What Elevate Credit does
Subprime and fintech together make an unlikely couple, and together they certainly don’t sound like a value play. But that’s precisely what Elevate Credit (ELVT, Financial) is; a small-cap, value fintech opportunity in the subprime lending space.
The company began its life as Sequoia Capital and TCV-backed Think Finance in 2001, which developed technology and analytics for third party lenders to non-prime customers. Elevate’s original set of products - Rise, Elastic and Sunny - were created in 2013, but the company has been lending, or providing technology for lenders, since 2002, so it has experience lending through the 2008 financial crisis. In 2014, Think Finance spun off its consumer lending products portfolio into a new company called Elevate.
Rise is the company’s U.S. unsecured installment loan and line of credit product, targeting the millions of non-prime Americans living paycheck to paycheck. Loan amounts vary between $500-$5,000, with a repayment term of four to 26 months in length and interest rates ranging from 36% to 299%. These loans carry no prepayment penalties, and customers can obtain a 50% or more reduction in their rates by making timely payments. Sunny, now discontinued, was the same product as Rise but offered in the UK instead.
Elastic is an open line of credit, available in 40 states. The size of the line of credit ranges from $500 to $4,500. Elevate charges a 5% or 10% Cash Advance Fee, depending on the billing cycle (bi-weekly vs monthly), as well as a Carried Balance Fee of $5-$350 if the Carried Balance is greater than $10. Elastic’s products are underwritten by Republic Bank using Elevate Credit’s technology platform.
Today, Card is Elevate’s newest and latest product line, a Mastercard branded credit card that “offers a prime experience to non-prime users, including a mobile first experience, credit lines up to $3,500, credit monitoring and family line sharing." The company charges a $120 annual fee, and an APR of 32.25%.
What makes Elevate different
It’s easy to brand Elevate as just another online payday lender lending to subprime customers with scores less than 670. While the company is aiming to displace payday loan storefronts, pawn shops and title loans, it is offering much more than just moving the payday loan experience online.
Existing payday lenders resort to strong arm tactics and charge interest rates starting at 400%. These rates don’t go down even if the borrower makes successful, on time payments. These lenders don’t report to credit bureaus either, so customers do not benefit in the longer run from making timely payments and seeing their credit scores increase. Title loans often result in the customer losing property, a car, or some other all-important asset.
Elevate, on the other hand, wants to provide its customers with a way to escape their existing financial quandaries. The company aims to drive down its APRs over time, and has followed through on its vision by doing just that these past few years. Repeat customers can get 50% lower rates, and rates can continue decreasing over time. Importantly, Elevate reports to credit bureaus, allowing no-credit customers to establish credit with a few successful payments. As their credit improves, these customers can then refinance with cheaper options.
The company also offers free credit monitoring tools, financial education videos and online courses. Customers can also get lower APRs by taking these financial literacy courses all from the convenience of their smartphones.
Elevate is also differentiated from other modern day lending platforms such Lending Club (LC, Financial), which focuses on prime or near-prime customers and holds loans on its balance sheet as opposed to a fee-based/securitization model. Upstart (UPST, Financial), with a market cap of $27.6 billion and a recently minted investor darling, also lends to the subprime segment, but there is a case to be made that it is overvalued.
Besides the company’s progressive business model, Elevate Credit also differentiates itself through its underwriting technology. The company has developed a technology platform named DORA, built on Hadoop technology. Hadoop’s ability to analyze massive datasets is essential when dealing with subprime customers since Elevate can’t rely on typical off-the-shelf scores such as credit scores. The DORA database analyzes 10,000 different variables across a 40 petabyte database amassed from the 2.6 million customers it has served, and the $9.2 billion in cumulative loans it has issued. Elevate currently has $500 million in loans outstanding. The company employs several data scientists, and 95% of the loans through the platform are decisioned without the need for any human intervention. The proof is in the pudding, as Elevate Credit has demonstrated consistently stable charge-off rates in recent years.
The company has originated over $9.2 billion in loans to 2.6 million customers and saved them over $8.5 billion compared to payday lenders. Elevate has a long-term target operating margin of 20% (it was 38% in the most recent quarter). If the company becomes more profitable, its policy is to pass the profits onto customers in the form of lower APRs, which has the added benefit of expanding the company’s overall addressable market from the already huge 80 million customers in the U.S. The company’s average APRs have declined since 2013, reaching 95% for the six months ended June 2021, down from 189% in Q1 2015, showing a steady downward trend.
Covid-19 had resulted in a 21% drop in revenue at the start of the year, as government stimulus checks reduced users' needs for any of Elevate’s products. The company is now back in growth mode, showing a 13% increase in combined loans receivable. Rise has shown 14% quarter-over-quarter growth, with Elastic at 8% and Today at 42%.
The company has used the down cycle from the pandemic to focus on improving its credit quality, resulting in much lower net charge-offs (charge-offs as % of originations) and loan loss provision (10% vs. 14% for the same quarter in 2020).
One of the bear theses is how the loan pool will perform during a recession. Interestingly, Elevate’s management believes the subprime class will experience stable charge-off rates, or perhaps even better charge-off rates, in a recession. This is because a) the customer base is already “recessionary” by nature, so a broader market downturn doesn’t affect that segment of the population as much as prime borrowers, and b) in a recession, prime customers fall out of prime status and into subprime or non-prime categories, which has the effect of improving the subprime loan pool. Given Elevate’s previous history as Think Finance, it has experience lending through a recession; the company’s chargeoff rate remained stable between 2006 and 2011 (18.2%-20%), while credit cards tripled in the same period going from 3.5% in 2006 to 9.4% in 2009.
The company went public at the beginning of April 2017 in its second attempt. The first time it tried to go public, at the end of 2015, it was looking to price at $20 to $22 per share. Given the turmoil in January 2016 and the ensuing fallout from Lending Club’s and On Deck’s fall from grace at the time, the offering was postponed. The company had hoped its offering the second time around would fetch $12 to $14 per share, but the IPO ultimately priced at a mere $6.50 per share, and the stock now trades at $3.70.
In terms of valuing the company, management has put forth a target margin of 20% before debt costs, which I believe the company is quite capable of hitting. The company expects to hit $380-$400 million in revenue this year, for an adjusted Ebitda of $50-$60 million (both figures down from 2020 figures due to the pandemic, but with much higher credit quality and lower loss rates driven by its technology). Elevate has served less than 5% of the overall market here in the U.S., and with 13% quarterly growth so far this year, that market is ripe for the taking.
If the company continues at this rate of growth, which is not inconceivable given their renewed focus on growth, it would put total revenues in 2025 at roughly $2 billion. At a 20% operating margin, that would equal about $400 million in Ebitda.
Now, the question is, how much will its debt cost and how much debt will the company need (as opposed to internally generated cash flow)? I assume that the company will lower its average interest rate by 30 percentage points from today’s rate of 95%. So it will take about $3 billion in debt financing to generate $2 billion in revenue. Assuming the company is able to lower its average cost of debt (with some no-coupon equity) to around 10% over that period, and funds a similar large portion of loans, let’s call it $300 million in interest costs, leaving $100 million in pre-tax income. Assume a 35% tax rate, and one gets about $65 million in earnings.
In sum, I think Elevate is a high-quality technology leader in a large market with few players. The numbers to date indicate that its underwriting technology is sound. The company’s scale, its experience lending through a recession and its use of 10,000+ data points to drive credit quality give it lower costs of acquisition and the ability to undercut new entrants on loan pricing over time, which it has done so consistently in the form of lower APRs. As Elevate gets bigger, it can drive down operating expenses to its target margins, thereby lower its cost of funding and in turn passing the savings on to the consumer, establishing a flywheel effect not unlike Amazon’s scale and price based advantages in retail.
Then, what earnings multiple would a company like this trade at? There are no easy comps as far as I know, but let’s say that, even with a higher growth rate, the risk entailed calls for a discount multiple to big banks, so the company only trades at a 12 times earnings multiple. That means the company would be worth $780 million five years out, for a 44% annualized return from these levels. Discounted back by 12%, that figure would yield about $12 per share, assuming about 10% share dilution.