Is SoFi A Buy Now?

There are two types of SoFi (SOFI) investors:

• Some investors believe it's a meme stock, a stock riding the market's hype cycle, beloved by retail investor communities like Reddit. For example, Roundhill's Meme stocks ETF has more than 4% of its fund allocated to SoFi.
• On the other extreme side sit investors who believe the company is shaping the future of financial technology. For example, Ark Invest's Future of Fintech ETF just picked up nearly 300,000 shares of SoFi.

Which side is right, and is SoFi a fundamentally solid company to give us a 10,000% return, or are there big red flags and hidden risks that will bring the stock down and crashing sometime soon?

Let's talk about that!​

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I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.

This post is part of a series I started a few weeks ago to fundamentally research companies to  manage my real-money portfolio. I've already researched Canopy Growth (CGC), Fastly (FSLY), Snap (SNAP) ,  Shopify (SHOP),  Airbnb (ABNB), Unity (U), JD.com (JD), NVIDIA (NVDA) and several others. I'll continue with this series for a few more weeks.

​Remember, this content is for education and sharing ideas and not advice to buy or sell any securities. 
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I had always ignored SoFi. At some point, I assumed the business focused too much on student loans and didn't think it could scale to very large business. At another point, when the government put a hold on student load payments due to COVID, I disregarded SoFi as a dead business. But in all honesty, I never fundamentally researched the company. 

Today, let's change that. So many of you on YouTube, Twitter, and the Stock Card platform have asked about SoFi. It is one of the top 10 most viewed stocks on our platform. The most important question that grabbed my attention is whether SoFi is a possible 100-bagger stock, because it is a legacy bank disruptor and is shaping the future of fintech. If that's true, then I cannot ignore SoFi anymore.

Today, I stop speculating and fundamentally research the company using our usual 6-part framework:

1. How the company makes money,
   
2. Its top and bottom line trends,
   
3. Noteworthy changes in the top and bottom line,
   
4. Balance sheet strength,
   
5. Ability to generate cash to reinvest in its future,
   
6. Current valuation and the feasibility of growing into it.
   

SoFi's Revenue & Growth Potential

Visiting SoFi's website, the company comes across as a full-fledged financial service provider, offering loans, bank accounts, credit cards, insurance, and other financial products. 

However, looking at its financial statements, SoFi is still a lending company and makes most of its revenue from offering various loans and collecting interest on those loans from its members. 

The company also sells those loans to other financial institutions and collects revenue from the sale, or at least, that's what it used to do before it stopped selling loans in Q1 2023. Based on my math, nearly 70% of SoFi's revenue is related to lending activities. The rest of its revenue comes from financial services like credit cards and insurance products and a technology platform that sells banking products to other companies. 

When talking about SoFi's revenue, we must discuss the big elephant in the room – the student loan business. SoFi started as a student loan platform and is still a leading student loan provider in the U.S. market. It focuses on high-interested mid-term student loans. Because student loan payments and interest accumulation on the loans have been on hold since 2020 due to Covid-19 financial hardship, and the government has offered a student loan forgiveness program, there have been limited opportunities for SoFi to originate new loans or collect interest rates on the balances. Therefore the company's stock price was negatively impacted for quite a while. Now, and partially thanks to SoFi's legal actions, the student loan repayment is expected to resume in 2023, and the interest accumulates on the outstanding balances. Therefore, the negative sentiment about SoFi is gradually evaporating. 

There is still a lot of argument about the timing of the student loan repayments and the loan forgiveness program, but investing in SoFi just because of its student loan program isn't a good case for long-term investment in SoFi, and long-term investors shouldn't worry about it too much. Let me tell you why? According to the company's CFO at the latest Morgan Stanley conference, the total addressable market for student loans that SoFi can access is about $200B in the loan amount, and SoFi already has a 60% market share in that category. The student loan market has no significant growth opportunity for SoFi long-term investors looking for companies with rapid revenue growth and profitable operation. If all SoFi does is return to its old student loan program, we should stop researching now. But the company has been clever and used the student loan hold period to transition its business to a one-stop-shop platform for all-money-related needs of its members. So the negative or positive sentiment around the student loan programs is irrelevant to long-term investments, especially if we are looking for a company that shapes the future of fintech and can generate a significant return. 

The rest of SoFi's business, specifically its short-term, high-interest-rate personal loans to members with high credit scores, other financial products such as bank accounts, and its technology platform that serves other businesses with their banking infrastructure needs, are more important to our long-term investment strategy. 

Before we dig further in, there is an immediate red flag here. For a small $8B company, SoFi is doing too many things. It issues loans, securitizes and sells loans, offers various financial products and services, and sells banking infrastructure. Each of those segments can be a full-fledged business by itself. I fear that the lack of focus and doing too many things at the same time can be a double-edged sword. On the positive side, it diversifies SoFi's revenue away from the complex lending and loan reselling business. On the negative side, it makes the business quite complex to run. 

Having that red flag in mind, let's explore potential growth opportunities SoFi had created for itself by diversifying away student loans. It has expanded into broader banking services by getting a national banking charter certification through a bank acquisition in the U.S. in 2022, and it offers banking infrastructure tech to other financial institutions through acquiring the Galileo and Technisys platforms in 2022. These moves create at least three growth opportunities:

• By becoming a bank, it can hold customers' deposits and use them to offer more personal loans, growing its lending services and diversifying away from student loans. 
• According to the company's leadership, offering banking and financial products such as investing and no-fee banking accounts allows SoFi to acquire new members at a low cost and then sell them a loan, generating higher revenue. In the latest earnings report, we heard that the selling and marketing expenses ratio to revenue had decreased from 60% to 51%, indicating higher user acquisition efficiency thanks to the halo effect of banking products on lending services. 
• Lastly, in the financial technology market, there is a trend toward making any company a financial services provider. For example, think of Uber offering bank accounts to its drivers. Or Shopify is offering loans to its merchants. Those are examples of non-financial services companies embedding financial services into their product. But not every company wants to build the infrastructure required to offer banking solutions. Instead, they need technology platforms such as SoFi's Galileo to quickly and efficiently offer those services. This is commonly known as Embedded Finance, and its market is expected to grow by 32% per year in the next decade. This direction is potentially why Ark Invest's Future of Fintech ETF picked up shares of SoFi recently. 

So what does all this mean for SoFi's topline? There are positive trends and forces in the market to believe the company's revenue can grow in the years to come even if the student loan segment doesn't return to the pre-COVID and low-interest rate era.​

SoFi's Bottom Line

Let's pull up SoFi's Stock Card to continue our research. I leave a link to SoFi's Stock Card in the show notes. If you've been with me for a while, you already know I built Stock Card to help me and fundamental investors like me easily research and pick companies for the long term. If you are new around here, check out StockCard.io, look up your favorite stock or ETF ticker, and see how intuitive and easy it is to research them on Stock Card.

Back to SoFi, on the bottom line, the company doesn't generate positive income and is still losing money. But the losses have shrunk to $34M quarterly in Q1 2023, compared to a negative $110M in Q1 2022.  Also, the company generates positive adjusted EBITDA. The adjustment comes from adding back stock-based compensation and amortization to the loss from operations. Those are positive improvements. Assuming SoFi can continue to sell high-yield personal loans and expand its embedded finance tech platform business, we should see more profitable operations in the near future.

However, one red flag to be mindful of is that even though the company is steadily growing its banking products, evidenced by rapidly growing deposits by customers into SoFi's banking accounts, that business segment is making heavy losses. It's because SoFi offers high-interest-rate bank accounts and charges no fees to attract new members. Assuming high-interest rates stay around for a while, eventually, bigger banks will catch up, and SoFi may lose its deposit and member growth. We must monitor how well SoFi converts its banking customers to lending customers, turning them into profitable members before others catch up. Otherwise, the banking product divisions will become a profitability drag.

SoFi's Balance Sheet

Losing money makes us wonder about SoFi's balance sheet. Does it have enough cash to keep funding its loss-making operations, and more importantly, does its balance sheet allow issuing more personal loans where the company still makes most of its revenue?

As we dig into its financial statements, it's good to see SoFi has a solid balance sheet. It raised money through convertible notes in 2021 and now has more than $2B in cash and cash equivalents. 

Moreover, because the company has started accepting deposits into its bank accounts, it now has access to those deposits to improve its ability to issue new loans. The company has a fair balance sheet. And the management doesn't believe it needs additional fundraising to continue funding its growth.

SoFi's Accounting Methodology Issue:
Despite management's take on its balance sheet strength, because the business doesn't generate free cash flow, it isn't too far-fetched to believe SoFi may need to raise additional capital or borrow money if things don't pan out as planned. For example, if deposit growth slows down or if SoFi needs capital to allocate to R&D expenses and acquire new companies to shore up its tech platform side. Moreover, there is an unlikely case that the regulators ask SoFi to use a different accounting methodology for its lending business. This has been the topic of heated conversation between SoFi bulls and bears, and regardless of your position in that fight, it makes sense to understand the risk. So far, because SoFi has been issuing and reselling its loans to other financial institutions, it didn't need to calculate any loss provisions in the loan values on its balance sheet. Typically, lenders who carry the loan and don't sell them have to put 7% of the loan's values as loss provisions on their balance sheet. If SoFi is forced to follow a similar accounting methodology, the loss provisions will deplete its assets significantly, which may force the company to raise capital or borrow money to continue to fund its loans and unprofitable operations. This is the primary reason a Wedbush analyst had recently downgraded SoFi and has caused the stock price to come down from its recent highs. I'd leave a link to an excellent article on this accounting issue on Seeking Alpha in the show notes. As a side note, Seeking Alpha is one of our preferred news partners, and you can access recent articles and news related to any stock on its Stock Card by clicking on the News button on top of all Stock Cards. 

Back to SoFi's loan value accounting red flag, SoFi didn't need to follow that methodology because it had always originated and then immediately sold those loans to other institutions. In Q1 2023, the company changed its approach and is holding on to its loans. Management argues it is because it generates a higher yield by holding on to the loans. The bears argue that it is holding on to the loans because other financial institutions aren't interested in buying high-yield, unsecured personal loan portfolios in the current economic conditions. According to the Wedbush analyst, we can expect regulators to catch up and force that accounting methodology change on SoFi which will result in reducing the value of SoFi's assets on the balance sheet, forcing it to raise capital and dilute investors. No one really knows whether this will happen or not, but we cannot ignore its possibility as a red flag. 

We now know enough about SoFi's financials to discuss its valuations.

SoFi's Fundamental Recap

Let's recap SoFi's fundamentals.

• The company is growing its members and revenue by offering diversified financial and leading products.
  
• It is expanding its reach into the embedded finance market to accelerate its growth. 
  
• However, the operations are still unprofitable
  
• Also, there is the risk that other financial institutions to catch up to SoFi's no-fee, high-yield bank accounts, and the company loses its main driver of member growth. 
  
• SoFi has its eye on profitability and is already generating positive adjusted EBITDA. 
  
• Whether the company can continue to grow its revenue and become profitable is heavily dependent on its ability to execute its plans, continue to benefit from the halo effect of financial products and lending products, and its ability to run its newly acquired b2b technology platform business flawlessly. Those are some big bets on the management's skills and execution abilities. 
  
• On the balance sheet side, it has enough cash to continue its operations without capital concerns, even though any significant acquisition or R&D expenditure or possible regulatory interventions about its loan value calculation methodology may force the company to raise capital through diluting current investors or borrowing money in the future.  
  
• It doesn't generate free cash flow yet, and that's another pressure on its balance sheet. ​
  

SoFi's Valuation

There are many positives about SoFi and some red flags we just discussed. But can the company realistically become ten times bigger by disrupting the legacy banks and leading the embedded finance market?  It's time for valuation analysis. At 5 times the price-to-sales ratio, investors believe SoFi can grow its revenue by five times, which means an 18% compounded annual growth rate in the next ten years, all else equal. Is it possible? 

If SoFi was only in the lending business, 18% consistent annual revenue growth wouldn't be easy. If we believe the company can keep growing its financial product business, 18% annual growth may not be too difficult to believe. With $2B annual revenue and 5.6M in members now, SoFi makes about $350 per member. If the company grows its member base to the same 50 million members as CashApp by Block, the estimated revenue will be $17B, eight times bigger than its current estimated annual revenue. I know there are a lot of assumptions involved, and growing the membership base to 50 Million is a giant undertaking, but at least it gives us a sense of the feasibility of its current valuation. There is a path, even if it has a low probability, the SoFi grows into its current valuation and even higher. 

Let's assume SoFi generates $17B in revenue, which is not too far from Block's current revenue. And it gets a 2X price-to-sales valuation at that level. It can be a company with $34 B in market cap. That means SoFi can be a 4-bagger, giving us a 400% return. 

But, that story I gave you is with the assumption that SoFi stays a tech company, builds its embedded finance business, and moves away from lending as its core business.

If SoFi focuses on lending and banking, then price-to-sales and high-growth valuation ratios won't be applicable to it. Many argue because SoFi is a bank, the better valuation ratio is the company's price-to-book value which is about 1.6 times on the day I'm researching the stock. This is almost the same price-to-book valuation as JPMorgan Chase. So Investors are already pricing SoFi the same as the biggest bank in the U.S. 

As a matter of fact, the stock has recently received a few valuation downgrades from financial analysts from Piper Sanders and Bank of America due to high valuation concerns. 

So whether SoFi is overvalued or undervalued depends on which direction you believe in a lending and banking business or a banking infrastructure provider.

Is SoFi A Buy Now?

I see many risks, especially short-term, that can hinder SoFi from ever implementing its broader aspirations in embedded finance. I can also see the growth potential in that story if all goes well. But in business, as in life, you rarely get lucky for everything to go well. So this is one of those cases in which you can buy a small amount and monitor the company's track record in implementing its strategy. We are likely dealing with a volatile stock in the short term, especially if any news comes out about student loans, interest rates, regulatory interventions to force SoFi to change its accounting methodology, and SoFi's ability to grow its b2b business. 

If the stock price goes down in response to short-term news, we should return and redo our analysis to see whether the company is moving in the right direction. Those can be good buying opportunities assuming SoFi is on track to implement its banking infrastructure plans. After all, investing in big winners requires a lot of patience and monitoring. SoFi has a good direction, and it's all about whether it can implement and execute its plan and do some of the short-term risks related to its lending business.

You also have the less risky option of investing in an ETF that is holding SoFi in its top holdings, which you can get from the company's Stock Card by clicking on the top ETFs holding SoFi. 

See you next time!

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