Lending Club + IPO = ???

Initial Public Offering: Three words that represent both the ultimate fantasy for entrepreneurs and one of the riskiest bets for investors. With sustained rumors of Lending Club becoming public before the end of 2014, let us reflect about what it will mean for the company, for investors and for direct lending in general.

Wait, Lending Who?

With a valuation at \$3.8B at its last round, Lending Club is one of the most valuable private companies in the U.S., and one of the largest direct lending (also called ‘peer lending’) marketplaces in the world. Direct lending is the practice of lending money to unrelated individuals through an online marketplace. Such a system benefits from low operating expenses, which translates into both lower interest rates for borrowers and higher returns for lenders.

In a way, direct lending is not lending without banks; it’s simply a new kind of bank. Fundamentally, a bank is a financial intermediary whose business is to monetize transfers between a surplus and a scarcity of money. On one side are people with money, but no immediate need for it. On the other are people who need (or want) money now but don’t have it. The bank gets deposits from lenders, transfers them to borrowers, then at payback, keep a big cut and return the rest. Although the oldest modern bank, located in Sienna, is ‘only’ 600 years old, the principle of banking as we know it today appeared more than 4,000 years ago in Mesopotamia. What has changed in the last 10 years is using Internet instead of brick-and-mortar buildings (or stone-and-mortar, since we’re talking about fancy financial institutions). In a way, Lending Club is a modern bank, the same way Expedia is a modern travel agency.

Saying that Lending Club is on a roll is an understatement. The amount of loans they’re issuing is doubling every 9 months. So far they’ve issued more than $4B. It may be the most spectacular IPO of 2014.

When it will happen

There are rumors of an impending Lending Club IPO since more than a year already. Considering nothing is official yet, it cannot happen in less than 4 months (3 months from S-4 to end of road show, plus 40 days of quiet period). IPO activity is also quite seasonal, so an IPO before mid-September is also very unlikely. Google search data shows a peak in IPO-related queries 3 weeks before the IPO becomes official. Since the term ‘Lending Club IPO’ is currently trend down, it probably won’t happen before Q4, which is also, as shown by historical data, the busiest quarter of the year.

What’s Next for Lending Club

When the company becomes public, a lot of things will change for Lending Club:

First, as of today, residents of only 26 out of the 50 U.S. states can invest in Lending Club. The registration of securities offerings by Lending Club (the loans that lenders invest in) is done on a state-by-state level. Some states deny such registration, which means their residents cannot access Lending Club, at least its primary market. However, once Lending Club is publicly traded, it will benefit from a so-called ‘blue sky exemption’ that means state-level registration won’t be required anymore; all 50 states will become instantly eligible. That means increased competition for the best possible loans.

Second, Lending Club will have to align with public companies’ reporting requirements, and that may collide with the spirit of total transparency they’ve demonstrated so far. We can see that in effect even before the IPO: up until April 2014, Lending Club was updating its publicly available statistics on a daily basis. Now they update such data on a quarterly basis only.

Third, with the money raised, Lending Club will be able to accelerate its growth alongside 2 axes. They will be able to acquire specialized lenders or even small banks. The growth-limiting factor today is money demand, not money supply. In April 2014, Lending Club took over a ‘traditional’ lender specializing in medical and tuition financing, Springstone Financial, and it wouldn’t be surprising for them to consolidate their leadership with similar acquisitions after the IPO.

They will also have the muscle to expand to other kind of loans. Besides consumer credit, Lending Club also started offering small business loans in March 2014. Once public, they can get more than enough resources to expand to education, real estate, or purchase lending.

That being said, the one unlikely expansion is geographic. Not only is the U.S. market gigantic by itself, but between different regulations and the lack of easily accessible credit scores, foreign countries are hard to penetrate. Besides, Lending Club’s CEO Renaud Laplanche told international wasn’t a priority.

What’s Next for Direct Lending

If the Lending Club IPO is as formidable as it should be, it may act as a catalyst for the direct lending industry and pave the way for more action to follow. After all, Renaud Laplanche said, “The main reason we are considering an IPO is to use it as an opportunity to raise awareness for the company and better establish the brand.”

Prosper, the second U.S. marketplace, could maybe do an IPO of its own in 2016. Awareness of direct lending will grow considerably. There are over 50 direct lending marketplaces already, but with a successful IPO even more will sprout. Besides, the cost advantage of direct lending is here to stay: first, traditional banks make little progress in term of efficiency (according to a McKinsey study, 70% of the top 500 banks did not make any progress in term of efficiency between 2009 and 2012). Second, regulations such as Basel III put lots of limitations on lending from balance sheet. These limitations are avoided in direct lending, since the money lent by marketplaces isn’t even theirs.

What’s Next for traditional lenders

Today, direct lending represents less than 0.2% of U.S. consumer credit, so even if Lending Club’s IPO has a tremendous impact for its industry, the short-term effect on public lenders will be limited. That being said, since it will bring the spotlight on the disruption of traditional credit, investors will become increasingly bearish towards traditional lenders.

To Buy or Not to Buy

Historically, IPOs are not good for retail investors. See these amazing interactive graphs on betterment. An anecdotal example is the well-publicized Facebook (FB) IPO: one year after becoming public in May 2012, the stock was down 32.6% while the S&P500 increased by 22.6% over the same period.

On the first day(s), without the ability to get stocks at the introductory price, individuals usually buy them too high and just before institutional investors flip theirs.

That being said, as shown by this graph from Tableau, profitable companies tend to fare much better, especially in the last decade. In one year, Tableau (DATA) itself went from \$50.75 to \$57.66, a 13.6% increase, even when the first-day quotation was way above the introduction price of \$31.00.

Lending Club could represent an excellent investment as a stock as well. After all.

Note: this was originally posted on SeekingAlpha.