I recently explained that Valeant Pharmaceuticals Intl Inc (VRX) is a risky investment, one that will require the utmost patience from investors who choose to buy at these levels. However, it is also a great opportunity, as long as you have the patience required to own such a volatile battleground stock.
Therefore, you might wonder if LendingClub Corp (LC) could be a similar investment opportunity. After taking a long look at LC stock, I think it might just be.
LC Is Very Much Like VRX
Much like VRX, LC stock has seen most of its value wiped out over the last year amid CEO controversy and questionable decision-making processes at the top. Also like VRX, LendingClub’s high debt load has come under recent scrutiny, mostly brought on by the decline in LC stock and the decision-making of top-level executives.
So, while LC and VRX operate in completely different industries and have different philosophies, the circumstances that brought each stock to these levels are remarkably similar.
With that said, VRX is a pharmaceutical company and LendingClub is the country’s largest marketplace to connect borrowers and investors, also called peer-to-peer. Historically, LC has been very transparent with loan data, from the number of loans originated to credit scores of borrowers.
LendingClub’s big transgression was that it falsified documentation while selling a $22 million loan package that did not meet the investor’s criteria. Furthermore, there have been reports of its previous CEO being a little too involved with the actual lending process. But at this time, all financial gains from the single known $22 million transgression have been called “minor” by the company.
LC Will Get Banks Back
In retrospect, the $22 million loan package that LC executives falsified is not the problem, but rather the fallout from lenders. Goldman Sachs Group Inc (GS) halted loan purchases with LendingClub, Citigroup Inc (C) denied a request from Jefferies to support LC, and BancAlliance, a consortium of 200 small banks, has suspended its program to buy loans from LC.
All that said, the big issue is that banks are not buying new loans because of LendingClub’s past actions; a DOJ and SEC investigation isn’t helping matters, either. What’s being forgotten, and why I believe value still exists in LC stock, is the fact that only one-third of lending comes from banks. So, even if all banks were to suspend loan purchasing — which has not happened — 75% of the company’s business would still be fine.
My bet is that banks will eventually come back due to the overall safety of LC loans, the growth of originations, and high interest rates ranging from 5%-30% in an otherwise low-interest-rate environment for banks.
Hence, the banks that can see past the questionable behavior and decision making of a few individuals stand to profit significantly thanks to these three factors. At the end of the day, we’re talking about questionable, even illegal activity on a relatively small percentage of loans. Keep in mind that LC originated $8.3 billion worth of loans last year, and that number continues to rise year after year, up from just $600 million in 2012.
Why LC Stock Is a Good Buy
Nonetheless, LC has $4.7 billion in debt, much of which is tied to low-risk borrowers, therefore it is not as big of a liability as it may seem. LendingClub also has $868 million in cash and equivalents, which gives LC a market capitalization of only $1 billion minus cash.
Therefore, investors get a company that is expected to grow 48% this year and 31% next year. Thus, LC stock trades at 1.2x next year’s revenue, very cheap for a growth company. Finally, LC may not be profitable right now, but does have a profitable business model with low costs, and is expected to generate consistent profits moving forward. Even after these recent events, LC is expected to earn $0.17 and $0.26 per share over the next two years, respectively. Hence, 19x FY2017 EPS for a company growing this fast is very cheap.
So at the end of the day, I expect LC to overcome these obstacles. Much like VRX, it may take time and patience, but long investors should be rewarded.
As of this writing, Brian Nichols owns shares of Valeant.
