SoFi (NASDAQ: SOFI) | One-Stop Financial Digital Platform


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Key Points

  • SoFi is a one-stop financial digital platform that offers a comprehensive suite of financial products

  • Its holistic financial solutions promote the flywheel effect

  • It utilizes lower CAC products (i.e. stock brokerage accounts) to strengthen its top-of-the-funnel approach

  • It owns Galileo, a BaaS provider, which serves 70 of the top 100 Fintech companies globally

  • Approval of its bank charter application could significantly improve profitability margins

Company Overview


Social Finance (SoFi) is a one-stop financial digital platform that offers a comprehensive suite of products that allows members to borrow, save, spend, invest and protect their money. Founded in 2011, the company prides itself on speed, selection, financial education content, and convenience, and has served approximately 2.3 million members since inception through 31 March 2021. It went public through a merger with a Chamath Palihapitiya-backed SPAC, Social Capital Hedosophia Holdings V (IPOE), on 1 June 2021.


Management


SoFi was started by four Stanford graduate students Mike Cagney, Dan Macklin, James Finnigan, and Ian Brady. The original CEO Mike Cagney was succeeded by Anthony Noto in 2017 due to allegations of sexual misconduct and toxic workplace culture. The current CEO was the CFO for Twitter, co-head of Global Telecommunications, Media and Technology Investment Banking at Goldman Sachs, and a U.S. Army captain before leading SoFi. On top of the discipline that he brought to the company, he has transformed it from a lending-only business to a one-stop-shop and has taken key steps in SoFi's bid to attain a crucial bank charter that will improve its earnings quality.


Product Overview


As of August 2021, SoFi’s products are categorized under lending, financial services, and technology platform which are all accessible via its mobile application. It started as a lending-only business in 2012 and expanded to include a technology platform service in 2018 with the acquisition of a 16.7% stake in Apex, a full-service clearing, and custody firm. In 2019, it launched its financial services segment with the introduction of SoFi Money, SoFi Invest, and SoFi Relay.

Lending


SoFi offers student loans, personal loans, and home loans, but it is best known for its student loans, in particular refinancing. It operates the lending segment on a gain-on-sale model, whereby SoFi originates loans at an efficient cost and sells them to financial institutions either through the whole loans or securitization channels. Given that it does not have a bank charter and is thus unable to utilize customer deposits, it originates loans through warehouse financing that is combined with some of the company’s capital.

Financial Services

SoFi’s main financial services are SoFi Money, an online cash management account, and SoFi Invest, a digital brokerage that offers robo-advisory and stock and cryptocurrency trading services.

In addition, it provides other financial services including credit cards and insurance.

Technology Platform

The technology platform segment comprises only Galileo which it acquired for US$1.2b in April 2020. It is a provider of technology platform services to financial and non-financial institutions and is commonly known as a Banking as a Service (BaaS) provider. It helps both unregulated and regulated startups to offer financial products through application programming interfaces (APIs) and bank partnerships. On top of navigating regulatory requirements, firms engage BaaS providers like Galileo to outsource the backend technology, to focus on building customer experience.

Industry Overview

According to Research Dive, the global digital banking market is expected to grow from US$804b in 2018 to US$ 1,610b in 2027, representing a CAGR of c. 9% during the period. Focusing on SoFi’s key market, the North America digital banking market is forecasted to grow from US$376b in 2019 to US$721b in 2027, representing a CAGR of c. 8% for the period. This is supported by factors including increasing smartphone and internet penetration, unmet customer needs by traditional banks, and less-restrictive financial regulations on Fintech firms as detailed in a BCG report.


Given that SoFi operates in 3 different segments - lending, financial services, and technology platform, we will be analyzing each one individually.


Lending

Within the consumer lending value chain, SoFi operates in the areas of origination and servicing while outsourcing the underwriting and financing to third parties given that it does not have a bank charter. For its servicing operations, it relies on sub-servicers to service all its student loans and credit cards and perform certain backup servicing functions concerning personal loans.


We will further break down the lending segment’s dynamics by SoFi’s lending sub-categories – student loan refinancing/in-school loans, personal loans, and home loans.


Student loan refinancing/in-school loans

Referencing the chart above, the funding of the student loan market is dominated by the U.S. federal government while non-federal private sources (i.e. banks, credit unions, and state agencies) where SoFi lies under, make up a small proportion of the total funding.

Within the private student loan market, SoFi holds a strong market share of 40% to 50% of total U.S. in-school private student loan originations based on the value of the originations. However, there was a marked drop in its market share in 2020 due to the CARES Act pausing the need to pay federally held student loans from March 2020 until January 2022 which decreased the demand for refinancing, SoFi's specialty.


This was compounded by the c. 12% decline in new originations for Q1 of Academic Year 20/21 to the same quarter of AYTD 19/20. This was partly due to a c. 5% decline in undergraduate student enrollment which was caused by the pandemic as more students chose to take a gap year over remote learning. However, we believe that the lower AYTD 20/21 enrollment could spur an increased AYTD 21/22 or 22/23 enrollment should the pandemic subside and colleges resume in-person learning.


Personal loans

As seen from the chart above, the personal loan market is volatile as it moves in tandem with the U.S. Economy which affects interest rates and overall disposable income.

As of 3Q20, SoFi had a c. 3% market share and given the highly price-competitive dynamic of this segment, it might be difficult for it to significantly increase its share against personal-loan-focused Fintech companies such as Upstart and Earnest that may have access to lower personal loan funding costs given their higher personal loan origination volume.


Home loans

The home loan industry is highly fragmented with the largest player, Rocket, holding an 8% share as of 3Q20. Similar to the personal loan industry, the home loan industry experiences fluctuations in origination volume depending on the macroeconomic environment.

This was especially evident in the wake of the pandemic when the 10-Year Treasury Constant Maturity Rate plunged 1.41ppts from 1.93% in December 2019 to 0.52% in August 2020. This triggered a c. 65% YoY spike in 3Q20 mortgage originations (purchase + refinance for 1-4 family properties) as homeowners took advantage of the low-interest rate to refinance while homebuyers were incentivized to purchase which contributed to a c. 8% YoY increase in the number of U.S. homes sold in 2020.

Financial Services


We will focus on SoFi Invest given that analysts project it will make up 50% of SoFi’s 2024E revenue. In summary, SoFi Invest encompasses stock and cryptocurrency brokerage services.

Stock brokerage

The industry is fiercely fee competitive with many dominant stock brokerages (i.e. Robinhood, E-Trade*) offering commission-free trades like SoFi and earning revenue partly through selling order flow. As many retail traders are solely focused on fees charged, there is minimal to zero competitive advantage for SoFi over its competitors.


Cryptocurrency brokerage

For retail traders, the main factors in choosing a cryptocurrency brokerage are low transaction fees, large token offering, and the ability to stake their tokens. Based on the table above, SoFi’s cryptocurrency service is a relatively uncompetitive offering. However, both stock and cryptocurrency trading services are important to SoFi as it expands its top-of-the-funnel which will be elaborated on in Investment Merit 1.


Technology Platform

Within the technology platform provider segment, Galileo is the dominant player as it partners with 70 of the top 100 Fintech companies globally. Given that one of Galileo's primary clients is neobanks, we believe its growth will be closely linked to the rise in the number and adoption of neobanks that will also signal greater Fintech adoption which Galileo benefits from as a Fintech infrastructure provider.

Financial Highlights

Revenue

SoFi generates revenue through 3 main streams – lending, financial services, and technology platform. Out of which, lending is the main revenue segment as seen from the chart above where it constituted c. 83% of 2020 adjusted net revenue (ex-corporate).

In 2Q21, revenue rose by c. 74% YoY as total loan origination volume recovered from its 2020-low driven by a spike in personal and home loans. In addition, the number of Galileo accounts increased by c. 119% YoY which caused a rise in technology platform revenue. We detail below the main drivers of SoFi’s revenue growth.

A) Total SoFi members

From 1Q19 to 2Q21, the number of SoFi members grew quickly at a CQGR of c. 15%. SoFi’s management attributed the growth to the significant expansion in product offerings, particularly in the financial services segment. This is evident from the c. 146% increase in the number of financial services segment products sold in 2Q21 compared to 2Q20.

B) Total Loan Origination Volume

As of 2Q21, SoFi’s total loan origination volume is still below its pre-pandemic level as the suspension of principal and interest payments on federally held student loans that started in March 2020 was further extended to January 2022. This caused a more than 50% drop in its student loan refinancing business when compared to its pre-pandemic level.


However, the decline was partially mitigated by the increase in personal and home loan originations which have surged past their pre-pandemic levels. Management has attributed this to low-interest rates and an improving U.S. economic trend that has enabled it to return to more normalized credit qualification standards, on top of increased marketing and automation enhancements.

C) Blended Take Rate

SoFi’s blended take rate on loans originated includes origination fees, a spread on loans when securitized or wholly sold to investors as well as interest income from holding some of the loans.

D) Number of Galileo accounts

Galileo has registered over 119% YoY growth in accounts since 3Q20 which resulted in greater technology platform fees. Thus, we believe that total accounts will grow relatively in tandem with Galileo’s revenue.

Margins Analysis

From 1H20 to 1H21, SoFi’s non-interest expenses margins, in general, have improved as it benefits from economies of scale. However, the general and administrative expense margin worsened by c. 39ppts from 2H20 to 1H21 due to a) significant non-cash stock-based compensation expenses, b) fair value changes in warrants primarily related to the fair market value of SoFi stock and c) one-time transaction expenses related to the business combination with IPOE.

SoFi is profitable on an adjusted EBITDA basis but is unprofitable at the net income level as it is heavily investing in technology and product development to develop a better and wider product suite. Furthermore, it is increasing its marketing expenditure to attract more customers but this is expected to decrease on a margin basis in the long run as cross-selling reduces customer acquisition cost per product, which will be elaborated on under Investment Merit 1.


From 1H20 to 2H20, SoFi’s profitability margins improved as the improved cost margins flowed down. However, the margins worsened in 1H21 mainly due to the above-mentioned expenses which totaled c. US$144m for just 2Q21.

Investment Merits


Investment Merit 1: Holistic financial solutions promote the flywheel effect

According to Go Banking Rates, c. 50% of Americans use more than one bank for financial services.

The top 2 reasons for doing so were flexibility/convenience and the availability of different services/products. We believe these problems are solved through SoFi’s convenient mobile application and its wide suite of financial products as mentioned above, making its one-stop-shop for financial products strategy attractive.


According to SoFi’s February 2021 investor presentation, it is the only one-stop mobile application. This means that it could reap the benefits of the first-mover advantage such as gaining significant market share without having to incur additional expense to fight off competition in a potentially ‘winner takes most’ Fintech market.

In addition, this large product base enables SoFi to take advantage of the flywheel effect or in its own language, the ‘financial services productivity loop’. The flywheel starts spinning when members buy their first product from SoFi and after enjoying the experience, use SoFi to buy a second/alternative product which further reinforces the benefits of using SoFi and the cycle continues.


This flywheel benefits SoFi through:


a) Increase in topline revenue with the increased product revenue streams


b) Significant improvement of unit economics through cross-selling

As seen from the table above, cross-selling cuts the CAC for the 2nd/3rd product sold to the same customer to zero, which flows down to significantly improve variable profit margin. In the above-mentioned example, a combination purchase of a SoFi Money product and personal loan boosts the variable profit margin by 36 ppts (80% vs 44%). In addition, as members buy different products, their lifetime value (LTV) improves causing a lift in the overall LTV/CAC.


c) Cost synergies


SoFi’s lending business is vertically integrated across its technology stack, risk protocols, and operations processes. This has led to strong lending unit economics as evidenced by 1Q21’s contribution profit margin of c. 59%.

Since SoFi launched its one-stop-shop strategy in 2019, it has gained good traction. This is seen from the c. 218% spike in members using multiple products from 4Q19 to 7 December 2020. Given that as of 7 December 2020, multi-product members represent only c. 22% of its total customer base, we believe there remains a significant growth runway in multi-product members that should improve the unit economics of the overall business.


Strengthening its top-of-the-funnel approach


On top of the flywheel effect, SoFi’s wide range of products strengthens its top-of-the-funnel approach by expanding its value proposition and use cases to more potential members. Despite its financial services segment, in particular SoFi Invest, generating a small amount of revenue relative to the lending business, it still plays a key role as stock/cryptocurrency trading services are commoditized (basic table stake) products that are necessary for becoming a dominant player as all its competitors have them.


In addition, management commented that financial services products have much lower CAC, and thus, they leverage them at the top of the funnel, and it feeds to the bottom of the funnel, where SoFi makes significantly higher LTV on loan products, which have higher variable profit margins. Furthermore, the key inflection point currently seen at the top of the funnel (i.e. c. 146% YoY increase in the number of financial services segment products sold in 2Q21) is meaningfully greater than at the bottom of the funnel. This could indicate that the LTV per member will see a marked increase over time if they are kept active within the ecosystem and sold loans.

Referencing the above chart, given SoFi’s strong track record of cross-selling products, there is a good chance that members can be locked into the ecosystem. The stickiness of SoFi’s ecosystem is further improved by SoFi Learn, its financial education arm, and member experiences such as networking experiences. We believe that its industry-leading net promoter score (NPS) of 90 is an indication of a superior user experience that could help submerge users deeper into the ecosystem and grow the LTV per member significantly with time.

Investment Merit 2: Galileo is the dominant Fintech platform provider


According to Forbes, Galileo powers c. 95% of digital banking in North America and serves 70 of the top 100 Fintech companies globally which include Robinhood and Chime.


We believe one of the factors for its dominance is its first-mover advantage in the BaaS industry given that it was founded in 2000. This would have enabled it to establish a wider network of relationships with traditional banks that it works with, for example, to provide credit cards as part of its Galileo Secured Credit Card Solution. Furthermore, its long duration in the business coupled with a good reputation could have attracted firms given that reliability is a key trait to look out for when partnering with a BaaS provider.

From 1Q19 to 2Q21, Galileo’s accounts grew at a CQGR of c. 19%. In addition, its growth accelerated through the pandemic with total accounts growing by at least 119% YoY in every quarter thus far since 3Q20.


We believe this was partly driven by the strengthening of the secular trend towards digitalization as a result of the pandemic as seen from a Deloitte report which highlighted that c. 44% of retail banking customers are using their primary bank’s mobile application more often. Furthermore, in June 2020, Galileo released Galileo Instant, a solution that has a setup time of 2 weeks as opposed to the typical 18 months for a go-to-market fintech option. By December 2020, it had more than 1,500 sign-ups from businesses, and cardholder spend increased by nearly 14x.


In a bid to continue expanding, Galileo is planning to release new technology services as well as grow operations in Latin America as indicated by the opening of its Latin America Headquarters and Innovation Center in Mexico in 2021.


On top of its immense growth, Galileo has a moat and pricing power over its customers given that there is high cost and uncertainty when switching to another BaaS provider. In addition, it has recurring revenue and good revenue visibility. It typically enters multi-year service contracts with its clients that are generally either non-cancellable or cancellable with a substantive payment. Most of the contracts contain minimum monthly payments with agreed-upon monthly service levels. This should partially mitigate the cyclicality of the lending segment that is partially driven by macroeconomic factors as highlighted under the financial highlights section.


Furthermore, Galileo has built out an entire cloud environment over the last 15 months that it will be transitioning partners onto from on-premise. Management expects this to have significant cost savings that it plans to reinvest back in the business to develop more new products. We believe this has been possible because SoFi’s management runs it like a separate entity which gives the Galileo team the autonomy to conduct operations.

Valuation

SoFi is currently trading at 13.7x EV/2022E revenue which is higher than the peer averages of the lending and financial services segments. However, it must be noted that SoFi has the highest 2022 YoY consensus revenue growth of c. 53% that could warrant a higher valuation multiple.

SoFi’s management forecasted a base case 2025 adjusted revenue of US$3,669m which represents a CAGR of 43% from 2020. In addition, it expects 2025 adjusted EBITDA to reach US$1,177m which represents a CAGR of 130% from 2021 and implies a non-discounted EV/2025E adjusted EBITDA of 17.3x.

However, it must be noted that the forecast includes a sharp expansion in technology platform and financial services revenue, both of which are still in the early stages of growth as seen from the table above. As a result, they are exposed to high execution risk which could derail the forecasts.

Risks


1. Other Fintech firms expanding to become one-stop-shops


Given that SoFi has expanded from a loan-only business to a one-stop-shop in the last 2 years, optically, the entry barriers to developing into a one-stop-shop seem low. However, this is certainly not the case as SoFi’s main lending segment has taken about 10 years to date to build to what it is now, where it has a 40.0% to 50.0% market share of the private student loan refinancing industry.


2. Competition in attracting and retaining members