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Lending Club is scheduled to begin trading next week as an initial public offering, and it is one of the most talked about IPOs of the year.
With an expected price range of $10-12, the shares would be valued at about $4 billion if priced at the midpoint.
But is the Lending Club IPO worth getting in on early, or does it spell trouble for investors?
Lending Club has an interesting model. Originally, the company offered direct peer-to-peer loans. If Joe needed $3,000 to pay off some credit cards, he’d offer a certain interest rate. Individuals who wanted to earn that rate could offer Joe anything from a few dollars to the entire thing.
Alas, the SEC got involved and deemed these peer-to-peer loans security offerings. So Lending Club changed things up in a clever way.
They allowed investors to purchase an interest in various notes, spread across the risk/return spectrum. The company is thus diversified across those notes. Lending Club collects a fee for servicing loans, transaction fees when notes are issued, and management fees for investment funds.
It is a terrific model. Thus far, however, Lending Club is losing money and not generating much cash flow.
Let’s look at why this is happening, if it will change, and what it means if you are considering an investment in Lending Club stock.
For the first nine months of 2014, Lending Club had net revenue of $143 million, based on $3 billion in loan originations. The revenue increase was 122% year-over-year, and adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) came in at $13.4 million. All told, the company shows a $23 million loss so far this year.
I am not crazy about a company generating 4.7% in net revenue off loan originations, and cash flow margins of 0.44%. In fact, I can earn a better return investing my money in the very notes Lending Club offers than what the company itself is making for shareholders. That, of course, discounts whatever increase in stock price may await.
All those headwinds …. and still the company is expected to be valued at $4 billion. Go figure.
Okay, so the company isn’t profitable now, but Lending Club is growing by investing in its infrastructure. Most importantly, it is serving a very important part of the population. The average client has a FICO credit score of 699, what is often referred to as “non-prime”. The FICO cutoff for Lending Club borrowers is 660.
Lending Club’s borrowers are generally folks who can get credit cards and other credit, but they’ve likely not been all that great at managing credit. They aren’t quite at the next level down, where they’d only qualify for payday or pawn loans.
So there’s a need being filled here – a group of borrowers that banks won’t even look at, who can still get high-interest credit in a few places, but aren’t in the absolute lowest tier of creditworthiness.
Thus, Lending Club’s success will depend on keeping delinquencies in line, so as not to scare off investors who have put money in at this early stage. The loans are for three- to five-year terms, so we’ll see what appetite people have once this first term ends.
Other money comes from institutions and investment managers, so their appetite for this kind of security is going to wax and wane. There are hundreds of high-yield investments out there, and many of them are more secure than Lending Club.
As for the stock itself, I suspect the hype surrounding the IPO is going to give short-term traders a great opportunity. I think there’s money to be made by moving quickly in and out of Lending Club stock during its first few weeks of trading.
For long-term investors, I would be cautious about entering at anything much above the IPO price. You’ll need to have patience, and wait to see if the model plays out. That’s going to take years.
In the meantime, you may be better off earning a decent yield by investing in the higher-grade notes Lending Club company offers to help its borrowers!
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