Lending Club’s Valuation Wonderland

I’m not one to argue too often with the stock market’s collective judgment on a given stock, or with analysts’ valuation methods, but was struck by this comment from BTIG’s Mark Palmer on the just-IPO’d Lending Club (LC):

We are reiterating our BUY recommendation on Lending Club (LC) while increasing our price target to $31 (from $19) based on 0.8x the company’s FY16 total loan originations of $13.7bn discounted back at 10%. . . . .

 

We acknowledge that we were overly conservative with our initial price target on LC, which was based on a 15x multiple of its FY18E adjusted EBITDA, and we believe a significant premium valuation is warranted given the company’s remarkable growth potential. As consumer awareness of the benefits of LC versus traditional banks becomes widespread, we believe a consumer preference shift is likely to occur that would be akin to previous shifts such as those from traditional booksellers like Borders to Amazon and from video rental firms  like Blocbuster to Netflix. . . .  [Emph. added.]

Oy. Lending Club, in case you’re unaware, is a so-called peer-to-peer lender. Which is to say, would-be-borrowers go to its web site to apply for loans, and would-be lenders go to its site to decide if they want to fund those loans. The company does the underwriting and matches borrower to lender. (I’m oversimplifying a lot, but that’s basically what happens.) During the road show, Lending Club apparently went out of its way to position itself as a tech company, in order to convince the market to award it a rich tech multiple—but from where I sit as the manager of a financial services fund, the company sure looks like a plain-vanilla financial services firm. It underwrites loans and arranges their funding.

Which is why Palmer’s note above is so  . . .  interesting. I’ve been at this for 30 or so years, and have to confess I can’t recall a single instance of an analyst valuing a lending business on the basis of its EBITDA. Why would anyone do that? To begin with, what the heck is there to depreciate? And I’m virtually certain I’ve never seen anyone try to value a company based on its annual loan originations. It’s the kind of idea—and, again, I’m just a financial services analyst, not a tech maven—that makes my head hurt. I’ve seen more than my share of financial crackups and, trust me, you don’t want to reward companies for unvarnished loan growth. More generally, if a financial services company is touted as having “remarkable growth potential,” there’s a fair chance things won’t end well.

Nor (even though, again, I’m no tech analyst) is it clear to me that peer-to-peer lenders will doom the banking business the way Amazon toppled booksellers and Netflix did in Blockbuster. The banking industry is a whole lot more regulated than bookselling and video-mongering. I may complain a lot about banking regulation, but regulation can serve as a powerful barrier to new entrants. And incumbent banks have their own advantages, not least of which is ultra-low and stable funding costs, thanks to federal deposit insurance.

The fund I manage doesn’t own Lending Club and I haven’t done enough work on the company to know whether it’s an attractive investment or not. But I do remember the tech boom of the 1990s. I was on the sell-side back then, and recall fast-growing, low-profit Internet IPOs being justified based on whatever metric analysts could come up with, like eyeballs-per-share or the number of Ph.D.s on a company’s board. Using EBITDA and origination volume to figure out what a company like Lending Club is worth may not be quite that preposterous. But it’s close.

What do you think? Let me know!