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2021-07-27

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SoFi Technologies: A Next Generation Banking Disruptor

Summary SOFI started off as a simple provider of loans, and has since expanded its offerings to enc

SoFi Technologies: A Next Generation Banking Disruptor

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{"i18n":{"language":"zh_CN"},"data":{"magic":2,"id":809403772,"tweetId":"809403772","gmtCreate":1627383960096,"gmtModify":1633765536629,"author":{"id":3574912808627652,"idStr":"3574912808627652","authorId":3574912808627652,"authorIdStr":"3574912808627652","name":"KelseyA","avatar":"https://static.tigerbbs.com/38c8f824044b4d30d14a28c5eaf76093","vip":1,"userType":1,"introduction":"","boolIsFan":false,"boolIsHead":false,"crmLevel":3,"crmLevelSwitch":0,"individualDisplayBadges":[],"fanSize":1,"starInvestorFlag":false},"themes":[],"images":[],"coverImages":[],"extraTitle":"","html":"<html><head></head><body>Good</body></html>","htmlText":"<html><head></head><body>Good</body></html>","text":"Good","highlighted":1,"essential":1,"paper":1,"likeSize":1,"commentSize":1,"repostSize":0,"favoriteSize":0,"link":"https://laohu8.com/post/809403772","repostId":1139811761,"repostType":2,"repost":{"id":"1139811761","kind":"news","pubTimestamp":1627378490,"share":"https://ttm.financial/m/news/1139811761?lang=&edition=full","pubTime":"2021-07-27 17:34","market":"us","language":"en","title":"SoFi Technologies: A Next Generation Banking Disruptor","url":"https://stock-news.laohu8.com/highlight/detail?id=1139811761","media":"seekingalpha","summary":"Summary\n\nSOFI started off as a simple provider of loans, and has since expanded its offerings to enc","content":"Summary\n<ul>\n <li>SOFI started off as a simple provider of loans, and has since expanded its offerings to encompass a large array of services that make for a compelling fintech ecosystem.</li>\n <li>Against traditional banks and fintech players, SOFI has a competitive advantage, as a result of its horizontally integrated offerings cutting across many areas of fintech and banking.</li>\n <li>When valued as a traditional bank, SOFI checks off all the boxes for a compelling business, with a strategy that will likely lead to stellar metrics in the long run.</li>\n <li>SOFI can also be seen as undervalued relative to expectations, which suggests the strong likelihood of upside even at this price.</li>\n <li>While there might be salient risks in an investment in this newly-IPOed company, its strategic positioning and strong fundamentals give investors confidence that they will be able to outperform in the long run.</li>\n</ul>\n<img src=\"https://static.tigerbbs.com/86757d2b7d17b7fe7071210bad77f795\" tg-width=\"1536\" tg-height=\"800\" width=\"100%\" height=\"auto\">ipopba/iStock via Getty Images\nIntroduction\nSoFI(NASDAQ:SOFI)represents the next generation of banking, and plays into a growing fintech industry. They started off as a simple provider of loans in the student loan market, and have since expanded their offerings to encompass a large array of services in the consumer finance sector - from personal loans, home loans, and even to insurance, credit card services, cash management, brokerage services and recently to payments and financial services APIs for enterprises.\nUnsurprisingly, their diverse and integrated ecosystem of services in a single app has gotten SOFI tremendous user growth, as increasingly frustrated customers of traditional banks opt to switch to SOFI for the ease of convenience. Q1'21 was their best showing yet, with a year-on-year increase of over 110% in members, as well a 121% y/y increase in the number of products sold.\n<img src=\"https://static.tigerbbs.com/2687200d2eb156aaaf3715e1d94bc0b1\" tg-width=\"640\" tg-height=\"361\" width=\"100%\" height=\"auto\">(Accelerating User Growth. Source:SoFI Q1'21 Investors Presentation)\n<img src=\"https://static.tigerbbs.com/fdeb614c065bc50b1727d89843549d6c\" tg-width=\"640\" tg-height=\"331\" width=\"100%\" height=\"auto\">(Accelerating Product Growth. Source: SoFI Q1'21 Investors Presentation)\nCrucially, SOFI's integrated platform differentiates them from traditional banking peers as well as new age fintech players. From the angle of a traditional bank, SOFI appears to check-off all the boxes for a compelling business, which gives investors confidence that they are operating a model that is sustainable in the long-run.\nCompetitive Advantage\nTypically, there are a few metrics to look at when evaluating traditional banks. These include, customer acquisition costs, lifetime value of consumers, interest and non-interest income, as well as investment quality. From each of these angles, SOFI appears poised to outcompete peers, be it from traditional banking or from other fintech players.\nLow Customer Acquisition Costs But High Lifetime Value of Consumers\nCritically, banks seek revenue growth through two means: increasing the number of customers that they have, and increasing the value they are able to derive from each of their customers through selling them different financial products. This is akin to a traditional consumer electronics firm like Apple(NASDAQ:AAPL), where their goal is to get more people to buy their products, and increase their bargaining power against consumers to get them to spend more on products.\nHere, SOFI has an advantage over other banks and other fintech firms because of its horizontal diversification to different aspects of consumer finance and to traditional lending as well.\n<img src=\"https://static.tigerbbs.com/8245af4c17fbe75bcaf938b49c12062d\" tg-width=\"640\" tg-height=\"339\" width=\"100%\" height=\"auto\">(SoFi has a large range of products that is constantly expanding. Source:SoFi 2021 Investors Presentation.)\nAs part of its strategy, SOFI intends on building a full suite of consumer finance as well as banking services to each of its individuals on a single platform. Currently, they offer a range of products from high-frequency, high-volume but low-value financial services such as SoFi Money, Relay and Invest, to low-frequency, low-volume but high-value financial services such as Home Loans, In-School Loans as well as Personal loans. The former category relies on taking a small cut on a large volume of small transactions, while the latter category monetizes from large interest payments from a large capital base. These happen to cut across many categories of fintech as shown in the fintech map provided by Business Insider:\n<img src=\"https://static.tigerbbs.com/ff4568c118cc17271759796b6d7e48d1\" tg-width=\"640\" tg-height=\"480\" width=\"100%\" height=\"auto\">(The fintech ecosystem and some players within it. Source:Business Insider)\nAgainst fintech firms that primarily monetize on the former category such as payment processors like PayPal(NASDAQ:PYPL), peer-to-peer lending apps like Cash App from Square(NYSE:SQ)and brokerages like Robinhood (HOOD), SOFI is able to differentiate sufficiently using the latter category of financial services. This is because high-frequency financial services typically have lower margins and rely on the increase in volume and size of transactions as well as growth of their userbase to sustain revenue growth. With high-value loans earning high interest income, SOFI is able to theoretically derive more revenue per customer in the long run, without the need for as high of a userbase growth. SOFI certainly is aiming for high user growth as well, but the point here is that there is an additional lever for SOFI to pull in pursuing revenue growth - preferentially selling users high-value products already in its ecosystem - which reduces the need to devote significant resources to marketing strategies to fuel growth.\nAgainst traditional banks, SOFI differentiates itself using its low-cost consumer acquisition strategy, enabled through cross-buy opportunities. Instead of directly pursuing user growth with the proposition of selling them high-value financial services, SOFI eases consumers into the ecosystem by giving them free access to low-value but high-frequency products. From that point, it is easier to rope consumers into the higher-value financial services since it is simply getting them to press a few buttons with an account they already have.\nAccording to SOFI's official pitch deck for their PIPE presentation, the combination of low-value financial products and high value loans on the same app increases the opportunity that its customers cross-buy into these loans. Since the customer was acquired with low cost into its low-value offerings, the variable profit per customer that cross-buys into high-value loans now increases by 180% compared to when obtaining that same loan customer through traditional means.\n<img src=\"https://static.tigerbbs.com/991b3363d25bc185f927e2cb8c71f066\" tg-width=\"640\" tg-height=\"320\" width=\"100%\" height=\"auto\">(SoFi's Cross-buy opportunities. Source: SoFi 2021 Investors Presentation.)\nHigher margins will directly translate into the greater ability to reinvest in diversifying their products further or to expand internationally, both of which can help feed into further growth in the future.\nIn a nutshell, SOFI's unique business model that ties in multiple aspects of fintech helps them to achieve impressive unit economics but at the same time high lifetime value per consumer, through low customer acquisition costs and opportunities for cross-buy. These two factors together will serve to differentiate SOFI from both the burgeoning fintech sector as well as traditional banks.\nFuture Interest and Loan Income\nFor SOFI's lending and cash management products, they primarily earn through a gain-on-sale model where they repackage loans made to customer and sell these loans to other large financial institutions or securitization channels. For loans still on their balance sheet, SOFI also earns an interest income on these loans.\nHowever, unlike a traditional bank, SOFI is currently unable to use the deposits made by SoFi Money Members to fund its loans because it does not have a national bank charter. Instead, SOFI relies almost entirely on warehouse financing facilities to originate loans and sell them to customers. This involves borrowing from large financial institutions, since a warehouse facility is essentially a large line of credit that they extend to SOFI for the purpose of loaning.\nFor SOFI Money, the interest income they are able to earn on their member's deposits is also constrained because of the middleman that they rely on to provide cash management facilities in lieu of SOFI's inability to function as a bank holding company.\nWhile banks significantly increasing their interest and loan income in the future may not be a sure thing, SOFI will easily be able to secure a higher return on their loans as well as a higher interest income by securing a national bank charter. For one, the bank charter will allow them to use the money that its members deposit with them to fund their loans and therefore use their capital resources more efficiently without relying on a third party for financing options. Alternatively, when combined with existing warehousing facilities, having access to a pool of deposit money will allow SOFI to grow their loan base and therefore increase interest income levels at a higher rate. Cutting out the middleman will allow them to save on premiums paid for these intermediary warehousing or cash management services and therefore earn a greater net interest margin.\nIn October last year, the OCC already issued a preliminary conditional approval of their application to be chartered as a de novo national bank.\nAs an alternative route to securing a national bank charter,SOFI also entered an agreementto acquire Golden Pacific Bancorp. Their preliminary conditional approval to be chartered as a de novo national bank in October last year may help them to hasten the process of approval for the acquisition and increase the odds of approval, but we will have to see the results in November this year.\nWhile there is an inherent risk of SOFI not being able to secure this bank charter, the risk/reward balance is asymmetrical because the tailwinds form being able to secure this charter greatly outweighs the downside from failing to do so. In the former case, revenues will begin to skyrocket, but in the latter case, SOFI's cross-buy strategy will still allow them to return better unit economics than most peers, and still grow albeit at a slower than expected pace.\nValue-adding via Noninterest, Non-loan income\nTheir ability to generate non-interest income is a differentiating factor from many traditional banks from the value-add perspective, not just from the unit economics perspective.\nOn the consumer end, the presence of many integrated features in a single app allows them to avoid the trouble of having to sign up with multiple banks under multiple accounts to enjoy the same suite of services. Currently, more than 50% of Americans use more than one bank for financial services, which presents an opportunity to value-add via the promise of greater convenience and accessibility to a whole suite of financial products.\n<img src=\"https://static.tigerbbs.com/310d5df2201205c227d7882783385f34\" tg-width=\"640\" tg-height=\"570\" width=\"100%\" height=\"auto\">(More than half of Americans use more than one bank, suggesting the opportunity for consolidation. Source: SoFi 2021 Investors Presentation)\nApart from consumer-facing products, SOFI has also expanded recently to the fintech infrastructure side of things through their acquisition of Galileo, which is apayments and financial services API platform. Galileo will likely mark the first steps into expanding towards a seller-side ecosystem focusing on connecting producers to other producers as well as their own sellers, helping SOFI to further diversify itself towards more areas of fintech to fuel user growth.\nWhile interest income is still crucial in the long term for maximizing the value per consumer, non-interest income crucially assists in hedging against poor macroeconomic headwinds that may cause a fall in net interest margin. For instance, while SOFI may not be able to charge high interest rates on its loans in a low interest rate environment, the increase in willingness to spend may lead to an increased volume of transactions on its payment network services as well as its brokerage services as cost of borrowing decreases.\nOther macroeconomic conditions like a global pandemic or an ageing population may lead to a decrease in risk attitudes and hence an increased willingness to save instead of borrowing to finance big-ticket purchases. However, SOFI is again able to hedge against this because risk-averse attitudes are typically correlated with an increase in demand for insurance policies, such as business continuity insurance or health insurance, on which SOFI earns a referral fee from third-party underwriters.\nAs of 2020, SOFI's Noninterest income less loan income less only takes up 20% of overall net revenue. This may not be as significant as its loan and interest income, but it still takes up a sufficiently large portion of revenues to effectively hedge against macroeconomic headwinds.\nRisk Attitudes, Returns on Investment and Investment Quality\nCurrently, SOFI targets a specific group of high earners not well served, who are individuals of ages 22+ that earn more than $100,000 annually. These individuals tend to have a relatively low default risk as their incomes are more stable, which allows them to reduce allocation to bad loans. For their student loan financing, in-school loans, personal loans and home loan segments, the weighted average origination FICO scores of their members were 770, 783, 765 and 763 respectively, which represent the higher percentile range of FICO scores.\nIn the future, SOFI's large range of product offerings across many different consumer finance segments will act as a moat that will enable them to shoulder more risk and theoretically earn a higher net interest margin. With their suite of high-volume financial products such as investing, payment/transaction and credit card services, SOFI will be able to outline a better risk profile of their customers using data about spending habits. Since such data is more nuanced than what can be expressed in a FICO score or other credit ratings, SOFI will be able to better estimate the borrowing risk that is inherent to each consumer. This will allow them to expand their loan base and loan to more risky individuals while charging them a higher interest rate to account for risk, while reducing the extent of any potential losses incurred from bad loans.\nExpanding to the enterprise side of things such as through the acquisition of Galileo can further improve the datasets they already have to paint a better picture of consumer risk profiles through even more transaction data. This also opens up the opportunity to expand towards providing business loans to enterprises using data that they have about firm performance, adding yet another avenue for growth and interest income.\nValuation\nSOFI's intrinsic value was found by discounting the terminal value of excess returns earned after FY25, and adding that to the book value of equity invested currently. In this case, the terminal value calculated was based on the excess returns earned above the market return and not absolute return, because the benchmark of a financial service firm's performance should be based on how much they are able to earn above the market rate. A traditional bank can be valued more accurately and simply using a Gordon growth model by projecting dividends over time, but since SOFI is neither profitable nor offering dividends, we are unable to use this method.\nIn addition, relative ratios do not work because SOFI currently has negative earnings (invalidating P/E valuation), and has a negative tangible book value (invalidating P/TBV valuation). Other metrics like EV/EBITDA or EV/Sales used in a typical relative ratio analysis also cannot be used because enterprise value is typically not calculated for financial services firms because it is difficult to distinguish debt from customer deposits and financing debt.\nBelow outlines the key assumptions used to value SOFI.\nValuation Assumptions\n<ul>\n <li>Revenues were projected based on two main categories: interest related income as well as non-interest income. The former category refers to interest income earned on loans, securitizations, and related party notes. The latter category refers to non-interest revenue such as SOFI's technology platform, referral fees, brokerage fees, as well as loan origination and sales.</li>\n</ul>\n<ul>\n <li>SOFI has some investment assets in the form of bonds, ETFS, and others on their balance sheet. I assume that these investments earn a constant ROI of 6% in line with the market risk premium. The increase in value of these assets will allow SOFI to shoulder more debt via their warehousing facilities and use a portion of this debt raised to finance their loan offerings to consumers. This will be based on the ratio of debt to investment assets, and loan to debt.</li>\n</ul>\n<ul>\n <li>In FY19 and FY20, the debt to investment asset ratios were 5.41x and 7.16x respectively. From FY21 to FY25, I took the average debt to investment asset ratio at 6.29x.</li>\n</ul>\n<ul>\n <li>The loan to debt ratios in the same period of FY19 and FY20 were 1.15x and 1.02x respectively. From FY21 to FY25, I took the average ratio at 1.08x.</li>\n</ul>\n<ul>\n <li>Finally, SOFI earns an interest income on these loans that varied from 7-11% in the past 3 years. Without factoring in the impact of the bank charter, I assume that the firm will be able to earn a constant interest rate of around 9% on these loans.</li>\n</ul>\n<ul>\n <li>Non-interest income has been doubling or more for the previous few fiscal years. For the sake of conservative valuation, I will assume a decreasing growth rate of 60% in FY21 to 20% in FY25 for this segment. This will likely cause a large underestimation of revenues for the next 5 years, as segments such as Galileo will likely provide significant non-interest income for the firm.</li>\n</ul>\n<ul>\n <li>Cost and expenses follow the FY20 percentage of revenues. This is excluding interest expense which was projected using a separate schedule and hinges on estimated financing for the next few years. Share-based compensation expense was also projected separately, using a 3-year average percentage of revenues.</li>\n</ul>\nOther assumptions used to balance the model are listed below:\n<img src=\"https://static.tigerbbs.com/1d541fcc8ba039276af2108320fe2014\" tg-width=\"640\" tg-height=\"211\" width=\"100%\" height=\"auto\">(Other DCF Assumptions. Source: Author)\nTerminal Value and DCF Results\nTo reiterate, intrinsic equity value of the firm is contingent on the current book value of equity invested as well as the terminal value of excess returns earned, calculated using the metrics below.\n<img src=\"https://static.tigerbbs.com/15aafdf761795232b9a903dc360b1991\" tg-width=\"353\" tg-height=\"117\" width=\"100%\" height=\"auto\">(Ratios and Metrics used to calculate terminal value of excess returns. Source: Author)\nStable ROE value is the average value of ROE obtained from peers as shown in the image below, since it is reasonable to assume that SOFI can earn a return on equity on par with traditional banks. The terminal beta is the current average beta of these peers.\n<img src=\"https://static.tigerbbs.com/fd3df2107e1e53c81faa82e17bf83b32\" tg-width=\"640\" tg-height=\"135\" width=\"100%\" height=\"auto\">(Peer Average ROE and Beta ratios. Source: Tikr.com)\nThe results are summarized in the football field below. After varying ROE, revenue growth, cost and expenses and various ratios, the range of values obtained were 14.62 at the 25th percentile and 33.32 at the 75th percentile. At the median estimate of 21.70, there is an implied upside of around 43% from its current price, which suggests a high degree of undervaluation relative to expectations. This falls in line with current analyst estimates, and well within the 52-week trading range of the firm. The large degree of uncertainty about its intrinsic value may be some cause for concern, but seeing that SOFI's current price is not too far off from the low end of estimates, there is an asymmetric opportunity in an investment in SOFI.\n<img src=\"https://static.tigerbbs.com/6d78fdbe30dd8af9e71d65fbdaf46a34\" tg-width=\"640\" tg-height=\"413\" width=\"100%\" height=\"auto\">(Football field for SOFI. Source: Author)\nSalient Risks\nSubstitutes and New Entrants\nWhat differentiates SOFI from their competition is their full suite of services cutting across many sectors of fintech.\nIt is challenging for new entrants and peers to mimic its offerings by simply expanding and acquiring new firms, because there will be significant regulatory and financial capital hurdles. Nonetheless, other firms can still opt to specialize, for example, in low-value but high-frequency financial services like payments with low barriers.\nHowever, specialization might be a threat to SOFI in the long term because the more niche firms tend to have a more nuanced focus on product strategy, so it ends up fitting their target consumer more. This will likely translate to a more loyal userbase in the future.\nIn contrast, a diversification strategy has a focus on giving consumers more choices on a single platform, and while not necessarily mutually exclusive, may lead to a certain degree of compromise on product quality and how watertight their ecosystem will be. In other words, specialists might be able to serve their target audience better in the future.\nBoth are valid ways gain users and to survive amidst cutthroat competition. For SOFI, the bet is essentially on consumers switching because they want the benefit of convenience, but they may not be that sticky in the long term as compared to specialist firms like PYPL or SQ that have their sights on running exclusively a payments and transaction platform. We will need to see how this plays out in the long term, but this is something worth nothing as a competitive risk.\nOutcompeted by Traditional Banks\nEven though SOFI's multi-dimensional consumer data from their suite of services can serve as a differentiating factor in the long run, the datasets are still quite small in comparison to the decades of credit card, spending, income, and loan repayment data at the hands of banks that have been running for much longer than SOFI has. This suggests the greater ability of banks to tolerate more risk than SOFI, so these banks can afford to make loans to more risky individuals and at the same time earn a higher interest income.\nWhether SOFI's proprietary risk model can lead to greater returns in the long term compared to the decades of transaction data in the servers of traditional banks remains quite speculative. For all the talk about their preferential ability to model risk with multi-dimensional data, datasets across time may turn out to be better predictors of risk than datasets across space, so SOFI will have to wait to gain more decades of data before they are able to expand their loan services to more risky individuals.\nOn the same note of competition from traditional banks, there is a risk that they will be able to innovate a whole ecosystem of services like SOFI, including payments, transactions, loans and investing on a single platform. If their new app or platform becomes equally as convenient as SOFI's, then user growth on the part of SOFI may be impacting, which may impede their path towards profitability.\nIn developed Asian markets, digital banking is now almost universal, with pandemic trends further accelerating the push towards digital banking infrastructure. While digital banks in other geographies are mostly startups like SOFI, digital banking in Asia ismostly driven by incumbent playerswho have innovated sufficiently to keep up with digitalizing trends. This suggests the possibility of incumbent banks to also innovate similarly, and cause SOFI's offerings to appear less appealing by comparison.\nBank Charter Risk\nEarlier on, I argued that even without the national bank charter, SOFI's integrated ecosystem will still allow them to enjoy excellent unit economics and grow their consumer base while expanding the lifetime value of their consumers. However, the failure to secure the bank charter might cause their outlook to turn pessimistic, and result in poor price performance in the short term. Their failure to secure a bank charter will also suggest the increased likelihood of continued dominance by large banking institutions, which may cause an outflow in investment capital away from fintech.\nConclusion\nDespite the risks at hand, there are also many opportunities that can help to catalyze upward price action. For one, SOFI may turn profitable in the coming quarters, which can make it salient to investors that they actually have a sustainable business model, and is further proof of their excellent unit economics. In their recent Q1'21 presentation, SOFI reiterated their guidance of 3% adjusted EBITDA margin by the end of the year, making this scenario even more likely to occur. SOFI securing a national bank charter will almost certainly improve their outlook for the future, as it validates their positioning as a future-oriented banking institution.\nWhile many factors such as their ability to secure the bank charter, their ability to outcompete traditional banks and fintech players, and ability to shoulder more risk in the future still remain uncertain, their excellent strategic positioning gives me confidence that it will occur. With their current undervaluation and stellar fundamentals, there is a clear asymmetric opportunity in an investment in SOFI.","collect":0,"html":"<!DOCTYPE html>\n<html>\n<head>\n<meta http-equiv=\"Content-Type\" content=\"text/html; charset=utf-8\" />\n<meta name=\"viewport\" content=\"width=device-width,initial-scale=1.0,minimum-scale=1.0,maximum-scale=1.0,user-scalable=no\"/>\n<meta name=\"format-detection\" content=\"telephone=no,email=no,address=no\" />\n<title>SoFi Technologies: A Next Generation Banking Disruptor</title>\n<style type=\"text/css\">\na,abbr,acronym,address,applet,article,aside,audio,b,big,blockquote,body,canvas,caption,center,cite,code,dd,del,details,dfn,div,dl,dt,\nem,embed,fieldset,figcaption,figure,footer,form,h1,h2,h3,h4,h5,h6,header,hgroup,html,i,iframe,img,ins,kbd,label,legend,li,mark,menu,nav,\nobject,ol,output,p,pre,q,ruby,s,samp,section,small,span,strike,strong,sub,summary,sup,table,tbody,td,tfoot,th,thead,time,tr,tt,u,ul,var,video{ font:inherit;margin:0;padding:0;vertical-align:baseline;border:0 }\nbody{ font-size:16px; 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}\n.meta {color:#5e5c6d;font-size:13px;margin:0 0 .5em; }\na{text-decoration:none; color:#2a4b87;}\n.meta .head { display: inline-block; overflow: hidden}\n.head .h-thumb { width: 30px; height: 30px; margin: 0; padding: 0; border-radius: 50%; float: left;}\n.head .h-content { margin: 0; padding: 0 0 0 9px; float: left;}\n.head .h-name {font-size: 13px; color: #eee; margin: 0;}\n.head .h-time {font-size: 11px; color: #7E829C; margin: 0;line-height: 11px;}\n.small {font-size: 12.5px; display: inline-block; transform: scale(0.9); -webkit-transform: scale(0.9); transform-origin: left; -webkit-transform-origin: left;}\n.smaller {font-size: 12.5px; display: inline-block; transform: scale(0.8); -webkit-transform: scale(0.8); transform-origin: left; -webkit-transform-origin: left;}\n.bt-text {font-size: 12px;margin: 1.5em 0 0 0}\n.bt-text p {margin: 0}\n</style>\n</head>\n<body>\n<div class=\"wrapper\">\n<header>\n<h2 class=\"title\">\nSoFi Technologies: A Next Generation Banking Disruptor\n</h2>\n\n<h4 class=\"meta\">\n\n\n2021-07-27 17:34 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4441446-sofi-technologies-a-banking-disruptor>seekingalpha</a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\nSummary\n\nSOFI started off as a simple provider of loans, and has since expanded its offerings to encompass a large array of services that make for a compelling fintech ecosystem.\nAgainst traditional ...\n\n<a href=\"https://seekingalpha.com/article/4441446-sofi-technologies-a-banking-disruptor\">Web Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","type":0,"thumbnail":"","relate_stocks":{"SOFI":"SoFi Technologies Inc."},"source_url":"https://seekingalpha.com/article/4441446-sofi-technologies-a-banking-disruptor","is_english":true,"share_image_url":"https://static.laohu8.com/e9f99090a1c2ed51c021029395664489","article_id":"1139811761","content_text":"Summary\n\nSOFI started off as a simple provider of loans, and has since expanded its offerings to encompass a large array of services that make for a compelling fintech ecosystem.\nAgainst traditional banks and fintech players, SOFI has a competitive advantage, as a result of its horizontally integrated offerings cutting across many areas of fintech and banking.\nWhen valued as a traditional bank, SOFI checks off all the boxes for a compelling business, with a strategy that will likely lead to stellar metrics in the long run.\nSOFI can also be seen as undervalued relative to expectations, which suggests the strong likelihood of upside even at this price.\nWhile there might be salient risks in an investment in this newly-IPOed company, its strategic positioning and strong fundamentals give investors confidence that they will be able to outperform in the long run.\n\nipopba/iStock via Getty Images\nIntroduction\nSoFI(NASDAQ:SOFI)represents the next generation of banking, and plays into a growing fintech industry. They started off as a simple provider of loans in the student loan market, and have since expanded their offerings to encompass a large array of services in the consumer finance sector - from personal loans, home loans, and even to insurance, credit card services, cash management, brokerage services and recently to payments and financial services APIs for enterprises.\nUnsurprisingly, their diverse and integrated ecosystem of services in a single app has gotten SOFI tremendous user growth, as increasingly frustrated customers of traditional banks opt to switch to SOFI for the ease of convenience. Q1'21 was their best showing yet, with a year-on-year increase of over 110% in members, as well a 121% y/y increase in the number of products sold.\n(Accelerating User Growth. Source:SoFI Q1'21 Investors Presentation)\n(Accelerating Product Growth. Source: SoFI Q1'21 Investors Presentation)\nCrucially, SOFI's integrated platform differentiates them from traditional banking peers as well as new age fintech players. From the angle of a traditional bank, SOFI appears to check-off all the boxes for a compelling business, which gives investors confidence that they are operating a model that is sustainable in the long-run.\nCompetitive Advantage\nTypically, there are a few metrics to look at when evaluating traditional banks. These include, customer acquisition costs, lifetime value of consumers, interest and non-interest income, as well as investment quality. From each of these angles, SOFI appears poised to outcompete peers, be it from traditional banking or from other fintech players.\nLow Customer Acquisition Costs But High Lifetime Value of Consumers\nCritically, banks seek revenue growth through two means: increasing the number of customers that they have, and increasing the value they are able to derive from each of their customers through selling them different financial products. This is akin to a traditional consumer electronics firm like Apple(NASDAQ:AAPL), where their goal is to get more people to buy their products, and increase their bargaining power against consumers to get them to spend more on products.\nHere, SOFI has an advantage over other banks and other fintech firms because of its horizontal diversification to different aspects of consumer finance and to traditional lending as well.\n(SoFi has a large range of products that is constantly expanding. Source:SoFi 2021 Investors Presentation.)\nAs part of its strategy, SOFI intends on building a full suite of consumer finance as well as banking services to each of its individuals on a single platform. Currently, they offer a range of products from high-frequency, high-volume but low-value financial services such as SoFi Money, Relay and Invest, to low-frequency, low-volume but high-value financial services such as Home Loans, In-School Loans as well as Personal loans. The former category relies on taking a small cut on a large volume of small transactions, while the latter category monetizes from large interest payments from a large capital base. These happen to cut across many categories of fintech as shown in the fintech map provided by Business Insider:\n(The fintech ecosystem and some players within it. Source:Business Insider)\nAgainst fintech firms that primarily monetize on the former category such as payment processors like PayPal(NASDAQ:PYPL), peer-to-peer lending apps like Cash App from Square(NYSE:SQ)and brokerages like Robinhood (HOOD), SOFI is able to differentiate sufficiently using the latter category of financial services. This is because high-frequency financial services typically have lower margins and rely on the increase in volume and size of transactions as well as growth of their userbase to sustain revenue growth. With high-value loans earning high interest income, SOFI is able to theoretically derive more revenue per customer in the long run, without the need for as high of a userbase growth. SOFI certainly is aiming for high user growth as well, but the point here is that there is an additional lever for SOFI to pull in pursuing revenue growth - preferentially selling users high-value products already in its ecosystem - which reduces the need to devote significant resources to marketing strategies to fuel growth.\nAgainst traditional banks, SOFI differentiates itself using its low-cost consumer acquisition strategy, enabled through cross-buy opportunities. Instead of directly pursuing user growth with the proposition of selling them high-value financial services, SOFI eases consumers into the ecosystem by giving them free access to low-value but high-frequency products. From that point, it is easier to rope consumers into the higher-value financial services since it is simply getting them to press a few buttons with an account they already have.\nAccording to SOFI's official pitch deck for their PIPE presentation, the combination of low-value financial products and high value loans on the same app increases the opportunity that its customers cross-buy into these loans. Since the customer was acquired with low cost into its low-value offerings, the variable profit per customer that cross-buys into high-value loans now increases by 180% compared to when obtaining that same loan customer through traditional means.\n(SoFi's Cross-buy opportunities. Source: SoFi 2021 Investors Presentation.)\nHigher margins will directly translate into the greater ability to reinvest in diversifying their products further or to expand internationally, both of which can help feed into further growth in the future.\nIn a nutshell, SOFI's unique business model that ties in multiple aspects of fintech helps them to achieve impressive unit economics but at the same time high lifetime value per consumer, through low customer acquisition costs and opportunities for cross-buy. These two factors together will serve to differentiate SOFI from both the burgeoning fintech sector as well as traditional banks.\nFuture Interest and Loan Income\nFor SOFI's lending and cash management products, they primarily earn through a gain-on-sale model where they repackage loans made to customer and sell these loans to other large financial institutions or securitization channels. For loans still on their balance sheet, SOFI also earns an interest income on these loans.\nHowever, unlike a traditional bank, SOFI is currently unable to use the deposits made by SoFi Money Members to fund its loans because it does not have a national bank charter. Instead, SOFI relies almost entirely on warehouse financing facilities to originate loans and sell them to customers. This involves borrowing from large financial institutions, since a warehouse facility is essentially a large line of credit that they extend to SOFI for the purpose of loaning.\nFor SOFI Money, the interest income they are able to earn on their member's deposits is also constrained because of the middleman that they rely on to provide cash management facilities in lieu of SOFI's inability to function as a bank holding company.\nWhile banks significantly increasing their interest and loan income in the future may not be a sure thing, SOFI will easily be able to secure a higher return on their loans as well as a higher interest income by securing a national bank charter. For one, the bank charter will allow them to use the money that its members deposit with them to fund their loans and therefore use their capital resources more efficiently without relying on a third party for financing options. Alternatively, when combined with existing warehousing facilities, having access to a pool of deposit money will allow SOFI to grow their loan base and therefore increase interest income levels at a higher rate. Cutting out the middleman will allow them to save on premiums paid for these intermediary warehousing or cash management services and therefore earn a greater net interest margin.\nIn October last year, the OCC already issued a preliminary conditional approval of their application to be chartered as a de novo national bank.\nAs an alternative route to securing a national bank charter,SOFI also entered an agreementto acquire Golden Pacific Bancorp. Their preliminary conditional approval to be chartered as a de novo national bank in October last year may help them to hasten the process of approval for the acquisition and increase the odds of approval, but we will have to see the results in November this year.\nWhile there is an inherent risk of SOFI not being able to secure this bank charter, the risk/reward balance is asymmetrical because the tailwinds form being able to secure this charter greatly outweighs the downside from failing to do so. In the former case, revenues will begin to skyrocket, but in the latter case, SOFI's cross-buy strategy will still allow them to return better unit economics than most peers, and still grow albeit at a slower than expected pace.\nValue-adding via Noninterest, Non-loan income\nTheir ability to generate non-interest income is a differentiating factor from many traditional banks from the value-add perspective, not just from the unit economics perspective.\nOn the consumer end, the presence of many integrated features in a single app allows them to avoid the trouble of having to sign up with multiple banks under multiple accounts to enjoy the same suite of services. Currently, more than 50% of Americans use more than one bank for financial services, which presents an opportunity to value-add via the promise of greater convenience and accessibility to a whole suite of financial products.\n(More than half of Americans use more than one bank, suggesting the opportunity for consolidation. Source: SoFi 2021 Investors Presentation)\nApart from consumer-facing products, SOFI has also expanded recently to the fintech infrastructure side of things through their acquisition of Galileo, which is apayments and financial services API platform. Galileo will likely mark the first steps into expanding towards a seller-side ecosystem focusing on connecting producers to other producers as well as their own sellers, helping SOFI to further diversify itself towards more areas of fintech to fuel user growth.\nWhile interest income is still crucial in the long term for maximizing the value per consumer, non-interest income crucially assists in hedging against poor macroeconomic headwinds that may cause a fall in net interest margin. For instance, while SOFI may not be able to charge high interest rates on its loans in a low interest rate environment, the increase in willingness to spend may lead to an increased volume of transactions on its payment network services as well as its brokerage services as cost of borrowing decreases.\nOther macroeconomic conditions like a global pandemic or an ageing population may lead to a decrease in risk attitudes and hence an increased willingness to save instead of borrowing to finance big-ticket purchases. However, SOFI is again able to hedge against this because risk-averse attitudes are typically correlated with an increase in demand for insurance policies, such as business continuity insurance or health insurance, on which SOFI earns a referral fee from third-party underwriters.\nAs of 2020, SOFI's Noninterest income less loan income less only takes up 20% of overall net revenue. This may not be as significant as its loan and interest income, but it still takes up a sufficiently large portion of revenues to effectively hedge against macroeconomic headwinds.\nRisk Attitudes, Returns on Investment and Investment Quality\nCurrently, SOFI targets a specific group of high earners not well served, who are individuals of ages 22+ that earn more than $100,000 annually. These individuals tend to have a relatively low default risk as their incomes are more stable, which allows them to reduce allocation to bad loans. For their student loan financing, in-school loans, personal loans and home loan segments, the weighted average origination FICO scores of their members were 770, 783, 765 and 763 respectively, which represent the higher percentile range of FICO scores.\nIn the future, SOFI's large range of product offerings across many different consumer finance segments will act as a moat that will enable them to shoulder more risk and theoretically earn a higher net interest margin. With their suite of high-volume financial products such as investing, payment/transaction and credit card services, SOFI will be able to outline a better risk profile of their customers using data about spending habits. Since such data is more nuanced than what can be expressed in a FICO score or other credit ratings, SOFI will be able to better estimate the borrowing risk that is inherent to each consumer. This will allow them to expand their loan base and loan to more risky individuals while charging them a higher interest rate to account for risk, while reducing the extent of any potential losses incurred from bad loans.\nExpanding to the enterprise side of things such as through the acquisition of Galileo can further improve the datasets they already have to paint a better picture of consumer risk profiles through even more transaction data. This also opens up the opportunity to expand towards providing business loans to enterprises using data that they have about firm performance, adding yet another avenue for growth and interest income.\nValuation\nSOFI's intrinsic value was found by discounting the terminal value of excess returns earned after FY25, and adding that to the book value of equity invested currently. In this case, the terminal value calculated was based on the excess returns earned above the market return and not absolute return, because the benchmark of a financial service firm's performance should be based on how much they are able to earn above the market rate. A traditional bank can be valued more accurately and simply using a Gordon growth model by projecting dividends over time, but since SOFI is neither profitable nor offering dividends, we are unable to use this method.\nIn addition, relative ratios do not work because SOFI currently has negative earnings (invalidating P/E valuation), and has a negative tangible book value (invalidating P/TBV valuation). Other metrics like EV/EBITDA or EV/Sales used in a typical relative ratio analysis also cannot be used because enterprise value is typically not calculated for financial services firms because it is difficult to distinguish debt from customer deposits and financing debt.\nBelow outlines the key assumptions used to value SOFI.\nValuation Assumptions\n\nRevenues were projected based on two main categories: interest related income as well as non-interest income. The former category refers to interest income earned on loans, securitizations, and related party notes. The latter category refers to non-interest revenue such as SOFI's technology platform, referral fees, brokerage fees, as well as loan origination and sales.\n\n\nSOFI has some investment assets in the form of bonds, ETFS, and others on their balance sheet. I assume that these investments earn a constant ROI of 6% in line with the market risk premium. The increase in value of these assets will allow SOFI to shoulder more debt via their warehousing facilities and use a portion of this debt raised to finance their loan offerings to consumers. This will be based on the ratio of debt to investment assets, and loan to debt.\n\n\nIn FY19 and FY20, the debt to investment asset ratios were 5.41x and 7.16x respectively. From FY21 to FY25, I took the average debt to investment asset ratio at 6.29x.\n\n\nThe loan to debt ratios in the same period of FY19 and FY20 were 1.15x and 1.02x respectively. From FY21 to FY25, I took the average ratio at 1.08x.\n\n\nFinally, SOFI earns an interest income on these loans that varied from 7-11% in the past 3 years. Without factoring in the impact of the bank charter, I assume that the firm will be able to earn a constant interest rate of around 9% on these loans.\n\n\nNon-interest income has been doubling or more for the previous few fiscal years. For the sake of conservative valuation, I will assume a decreasing growth rate of 60% in FY21 to 20% in FY25 for this segment. This will likely cause a large underestimation of revenues for the next 5 years, as segments such as Galileo will likely provide significant non-interest income for the firm.\n\n\nCost and expenses follow the FY20 percentage of revenues. This is excluding interest expense which was projected using a separate schedule and hinges on estimated financing for the next few years. Share-based compensation expense was also projected separately, using a 3-year average percentage of revenues.\n\nOther assumptions used to balance the model are listed below:\n(Other DCF Assumptions. Source: Author)\nTerminal Value and DCF Results\nTo reiterate, intrinsic equity value of the firm is contingent on the current book value of equity invested as well as the terminal value of excess returns earned, calculated using the metrics below.\n(Ratios and Metrics used to calculate terminal value of excess returns. Source: Author)\nStable ROE value is the average value of ROE obtained from peers as shown in the image below, since it is reasonable to assume that SOFI can earn a return on equity on par with traditional banks. The terminal beta is the current average beta of these peers.\n(Peer Average ROE and Beta ratios. Source: Tikr.com)\nThe results are summarized in the football field below. After varying ROE, revenue growth, cost and expenses and various ratios, the range of values obtained were 14.62 at the 25th percentile and 33.32 at the 75th percentile. At the median estimate of 21.70, there is an implied upside of around 43% from its current price, which suggests a high degree of undervaluation relative to expectations. This falls in line with current analyst estimates, and well within the 52-week trading range of the firm. The large degree of uncertainty about its intrinsic value may be some cause for concern, but seeing that SOFI's current price is not too far off from the low end of estimates, there is an asymmetric opportunity in an investment in SOFI.\n(Football field for SOFI. Source: Author)\nSalient Risks\nSubstitutes and New Entrants\nWhat differentiates SOFI from their competition is their full suite of services cutting across many sectors of fintech.\nIt is challenging for new entrants and peers to mimic its offerings by simply expanding and acquiring new firms, because there will be significant regulatory and financial capital hurdles. Nonetheless, other firms can still opt to specialize, for example, in low-value but high-frequency financial services like payments with low barriers.\nHowever, specialization might be a threat to SOFI in the long term because the more niche firms tend to have a more nuanced focus on product strategy, so it ends up fitting their target consumer more. This will likely translate to a more loyal userbase in the future.\nIn contrast, a diversification strategy has a focus on giving consumers more choices on a single platform, and while not necessarily mutually exclusive, may lead to a certain degree of compromise on product quality and how watertight their ecosystem will be. In other words, specialists might be able to serve their target audience better in the future.\nBoth are valid ways gain users and to survive amidst cutthroat competition. For SOFI, the bet is essentially on consumers switching because they want the benefit of convenience, but they may not be that sticky in the long term as compared to specialist firms like PYPL or SQ that have their sights on running exclusively a payments and transaction platform. We will need to see how this plays out in the long term, but this is something worth nothing as a competitive risk.\nOutcompeted by Traditional Banks\nEven though SOFI's multi-dimensional consumer data from their suite of services can serve as a differentiating factor in the long run, the datasets are still quite small in comparison to the decades of credit card, spending, income, and loan repayment data at the hands of banks that have been running for much longer than SOFI has. This suggests the greater ability of banks to tolerate more risk than SOFI, so these banks can afford to make loans to more risky individuals and at the same time earn a higher interest income.\nWhether SOFI's proprietary risk model can lead to greater returns in the long term compared to the decades of transaction data in the servers of traditional banks remains quite speculative. For all the talk about their preferential ability to model risk with multi-dimensional data, datasets across time may turn out to be better predictors of risk than datasets across space, so SOFI will have to wait to gain more decades of data before they are able to expand their loan services to more risky individuals.\nOn the same note of competition from traditional banks, there is a risk that they will be able to innovate a whole ecosystem of services like SOFI, including payments, transactions, loans and investing on a single platform. If their new app or platform becomes equally as convenient as SOFI's, then user growth on the part of SOFI may be impacting, which may impede their path towards profitability.\nIn developed Asian markets, digital banking is now almost universal, with pandemic trends further accelerating the push towards digital banking infrastructure. While digital banks in other geographies are mostly startups like SOFI, digital banking in Asia ismostly driven by incumbent playerswho have innovated sufficiently to keep up with digitalizing trends. This suggests the possibility of incumbent banks to also innovate similarly, and cause SOFI's offerings to appear less appealing by comparison.\nBank Charter Risk\nEarlier on, I argued that even without the national bank charter, SOFI's integrated ecosystem will still allow them to enjoy excellent unit economics and grow their consumer base while expanding the lifetime value of their consumers. However, the failure to secure the bank charter might cause their outlook to turn pessimistic, and result in poor price performance in the short term. Their failure to secure a bank charter will also suggest the increased likelihood of continued dominance by large banking institutions, which may cause an outflow in investment capital away from fintech.\nConclusion\nDespite the risks at hand, there are also many opportunities that can help to catalyze upward price action. For one, SOFI may turn profitable in the coming quarters, which can make it salient to investors that they actually have a sustainable business model, and is further proof of their excellent unit economics. In their recent Q1'21 presentation, SOFI reiterated their guidance of 3% adjusted EBITDA margin by the end of the year, making this scenario even more likely to occur. SOFI securing a national bank charter will almost certainly improve their outlook for the future, as it validates their positioning as a future-oriented banking institution.\nWhile many factors such as their ability to secure the bank charter, their ability to outcompete traditional banks and fintech players, and ability to shoulder more risk in the future still remain uncertain, their excellent strategic positioning gives me confidence that it will occur. With their current undervaluation and stellar fundamentals, there is a clear asymmetric opportunity in an investment in SOFI.","news_type":1,"symbols_score_info":{"SOFI":0.9}},"isVote":1,"tweetType":1,"viewCount":119,"commentLimit":10,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"symbols":[],"verified":2,"subType":0,"readableState":1,"langContent":"EN","currentLanguage":"EN","warmUpFlag":false,"orderFlag":false,"shareable":true,"causeOfNotShareable":"","featuresForAnalytics":[],"commentAndTweetFlag":false,"andRepostAutoSelectedFlag":false,"upFlag":false,"length":4,"xxTargetLangEnum":"ORIG"},"commentList":[],"hasMoreComment":false,"orderType":2}

SoFi Technologies: A Next Generation Banking Disruptor

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