SoFi Technologies: Poised For Long-Term Profitability (NASDAQ:SOFI)

Thesis

Back in May last year, I covered SoFi Technologies, Inc. (NASDAQ:SOFI), where I discussed the company’s strong range of products but assigned a hold rating to the stock due to the FED’s hiking cycle, which I believed posed a risk to the company’s loan portfolio. However, SOFI has continued to do well, and the stock is up 67% since my article. The company has continued to post strong result and has been able to grow its deposit base & benefiting from lower cost of funding, resulting in higher-than-expected profitability. I have revised my rating on the stock to a buy as I believe despite the run-up in the stock price, there is still a lot of room for SOFI to grow.

I believe SOFI is positioned for strong performance in personal lending and refinancing student debt, with robust deposit inflows that support loan retention. SOFI has built a one-stop platform primarily targeting young professionals, providing them with simplified sign-up, ease of access, helpful tools for customized banking, and a total financial perspective that is likely to be missing in normal banks. Furthermore, the technology platform aids other financial institutions and financial technology companies that strive to offer similarly comprehensive services. The company’s fourth-quarter financial performance can be taken as evidence of its long-term profitability potential. I am optimistic on the company’s prospects and assign a buy rating to the stock.

Q4 Results Were Positive For Bulls

SoFi posted a mixed Q4 performance, providing something for both the bears and bulls. The emphasis on GAAP profitability and an earnings guide that exceeds expectations provided optimism, whereas, credit and lower revenue growth in 2024 served as grounds for pessimism. The company forecasts a revenue compound growth rate of 20-25% from 2023 to 2026 coming mainly from the financial services sector that will benefit from credit cards and new product offerings, including an alternative investment option. SoFi expects its earnings per share to range from 55 to 80 cents by 2026, beating the market forecast.

The most contested point throughout 3Q reporting was the sale of $15 mn loans (and $100mn in October) at a 105.1% execution level. Investors were left in the dark as there were not any sufficient details up front on the nuances. In 4Q, management did a much better job addressing the issue, providing clearer disclosures up front. Specifically, in 4Q, SOFI sold $875mn in personal loans – $375mn from the previously announced ABS deal with Blackrock plus $500mn in whole loan sales to multiple parties at a blended execution of 105.6%. Management pre-emptively stated that these sales yielded cash proceeds at or above par, with most of the premium attributed to capitalized contractual servicing fees. These deals included a small loss share provision, which exceeded the base assumption of losses but was deemed insignificant compared to the exposure if the loans were retained.

Critics of SoFi argue that the revenue growth for this company is just a consequence of lower interest rates, whereby the fair value of the loans also increases leading to the increase in the fair value as well, which in turn results in the growth of the revenue due to the change in fair value. However, notably, SoFi deploys a significant part of its loans in the derivatives market to reduce the earnings risks (when fair value rises, SoFi incurs losses on interest rate swaps). The management clarified that there was no net effect on revenues resulting from changes in fair value due to declining benchmark rates.

SoFi’s Journey towards Fintech Innovation

SoFi’s consistent investments in the neobanking segment present a significant opportunity for the company for significant long-term benefits as the company introduces new products to strengthen its super-app platform. There’s an opportunity for a select few firms to establish widespread usage across the next-generation, digitally-driven banking platforms. For instance, providing SoFi Invest users with access to allocations of Instacart’s IPO exemplifies its distinctive offerings. While financial results currently reflect the neobank’s investment phase, operating losses are gradually decreasing. The management has expressed confidence that the business can achieve a positive profit contribution by the end of 2023. Moreover, the slowing pace of bad-debt provisioning for credit cards is supporting these results.

SoFi’s technology-platform business has been steady, but a pivot to larger clients could pick up steam in 2024. It operates as the back-end-technology partner to companies (e.g.: Dave and MoneyLion) & has the ambitious goal of becoming the Amazon Web Services of fintech. Reflecting investment and client exits in 2022, the contribution profit margin has been stifled at 20% vs. the longer-term goal of reaching 40%. Management expects improved revenue trends in this business in 2024 as new clients contribute to results. Accounts on the platform are at 145 million and still growing, albeit at a slowing pace as the firm has pivoted to working with more established financial institutions and away from a focus on startups. SoFi sees an opportunity as banks seek help modernizing their tech stacks.

Financial Outlook & Valuation

SoFi continues to show improvement in its EBITDA margin, showing solid potential for profitability as it matures. EBITDA generation has been improving, buoyed by robust lending volume and reduced losses within the Financial Services segment, encompassing deposit, investment, and card operations. If these trends continue, I believe that guidance for a longer-term 30% EBITDA margin is achievable. Though the fintech’s revenue growth is slowing, I see areas that can help support results, such as improvement in the technology-platform business & a rebound in student-loan volume, which could become more pronounced in 4Q as repayments resume. The possibility of interest-rate cuts this year may also improve net interest margin via lower deposit pricing.

SoFi sits in an interesting period of its life cycle as revenue growth slows while GAAP profitability nears. The acquisition of a bank charter has provided SoFi with stable funding, a valuable asset, especially amidst uncertainty for other fintech lenders. I primarily assess SOFI in comparison to unsecured consumer card issuers such as BFH and DFS, as well as AI-driven lending fintech companies like AFRM and UPST. The average of the comp set stands at 2.5x P/BV & SOFI is currently trading well below the average of the comp-set. SOFI is currently trading at a P/BV of 1.59x, below its 3-year historical average of 1.65x as per Capital IQ estimates. I believe SOFI should be GAAP profitable in 2024 and beyond; the company’s positioning to target digitally savvy consumers with its full-suite banking services keeps me positive that the stock can continue to re-iterate upwards in the medium term. I upgrade my recommendation and assign a buy rating to the stock.

Investment Risks

Sofi’s reliance on a small number of major partners for loan purchases, warehouse services, and Galileo’s revenues can negatively affect the company’s valuation, earnings during periods of partner loss or uncertainty. The company values its loans on its balance sheet at fair value rather than setting aside reserves. This valuation relies on subjective discount rate assumptions, which may be too conservative. The company reassesses the fair value of its loan portfolio every quarter, & any changes are reflected in its income through loan origination and sales.

Conclusion

SoFi is strategically investing in its neobank segment, aiming for long-term benefits by enhancing its super-app platform with new products. Its diverse offerings in loans, deposits, & investments position it competitively in the race for super-app dominance. The company is aiming to become a comprehensive financial services provider through its mobile app, which offers quick setup, convenient access, useful tools, and an integrated view that traditional banks often lack. I am optimistic about the company’s prospects & assign a buy rating to the stock.