SoFi - A Comprehensive Fintech Player
Company deep-dive analysis and discussion on Competitive Advantages
Good morning Subscribers,
We will continue with our Fintech theme for March. Since I’ve been publishing weekly deep-dive analysis since December. I will be off for the next three weeks for the Easter break and will be back on April 20th. I have many more companies to share with everyone. We’ve got a deep dive explore today.
Overview of Today’s report:
Convenience has and will remain the key force driving the change in consumer banking habits. Financial Institutions that offer customers a suite of financial products that cater directly to their needs and make banking easy, will win long-term. Digital banking and fintech platforms like SoFi are catering towards this need. Below is an overview what we will discuss today:
SoFi’s Company Overview
The business structure
The Competitive Advantages
Customer, Industry and Financials
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SoFi (NYSE: IPOE)
Social Finance (SoFi) provides a comprehensive digital banking platform in the United States without a physical presence. Their goal is to become the new age bank for millennials and Gen-Z. SoFi is built around the premise of enabling customers borrow, save, spend and invest for their future. The company was founded in 2011 by students in their early days at Stanford University. They started as a community-based student debt management platform that helped students with financing loans. Since that moment, they have grown to become a $15Billion company. They have a purposeful mission which is centered around helping their members get their money right (note - they don’t call them ‘customers’)
They provide their members with services such as lending, student loans, home loans or loans based off their personal needs. They also recently launched SoFi credit card which provides 2% unlimited cash back on all purchases when users redeem into a related SoFi product. They have an investing platform that enables customers buy and sell stocks including cryptocurrencies. SoFi strives to educate and set-up their members for a bright financial future. People learn, follow, and share insights within the SoFi community. Simply, they have everything in one platform.
The image below shows all the services that SoFi offers to their customers on the outer blue bands. Meanwhile, the inner circle shows their value proposition and how they differentiate themselves:
Speed: SoFi strives to be the platform that enables the fastest way to do everything banking which entails becoming a platform which enables the member get quick access to money (whether you are borrowing or making an application), ease of opening an account or depositing checks etc.
Selection: The goal is to become a financial platform that provides a broad array of products across a member’s lifecycle with unique terms and at attractive value prices.
Convenience: SoFi’ strives to enable ease of using their banking platform anytime and anywhere with a simple User Interface.
Content: This is built around providing Financial literary and content information that are provided within the application such as Personal Finance education, credit score information, budgeting apps, news and investment research to enable member investors make good decisions.
SoFi’s business can broken and structured into these 3-major segments:
1) Lending: This aspect of the business deals with everything for borrowing needs as can be seen above. Lending is almost a trillion-dollar industry. This is the oldest part of the business and SoFi generates a significant part of their revenue (>50%) from their Lending Services today.
2) Financial Services: This is the core banking service of the business that provides Saving and Spending platforms. They have an Investing platform for stocks similar to (Robinhood or Wealthsimple in Canada). They have Relay, money management and Protect services. The company hopes to expand its breadth in Financial Services by obtaining a bank charter. I will expand upon this later.
3) Galileo Technology Platform: This was a company that they acquired in 2020 for over $1.2Billion and has become a part of SoFi. Galileo isn’t a bank and isn’t a regulated entity, but it empowers Fintech platforms. Galileo provides an API - all the technology required to offer digital banking services without having a physical bank presence. It maintains a ledger, authorization settlement, funds movements and managing fraud all digitally. More on this below.
The future competitive advantage for SoFi primarily lies within these last two business segments.
a) Bank charter could be game-changing:
SoFi has applied for a bank charter that is likely to be approved. This charter will allow SoFi to take deposits from its customers and make loans using these deposits (similar to a normal bank). This enhances the value proposition for SoFi members while driving down costs versus the current process of financing their loan offerings as a non-bank. This would allow SoFi conduct normal banking operations without the legacy brick-and-mortar infrastructure which then creates a cheaper base for SoFi to make loans to its customers. The charter benefits includes a lower cost of capital and increased Net-Interest Margin on holding deposits and loans longer.
GPG Acquisition: SoFi announced an agreement to acquire Golden Pacific Bancorp, Inc (a small community bank in Sacramento, California) this year. The acquisition of this bank will help speed up its application and wait for approval. Currently, SoFi acts as a non-bank lender. As a result, they are required to develop a partnership with a third-party bank that acts as a middleman. This lowers their EBITDA margins and drives up the cost for their members to borrow money. Following the approval of a bank charter, this would also benefit product differentiation amongst other fintech competitors and drive down customer acquisition costs. If you combine a charter and the existing comprehensive platform that SoFi operates today, this could lead to a big moat.
b) The Moat from Galileo BaaS Platform:
Galileo dominates the Banking as a Service (BaaS) ecosystem. Similar to the Cloud and SaaS services that technology companies offer different organizations. BaaS aims to provide an easy platform that reduces both the time and cost fintech companies spend on getting regulatory requirements or licenses. BaaS provides digital banks with third-party access to core systems and functionality so that they can integrate digital banking and payment services into their own product. Also, BaaS reduces the technology requirements and capabilities to offer financial products such as maintaining account ledgers for different customer accounts that is required of a traditional bank. BaaS provides significant cost savings and this is the future of Fintech banking.
The reason for this explanation is that Galileo is the leader of the new BaaS Infrastructure. Galileo’s powerful payment processing platform offers the easiest way to create sophisticated payment card programs and digital banking solutions. Similar to the AWS Cloud service, Galileo is the underlying infrastructure for Finance Technology. Think of it as the way Amazon created cloud infrastructure enabling software companies to store and manage their data, new Infrastructure-as-a-service (“IaaS”) companies will create financial infrastructure enabling software companies to offer financial products. With regard to Galileo’s progress, by Q3 of 2020, Galileo powered over 50M digital accounts worldwide, compared to 21M in of 2019 (almost 100% growth YoY). The growth is expected to continue to accelerate overtime. Hence, to summarize, SoFi’s decision to acquire Galileo has created an incredible moat for them within the Fintech ecosystem.
c) Wide Brand Recognition: SoFi announced a 20-year partnership with the Los Angeles Chargers and a stadium naming rights partner in September 2020. The partnership has given SoFi a big brand recognition among their target market of millennials. There are many millennials who enjoy using the application because of its simplicity. Recently, they also announced an initiative that enables retail investors buy stocks early at the IPO. Lastly, the whole reddit and Gamestop saga in January and February created a significant viral marketing and brand awareness for SoFi as an alternative to Robinhood as seen on Google Trends. Recently within their Q4 results, the company expects to generate growth over 120% in Q1 2021. Hence, there is evidence the brand has grown substantially which bodes well for its future. We also need to recognize this is slightly trivial if the company does not retain the brand long-term.
In summary, a bank charter together with the comprehensive platform from SoFi, the moat from Galileo platform and the millennial brand recognition will be key to SoFi’s competitive advantage within the digital banking ecosystem.
Members & Industry:
Based off industry data, the digital banking market is set to rise by 15% a year over 2019 - 2025 period and reach $16B by 2025. The digital lending market is set to rise by over 20% a year over the same period. The market is growing, however, many Americans use at least two banks for their financial services because one bank doesn’t provide all their intermediate needs. SoFi has found a niche here by providing an all-in-one, comprehensive service available for their members in one bank.
SoFi primarily target high-income earners above the age of 22-years of age. They had over 1.7M members as at 2020 and are tracking towards 3.0M Unique members by 2021. These are unique members that represent the cumulative number of members that have borrowed on the SoFi platform or opened a financial services account through SoFi money, SoFi Relay, or SoFi Credit Card. The chart below shows the incremental and impressive growth in members:
I don’t plan to dig too much on the Financials in this deep-dive. On a high-level, we can recognize that revenue has been growing fairly rapidly.
The growth adjusted net revenue ($M) took a hit in 2020 with a lower 38% growth rate to $621M. This was primarily caused by the pandemic decreasing spending activities in the economy. However, in 2021, the company is expected to grow over 58%. They expect that as the economy reopens and the increased digitization of banking, this would increase revenue including synergies from Galileo.
To better understand a breakdown of the Revenue, everything is shown below. The technology platform represents the recognized revenue from Galileo.
Also observe that going forward, a majority of revenue will be coming from Galileo. Secondly observe the revenue growth expected between 2021 and 2022. The company is highly *betting* they will receive regulatory approval for their bank charter which will boost Financial Services revenue. As discussed, if they can obtain the charter, it will propel the company moving forward.
The current stock and valuation is a much better deal down below $18. The Market Capitalization is $14.7B based on 850M Share Outstanding (After the SPAC deal). The current valuation puts it at 2021 Revenue Multiples (P/S) of 15x and 2022 Revenue Multiple (P/S) of 10x which is pretty decent and cheap for its growth profile.
The current CEO is Anthony Noto. He is a top-notch leader. He was the previous Chief Operating Officer at Twitter [2014-2018]; Past Chief Financial Officer for the NFL for 3-years and lastly, Co-head & Partner at Goldman Sachs for over 10-years. Anthony also achieved the distinction of being the No. 1 ranked Internet analyst at Goldman Sachs from 2003 to 2007. Early on he was the Captain in the US Army as a telecommunications officer and went to Pre-West Point Academy/ Ranger School.
Anthony has got significant credential. After reviewing the financial statements, you will observe significant progress since he became CEO and the company appears to hold a culture of Innovation with the rapid acceleration of products built over the last few months. This is a top resume that is hard to replicate by any CEO. I am willing to bet on this CEO and the Management Team’s integrity.
Risks to business:
Some red flags to monitor:
Unrealistic targets: SoFi estimates they can achieve a EBITDA margin of 45% on $1.17B by 2025 from today’s $27M (26%) in 2021. They have similar revenue targets for 2025. EBITDA margin targets are extremely hard to justify with financial institutions. Although, we recognize that digital banks have significantly less capital costs and physical presence, but its hard for investors to justify such goals and find it difficult to estimate that much growth over the next five-years without a clear rationale beyond a bank charter.
Bank Charter: A majority of SoFi’s financial goals are built around SoFi obtaining a bank charter as discussed. Their most recent acquisition of CPG Bank was primarily influenced because they believe it will help achieve this charter goal faster. If the regulators have a problem with SoFi or this charter fails, there will be a major price drop because the current valuation is pricing in the success of the bank charter to drive revenue and margin improvement over the long-term.
High competition: There is significant competition around all areas of the SoFi business model. The competition range from similar investing platforms like Robinhood or Digital banking platforms like Square’s CashApp or similar players shown below. Then, there are major competitors that are also well-established with deep pockets like JPMorgan and Goldman Sachs that are significantly spending and already compete on these primary digital banking services. The key differentiation for SoFi is the comprehensiveness of the platform, Galileo’s platform, low CAC and ease of attracting millennials. It will be important to track the durability of their competitive advantage over the next 5-years.
(Image: Upcoming emerging digital neo-banking platforms)
High Short-Interest & Chamath Politics: I don’t like to pay a close attention to Short-sellers. However, there is a significantly high short interest. Is there something the Short sellers see? Currently, I don’t think there is anything rather than a bet that SPAC’s will lose their price value in a higher interest rate environment. I find it distracting that many people talk about Chamath’s association with the company, but I know that 5-years from now. This will not be news, so it is best to ignore it and focus on fundamentals.
Multiple business lines driving costs: One of the reasons why most of the neo digital banking players shown above don’t have a fully comprehensive, banking platform that offers all forms of banking needs is due to the increasing costs overtime and oversight. There is also the risk that SoFi tries to offer too much services thereby creating a lack of focus that decreases quality overtime. Right now, it is not a risk, but it will be worth monitoring overtime.
The bottom-line is that we know that digital banking represents the future of how we relate to our banks. Convenience will be key. SoFi is one of the leading players within this rapidly growing industry. They have created key competitive advantages such as a comprehensive (all-in-one) banking platform that could get bigger with the approval of a bank charter, they own Galileo’s BaaS infrastructure that is powering many new fintech platforms around the world, the company’s financials show huge acceleration and they have a growing well-recognized brand amongst millennials, all led with a top notch CEO with demonstrated success.
However, the bear case and risks include the fragmentation and steep competition posed by both existing neo-challenger banks as well as traditional banks, some unrealistic future targets that could affect valuations, the cost of managing a comprehensive platform and the sustainability of the business model.
Digital banking is here to stay and SoFi will be an interesting company to watch over the next decade.
Thank you so much for reading! I will be back again on April 20th to continue exploring more new rapidly growing innovative mid-cap companies and conduct a wrap up for all the Fintech players discussed in March.
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Disclosures / Disclaimer
Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. The author owns shares. The author no business relationship with any company mentioned in this article.