlined solutions – the earnings power to this potential is mega – I can’t quantify it but i’m sure some analysts on the street can – they will as soon as the model sinks in

Garret C
Garret C
Dec. 12, 2014 12:39 pm
Reply to  Jonathan Palan

I totally agree. I think 5 to 10 years down the road, these peer to peer lenders will we the main players in the loan industry. They will be the first place you think for look for a loan for the millennial generation.

Jonathan P
Jonathan P
Dec. 12, 2014 6:45 pm

Yup, it’s the simplicity of the model that makes it so powerful

This is no different than Netflx, Priceline, EBay or Amazon. It’s a more cost effective process va. Brick and Mortar storefronts and much more convene isn’t and user friendly for the co Sumer

Does wells even have an installment you can apply for online?

Aditya
Aditya
Jun. 4, 2016 12:14 am

Is the loan origination multiple based on cumulative loan origination till date or for the last quarter/twelve months?