Pagaya (PGY) $1.11 Speculative Buy.
High Risk, High Reward – Asymmetrical return with a potential upside to $4 in the next 2 years.
Only buy a small portion of your portfolio for this. I keep a small portion of my portfolio for a few risky stocks and would advise the same.
Trade Alert: Bought 1.13
It’s a lengthy post, with a fairly long segment on risks, which is important to read. I’m going to add this to Seeking Alpha as well, this week.
Researching Upstart, (UPST) which I rejected for taking on credit risk, I studied competitor Pagaya (PGY) in more detail. It’s an interesting story with possible asymmetrical returns given the low valuation of $1.11 or a market cap of just $855Mn. Pagaya is a Fintech, pick and shovels play providing a platform/software service to commercial lenders like Visa, Rocket, Lending Club and even Fintech competitor Sofi Capital (SOFI)
- Unlike Upstart, Pagaya doesn’t keep any loans on their books.
- Its business model is to charge fees to business clients like Visa and SoFi to provide due diligence and credit analysis of their potential subprime borrowers – sift through their initially-declined loan applications, find any good loans among the declined ones.
- Pagaya bundles these loans and moves them to their final destination. 80% of the loans get bundled into ABS, (Asset Backed Securities), which institutional clients agreed to purchase in advance. The other 20% of the bundled loans are sold to private investors, and Pagaya charges them a fee for that service
- AI Integration Fees: Charged to lending partners for using PGY’s AI
- Capital Markets Execution Fees: Loan markup before they are put into ABS structures, plus other fees for packaging the ABS
- Contract Fees: Charged to the private capital that PGY manages to purchase loans
Benefits to Pagaya:
- No credit risk – ABS deals are pre funded, Pagaya has to find creditworthy borrowers instead of looking to offload bad loans.
- No client acquisition costs – lenders pay for that.
- Strong relationships with ABS buyers because of the volume and with lenders because of the seamless experience. Lenders also don’t fear them because they’re not interested in acquiring their clients – they’re not in that business, pure service play.
- This is an AI/machine learning play – anyone in the lending business or credit rating business needs it to safeguard from credit losses. However, I do want to emphasize that credit appraisals and diligence has been around forever, and while strong technology and machine learning is giving some vendors an edge, over time this will be commoditized. I suspect most solutions will be the same.
- Sticky, large customers – Pagaya is the one of the market leaders in the ABS market, and the # 1 in personal loans and customers renew because of large volume deals.
In my opinion, even though analysts and management tout it as an AI play, which it might well be, I believe the real strength is scale with ABS buyers and lender relationships.
Risks, Weaknesses and Challenges
- It is a dreaded 3C – Cutthroat, Commodity, Cyclical.
- Over time, even M/L or AI platforms or software will become a commoditized business, without significant competitive advantages.
- Barriers to entry are low – for example, their lender customers could easily develop the same software.
- Another challenge is the possibility of continued dilution, there is a dual structure with the potential of additional shares for the founders and Pagaya could always raise capital for acquisitions to goose growth, or worse like Upstart keep loans on their books! Though that seems to be a very unlikely scenario for now – After seeing Upstart plummet from its peak price of $311 or Pagaya from $23 – I cannot imagine any management wanting to go through that nightmare again.
- Non USA company – Israeli listing, 20-F (for foreign companies) reporting standards are not as rigid as SEC’s 10K’s.
- While lower interest rates increase demand for all types of borrowings and therefore more volumes and sales, there is a downside. As Treasury rates fall, there are a lot of prepayments, which reduces the value of the ABS – An ABS’s value is derived from the expected interest income streams, if the borrower prepays the expected income stream gets reduced.
- Cash pile is decent now, with Singapore Govt (Sovereign Wealth Fund) a key player, but this could be an issue.