News of the Week (February 7-11)

Upstart; GoodRx; SoFi Technologies; The Trade Desk; Teladoc Health; PayPal Holdings + Duolingo; Lemonade; JFrog; Cannabis News; My Activity

1. Upstart (UPST) — New KBRA Surveillance Report + Affirm

a) KBRA Surveillance Report

On ratings and credit enhancements:

Kroll Bond Rating Agency (KBRA) published a new surveillance report this month detailing the performance of Upstart loan pools being funded through capital markets. Overall, credit rating action decisions were uniformly positive with the agency upgrading the ratings on 14 classes of notes issued through these loan funding programs and 18 more classes of notes having ratings reaffirmed. For 2021 transactions specifically, one note class was upgraded with the rest reaffirmed.

From a credit enhancement perspective, all asset-backed transactions continue to have excess reserve account funds and all continue to be sufficiently or over-collateralized as of February 1st, 2022. Most of its pass-throughs are structured without reserve accounts and do not build credit enhancements unless the trigger rate is breached. Thankfully, no triggers have been breached for Upstart pass-throughs to date. This all points to the loan pools being able to effectively compensate all investors which ensures continued capital market demand and justifies Upstart’s 6.1% take rate.

• Credit Enhancement definition: Financial cushion allowing securitized loan pools to palate a certain level of default-related losses.

On individual transactions:

Beyond upgrades and downgrades, KBRA shared new data on the performance of each individual pass-through and asset-backed securitization trust transaction. For 2018, 2019 and 2020, Upstart’s cumulative net less (CNL) leads continue to grow over Kroll’s base case current CNL projections.

2021 has been more of a mixed bag thus far. For all 2021 asset-backed transactions, CNL rates continue to outperform KBRA’s base case rates for all three of Upstart’s transactions. For pass-throughs, 1 of the transactions is outperforming, 1 is performing in line and 3 are actually slightly underperforming.

A few things to consider here. First, base case estimates from KBRA are arrived at using all past loss data from each individual company’s loan history. With stimulus massively aiding CNL rates amid the pandemic, this naturally dragged down base case CNL assumptions for newer 2021 transactions not benefiting as much from stimulus checks.

Furthermore, some of Upstart’s best performing transactions in the past had underperformed KBRA base case CNL estimates for the first few months of the transaction’s life before finding success.

Encouragingly, Kroll has not raised any of the base case ranges for the 3 underperforming pass-throughs. Additionally, no CNL rate is anywhere near the trigger rate which would lead to accelerated amortization of the loan pools and would spell trouble for Upstart on that particular tranche.

Also consider: as capital markets and partners become more and more comfortable with Upstart, they typically lower credit parameters and accept riskier and riskier loans. The result of this process is depicted below and naturally results in rising loss rates. Investors are compensated for this incremental risk in the form of heftier residual interest payments.

This risk-on trend appears to have leveled off in Upstart’s most recent transactions:

Overall transaction trends:

CNL rates for Upstart capital market transactions overall have shown upward pressure in some of its newer transactions. For asset-backed (left), the CNL trend is actual downward and so positive. For pass-throughs (right), the trend is more negative.

In a perfect world, every new transaction would feature lower and lower loss rates — but our world is far from perfect. The most important piece of all this is that reserve levels are comfortably sufficient to cover any default turbulence in residual cash flow coverage.

Delinquency rates for some of (not all of) the company’s transactions have risen back to pre-pandemic levels with some pass-through delinquency rates slightly overshooting historical means. This trend is less aggressive for asset-backed transactions (left) and more aggressive for pass-throughs (right):

While lower delinquency and CNL is always preferred, these sub-optimal trends have already been assumed and priced in to the company’s forward guidance:

“In terms of macro outlook, we are seeing the early signs of a return to the pre-COVID consumer profile with personal savings rates in the economy having fallen to pre-Covid levels and credit balances edging up to within 90% of pre-COVID levels. We expect the continuation of this trend to lead to an increase in consumer default rates consistent with pre-COVID levels and we believe that any issuer who has not priced this in is likely to experience a deterioration in their returns.” — CFO Sanjay Datta.

This next quarter for Upstart on February 15th is its most important since going public — by far. The primary risk to the company is whether its relative loan outperformance relies on a certain macroeconomic climate rather than the efficacy of its own machine learning models. With stimulus checks fading further away, the 2022 guide offered will be very telling of how much of Upstart’s success will be sustainable in the years to come. I’m excited to see the results. We’ll see how the company does.

I’m working on an interview with the head of asset-backed securities with KBRA. I want to learn — in his view — which are the most important trends in these reports to follow most closely. Hopefully I’ll get some specific feedback on Upstart as well. It should be completed in the next few weeks and will be included in a future News of the Week post.

b) Affirm

Affirm — a player in the buy now pay later (BNPL) space — posted what seemed to be fine results and then subsequently tanked perhaps due to language surrounding lowering credit quality to juice growth. While these two companies are often lumped together, I don’t think that is warranted. Here’s why:

Upstart relies on partners and institutions to fund its loans and set risk parameters. It cannot unilaterally lower restrictions to find more top line growth whenever it wants to — that’s up to the funders. Furthermore, while the growth rates of the 2 firms are similar, Upstart trades for roughly 30X EBITDA and 45X earnings for 2022 (assuming no beats) while Affirm remains fully entrenched in cash burn mode. Amid this tightening macroeconomic backdrop, cash burn like Affirm’s is out of favor and cash generation like Upstart’s is coveted. Finally, Upstart is not a buy now pay later company. Most of its loans are sourced to re-finance expensive debt — not to buy another depreciating asset like a Peloton. This is not me saying the quarter will be great, bad or anything in-between. This is merely me saying Affirm’s reaction should not be extrapolated to assume the same for Upstart.

Click here for my Upstart Deep Dive.

2. GoodRx (GDRX) — Prescription Costs Rise Again + a Clear Competitive Edge

a) Prescription Costs Rise Again

Drug manufacturers continued to precipitously raise prices into 2022. The average price hike for the year was 5.1% vs. 4.6% between 2020 and 2021: this problem is not abating but rather accelerating. Within this data set, the more expensive healthcare provider-administered drugs saw the most aggressive increases.

GoodRx’s branded manufacturers product directly combats this issue by bringing discount programs to its millions of consumers. As prices rise, the motivation to seek out these solutions rises and so does demand for GoodRx’s product. Considering just 3% of patients know about the discounting programs that branded manufacturers run, there’s immense (and growing) utility for this healthcare disruptor to create.

A small subset of generics saw their prices rise by an average of 12.6% which bolsters the value of GoodRx’s price comparison tool used predominately for these generics. Since 2014, GoodRx’s list price index has seen prices rise by 33% with broad-ranging price hikes seen every January and usually every July as well.

b) About Mark Cuban’s Project

A lot has been made lately about Cost Plus’s (Mark Cuban’s) entrance into the discounted prescription space. Knowing this, Co-CEO Doug Hirsch published a blog post depicting just how much better GoodRx is vs. its more intimidating competition (including Amazon). Richard Chu (@richard_chu97) brought this article to my attention and for that I wanted to thank him. Here were the key findings:

• Per Cowen, more than half of Americans prefer in person interaction with prescriptions. Beyond using pharmacy stops to buy other goods, keep in mind that patients must be at the door to sign for most scripts if they’re delivered, which is obviously not ideal or all that convenient.

  • Cost Plus and Amazon are both trying to build out a mail delivery system while most of GoodRx’s business is via brick and mortar (it does have a delivery offering too).

  • Specifically, mail order delivery as a % of total script volume topped at just 5% amid peak pandemic pain and even has begun to recede before we completely exit Covid-19.

• GoodRx beats Amazon pricing via mail or retail 90% of the time.

• Just 27/50 of the most popular drugs are available on Cost Plus. Cost Plus is solely mail and shipping rates are $5. Including this fee, GoodRx is cheaper 98% of the time (86% of the time without).

  • This isn’t unique to Amazon and Cost Plus… GoodRx is better than everyone else. That’s why its take rate continues to rise while competition like SingleCare is seeing its fall.

“We hope we can work with Cost Plus to introduce their service to our millions of monthly visitors. The bottom line: it’s really hard to do mail-order, even if your last name is Cuban or Bezos... The reality is that it’s not easy to lower the price of drugs.” — Co-CEO Doug Hirsch

GoodRx’s Pricing Edge Per Doug Hirsch’s Blog Post

Click here for my GoodRx deep dive.

3. SoFi Technologies (SOFI) — New Galileo Partner + a Marketing Campaign

a) New Galileo Partner

SoFi’s Galileo and Global Rewards announced a new partnership to tap into Galileo’s payment processing software. Global Rewards specializes in “payment and technology services” to automate all corporate payment flows. The firm is only 3 years old and is among Galileo’s smallest enterprise client wins to date — this is certainly no Chime or Robinhood. Still, Global Rewards is rapidly growing and could contribute more meaningfully to revenue in the distant future. For now, the announcement serves as yet another sign that SoFi’s transformation of Galileo’s product suite from on-premise to the cloud is gaining more traction. As of last quarter, Galileo had 35 total enterprise clients.

b) Marketing Campaign

SoFi has also launched its “Break Up With Bad Banking” marketing campaign following the issuance of its Banking Charter and the closure of its Golden Pacific acquisition. Per Wall Street Journal, banks feature a 33% approval rating yet the average American has used the same checking account for an average of 14 years — there’s a long runway for conversion if a company like SoFi can do things better like it thinks it can. With perks like a 1% annual percentage yield (APY) on savings accounts, I think they’re right.

SoFi’s digital-nativity and ability to cross-sell more products than its competition means its customer acquisition cost is relatively lower vs. alternatives while the value these customers provide to it is also higher. That reality paves the way for aggressive marketing tactics to claim more market share and that’s exactly what we are seeing here. The campaign has embarked on promotions across TikTok (where its last campaign got billions of impressions) and other social media platforms with linear TV and Connected-TV (CTV) placements as well. SoFi plans to give millions away in rewards to bolster campaign success.

Click here for my broad overview of SoFi.

Click here for a summary of banking charter perks for SoFi.

4. The Trade Desk (TTD) — UID2 Momentum Continues

The largest media network in Indonesia — KG Media — has officially backed Unified ID 2.0 (UID2). KG Media sees UID2 as a significant upgrade to expiring third-party cookies for enhancing the experience with more applicable ad placements. The Asia-Pacific digital ad industry is booming with 23% growth in 2021 and 16% growth expected this year.

“As the media industry digitizes, we’ve seen a huge shift towards a cookie-less open internet and privacy-driven online business. UID2 is a promising solution built upon current industry standards driven by those changes.” — KG Media Chief Marketing Officer Dian Gemiano

“By supporting UID2, we can achieve privacy and efficient advertising.” — News Lens Chief Content Officer and Co-Founder Shifan Yang

“Every corner of the Asia-Pacific market has publicly announced UID2 support. It’s rapidly becoming a new common currency for the internet in Asia.” — The Trade Desk blog post

Click here for my deep dive into The Trade Desk’s business (with a full explanation of UID2 and its appeal).

5. Teladoc Health (TDOC) — Amazon’s Nationwide Launch + A Chronic Care Warning

Amazon launched its telehealth platform nationwide. While new competitive entrants — especially Amazon — must always be considered, this is not all that alarming to me. Here’s why:

• Telehealth is largely commoditized. Teladoc differentiates via breadth of actionable virtual offerings. Amazon — and none of its other competition — can match this breadth. None come close.

• Telehealth is already a massive industry and will continue to briskly grow which will continue to invite more competition. Any business worth pursuing will have formidable competitive entrants to face. Teladoc’s success is far more up to its own value proposition than Amazon’s actions.

• Amazon competes with countless companies and industries. It’s hard to think these competitors will want to give this gigantic entity more business rather than giving it to an independent firm like Teladoc — even if the 2 offerings were identical in quality which is far from the case.

The more concerning news from the week came from a note out of Piper Sandler. The institution cited underwhelming Chronic Care Enrollment for the beginning of 2022 as a reason to lower its price target. I don’t care about price targets — the reasoning behind the price target change is what I find concerning. Chronic care enrollment will be a key piece of Teladoc’s success going forward. The company’s upcoming quarter will be vital for either dissuading long term growth and profit compounding concerns or confirming the validity of these worries. I wouldn’t call this a red flag, but it’s certainly yellow.

6. PayPal Holdings (PYPL) & Duolingo (DUOL) — Insider Buying

Over the last several weeks Durable Capital Partners has been aggressively accumulating shares of Duolingo. Since the beginning of the year, the fund has grown its stake by 75% to reach 2.9 million shares or $290 million in the company’s common equity.

PayPal also has seen some insider buying lately. President and CEO Dan Schulman spent about $1 million on new stock this past week with Directors Frank Yeary and David Dorman also making purchases. Dorman’s transaction accounted for over 5% of his net worth — quite the vote of confidence in the firm. It should be noted that Schulman had sold shares (as part of his 105b-1 plan) in December 2021. Insiders can sell for a plethora of reasons — to diversify, to start a new endeavor, to buy a really big boat etc. Insiders only buy for one reason — bullishness.

Click here for my brief PayPal bull thesis summary.

Click here for my Duolingo Deep Dive.

7. JFrog (FROG) — Earnings Review

“I’m pleased to report that in Q4 all of JFrog’s key metrics continued to trend upwards reflecting the continuous demand for our platform in an expanding market. Team JFrog, these 2021 results are a testament to your hard work and dedication… this success belongs to you and reflects the unique spirit of the Frogs.” — Founder/CEO Shlomi Ben Haim

(Shlomi milks these Frog puns for all they’re worth — and I’m a sucker for a good pun. :))

a. Demand

JFrog guided to a midpoint of $58 million in revenue for the quarter. Analysts wanted $58.1 million. It posted $59.2 million beating its own expectations by 2.1% and analyst estimates by 1.9%.

Client growth was negatively impacted by JFrog retiring its “Bintray product” which led to losing 200 small customers in order to focus on its core business. Growth here would have been 13.2% YoY otherwise. These 200 clients were minuscule revenue contributors.

JFrog’s TTM gross retention rate is at a historic high of “in the high 90s” for 2021. This is DESPITE hiking prices at the beginning of the year — depicting very strong pricing power.

35% of JFrog’s revenue comes from its highest margin Enterprise+ subscription (full product suite). This compares to 34% sequentially and 26% YoY.

This represented JFrog’s best sequential addition of users with over $100,000 in ARR since it went public. Annual revenue growth rate this quarter was also better than or equal to the company’s previous 4 quarters.

JFrog expects net $ retention to remain around 130% in the years to come.

b. Profitability

Guide Notes:

• JFrog guided to $550,000 in non-GAAP operating income. It posted $49,000 in non-GAAP operating income, missing expectations by $501,000.

• JFrog guided to $0.005 in earnings per share (EPS). Analysts were looking for $0.00. JFrog posted -$0.01 missing its own estimate by $0.015 and analyst expectations by $0.01.

• Analysts were looking for $3.9 million in EBITDA. JFrog posted roughly $3.65 million missing expectations by 6.4%.

Margin notes:

• Shrinking operating margin is the result of M&A integration which was previously discussed by management.

• For the full year 2021, JFrog’s gross margin expanded 170 bps from 82.4% to 84.1%.

• R&D as a % of revenue was 30% vs. 24% YoY as “JFrog continues to invest in enhancing our solutions along with integrating Vdoo and Upswift into the platform.”

• Sales and marketing as well as general and administrative expenses were all stable at 39% and 15% of sales respectively.

Like with many software as a service (SaaS) companies, JFrog’s cash flow margins far outpace net income margins due to deferred revenue and also stock based compensation in connection with the IPO. This gap should close over time.

The company has $421 million in cash on hand, is deeply cash flow positive and has no debt. The balance sheet is pristine.

c. Outlook

Q1 2022:

• Analysts estimated $60.92 million in Q1 2022 revenue. JFrog guided to $61.3 million, beating expectations by 0.6%.

• Analysts estimated -$0.01 in earning per share (EPS) for next quarter. JFrog guided to break-even, beating expectations by $0.01.

Full year 2022:

• Analysts were looking for $268.5 million in 2022 revenue. JFrog guided to $274 million, beating expectations by 2.0%.

• Analysts forecasted $0.02 in 2022 earnings per share. JFrog guided to a break-even midpoint, missing expectations by $0.02.

Implied forward valuation — Assuming a stable 20.6% 2022 free cash flow margin and $274 million in sales — JFrog trades for an EV to firm free cash flow multiple of 38X (& 8X sales) with 30% growth expected for 2022. I find that growth to be very attractively priced — though in this period of monetary hawkishness and growth re-pricing, we will see where things shake out.

d. Founder/CEO Shlomi Ben Haim Conference Call Notes

On How JFrog fits into the DevOps landscape:

“Complementary solutions for source code management can help make development more efficient but this isn’t enough to bring software quickly to market. The moment that first and/or third party code is compiled, it switches to binary form and requires full binary life cycle management.”

JFrog is a de-facto Binary/Artifact manager in the DevOps space. Others in the space handle source code.

On Log4j or “the software pandemic:”

“Log4j forced many to halt their entire software delivery system to manually find and fix the vulnerability. JFrog customers quickly identified and addressed wherever they were impacted.”

On a Log4j Fortune 100 JFrog Client Case Study:

“For example, a Fortune 100 bank with 20,000 developers globally identified where the infected Log4j binary was hosted and what dependencies it carried in minutes with JFrog Artifactory serving as the bank’s single DevOps database. We allowed them to replace their vulnerable binaries with an automatically applied patch version rather than manually finding every place it was being deployed.”

“JFrog Xray allowed them to easily protect themselves from additional exposure by setting security policies to automatically ensure vulnerable Log4j binaries couldn’t be used by developers again and to keep repositories from further risk.”

“JFrog Distribution rapidly delivered and validated the release to fix the software bug in all environments.”

“Altogether, this bank automatically found, rebuilt, replaced and protected themselves in under 12 hours. Development organizations without this approach have taken weeks to hunt these binaries down. Many are still trying to recover today.”

Log4j was essentially a free marketing campaign for JFrog.

On Customer Wins and Go-To-Market:

• “One of the largest” GPS and geo-location services firm in the World became a new customer. They switched as their existing offering couldn’t effectively scale to support cloud initiatives or other needs. JFrog’s multi-cloud and hybrid approach allowed for seamless migration of binaries.

• “One of the largest” financial institutions upgraded to JFrog’s Enterprise+ subscription to “distribute binaries for thousands of apps, written by thousands of developers and delivered to dozens of global locations each with unique compliance needs.”

• “One of the largest” telecommunication providers managed by JFrog’s enterprise sales team continues to standardize on the JFrog platform to cut costs from its disparate, legacy DevOps stack. Revenue from this user grew 80% YoY.

• Haim reminded us of the EKS Anywhere partnership with Amazon and AWS.

“During the year, we focused on building our sales team… during Q4 we saw the fruits of this investment as we welcomed more and more large enterprises expanding their JFrog product adoption… We believe that the expanded strategic sales team will continue to drive success as we bring more solutions to market.”

JFrog doubled the size of its workforce during 2021 to over 1,000 Frogs strong.

“This employee growth reflects the strong culture we have built and has cut through a challenging labor market.”

On JFrog Connect:

The company’s “JFrog Connect” product is now in beta. This “bridges the gap between DevOps and the world of connected devices.” Upswift — a recent JFrog acquisition — is a vital piece of extending DevOps to the endpoint and making this product a reality.

“This early offering for connected device management aims to greatly increase our addressable market by bringing binaries all the way to devices.”

e. CFO Jacob Shulman Conference Call Notes

“We are very pleased to have ended the year in line with the commitment we made in Q1 of this year for accelerating growth in the second half.”

As a result of merit-based employee compensation increases, Q2 2022 will be a low point for JFrog’s next-year profitability and will recover thereafter.

f. My Take

This was a solid quarter across the board. Net dollar retention rate rising back to 130% and a strong performance from a demand and margin point of view were all encouraging. The EBITDA miss and small forward profit guidance miss is never ideal, but the positives from this report easily outweigh the negatives. I’ve been a buyer and will continue to be one. JFrog will host its very first investor day (virtually) on February 15th.

8. Lemonade (LMND) — Pet Progress

Forbes named Lemonade the best-priced pet insurance vendor for kittens and puppies. Similarly to (but not as aggressively as) the company’s renter product, it leans on enhanced automation to cut input costs and pass savings onto its consumers. This — plus being top-rated insurer on the Apple App Store, Clearsurance, Supermoney & more — is evidence of that plan working. In other news, Lemonade launched this pet insurance product in Massachusetts during the week. That is state number 36 for the newer segment.

Click here for my broad overview of Lemonade’s business.

9. Cannabis News

a. Company-Specific

• Ayr Wellness took a step closer to closing more M&A as it signed a management services agreement (MSA) with Tahoe Hydroponics and NV Green — two related Nevada-based firms. With the MSA in place, Ayr gains access to Tahoe Hydroponics’s extensive, award-winning flower genetics and NV Green’s cannabis concentrates.

  • Ayr also gains licensing access to “LIT brand” which is a top selling Nevada flower brand. Ayr plans to use Tahoe’s genetics across its entire multi-state portfolio while leaning on its grow team to continue delivering new, compelling cannabis strains.

  • Ayr also opened its 45th Florida dispensary in the heavily-populated Tampa area.

• Green Thumb opened two new Rise Dispensaries in Virginia to bring its national total to 75. Green Thumb also named the CEO of YMCA Chicago — Dorri C. McWhorter — to its board of directors.

• Cresco Labs opened a new Sunnyside dispensary in Northern Miami. All of Cresco’s top-selling One Plant products will be available for purchase. This is its 15th in Florida and 49th across the nation. Number 50 is coming soon in Lady Lake, Florida.

b. Industry-Specific

A cannabis research firm — Headset — released industry growth projections through 2025. This report called for $45.8 billion in 2025 sales which would represent a compounded annual growth rate for the industry of 16.3%. Other projections assuming more state-level legalization call for a CAGR of closer to 20% through 2030.

Click here for my overview of American Cannabis regulation.

10. My Activity

I added to Penn National Gaming and PayPal Holdings during the week. My cash position is now sitting right around 10.2% of total holdings.