On June 1, SoFi Technologies (SOFI 0.85%) merged with Chamath Palihapitiya's Social Capital Hedosophia Holdings Corp. V, completing a deal as a special-purpose acquisition company (SPAC) to bring SoFi to the public markets.
You may recognize SoFi as the name of the new Los Angeles Rams stadium, which is a curious development for a "start-up." However, SoFi is 10 years old, and with companies staying private for longer, along with big-name executives in former Twitter COO Anthony Noto as CEO and Palihapitya as sponsor, SoFi isn't just any new SPAC.
Trading at a $14.4 billion valuation, could this new-age type of financial platform become a millionaire-maker stock?
SoFi targets well-educated customers who are likely to become affluent later on. Image source: Getty Images.
Inside SoFi
SoFi was founded in 2011 as a platform for student loans, with the goal of acquiring "highly educated, not rich yet" customers that were perhaps underserved by traditional financial solutions, especially in the wake of the 2008 financial crisis. The thinking with SoFi is that it builds a relationship with these potential high-earners early in their careers, before establishing a larger relationship with more financial products over time.
The company later expanded into personal loans and home loans, and in 2019, the company launched SoFi Money (cash management and deposits with partner banks), SoFi Invest (trading, robo-advisory, and cryptocurrency trading) and SoFi Relay (credit monitoring and financial tracking). In late 2020, SoFi launched its first credit card product, where customers can earn double rewards if they roll their points into SoFi Money or Sofi Invest. The company also earns referral fees on other loan products it refers to third parties, if a customer doesn't qualify for a Prime SoFi loan. Finally, in May 2020, the company purchased a financial platform-as-a-service company Galileo for about $1.2 billion. SoFi uses Galileo for its own back-end financial services, but Galileo also serves third-party customers as well.
The company calls its customers "members," and markets itself as an exclusive club, while also providing free financial wellness information to help members, "get their money right." With the goal of establishing a lifetime relationship and then selling them more and more financial products to its members, the company's strategy is to establish a "financial services productivity loop." This "productivity loop" means that while the company may not make large profits on any one product, as new members begin using additional products, the incremental marketing costs of that second product are almost zero, and a unified technology back-end platform creates additional platform cost synergies across products as well.
So while the company is still experiencing big net losses today, investors can see a more profitable future, should the sticky platform and cross-selling opportunities pan out.
Image source: Getty Images.
Big-time growth in the past year, but with a big asterisk
In its recent quarter, and really over the past two years, SoFi achieved breakneck growth. Members were up 110% last quarter, and total products used across the platform were up 121%. but before you think this was just a symptom of an easy compare to the onset of the pandemic, membership growth has actually accelerated each of the last seven quarters, going back to the third quarter of 2019.
However, there's a big caveat to that. When Anthony Noto took the CEO job in January 2018, he greatly pulled back on SoFi's growth – especially in lending products, which are the highest-profit products SoFi has. In fact, SoFi's total loans have declined every year since 2017, as Noto appeared to observe that the company's past growth was unsustainable from a risk standpoint. So, the recent torrid growth has come from financial products, which have much lower margins and are actually loss-making at the moment.
Another concern is that SoFi is still racking up some hefty losses. Although the company puts forward an "adjusted EBITDA" figure that was only a $44 million loss in 2020, its operating loss based on generally accepted accounting principles (GAAP) was a much larger $329 million last year. Notably, the company had over $100 million in stock-based compensation, which is a real cost to shareholders but excluded from adjusted EBITDA.
SoFi has been building out its cash management and investing platform in the past two years. Image source: Getty Images.
But there are silver linings and reasons for optimism too
Before you dismiss SoFi as a loss-making fintech that puts forward lots of rosy financial metrics to make itself look better than it really is, there are actually lots of good things going on under the hood.
First, while loans are down, they are now more profitable than they were when the company was employing a growth-at-all-costs mindset. In 2018, SoFi's loan portfolio was larger, but it had a contribution loss of $109 million. Though total loan originations are down, that's a function of the company pulling back on more risky personal loans and slowing student loans, while increasing home loans. As a result of this tightening, lending contribution profits have rebounded from that $109 million loss in 2018 to a $325 million contribution profit over the past 12 months.
The company is still losing money overall, but that is basically now all a function of it building out the financial services platform, which produced a $140 million contribution loss over the past 12 months. Still, the financial services platform is crucial to SoFi's business model, and was only commenced in 2019, so that may need some time to scale.
And while the company is still making losses, those do appear to be improving, with adjusted EBITDA losses of $227 million in 2018, improving to a $44 million loss in 2020 and a $26 million positive EBITDA over the past 12 months. While the company is still definitely losing money on a GAAP basis, it does appear SoFi is on a path to better profitability in the future as it prudently scales.
Time to buy, or is the stock too expensive?
For 2021, SoFi expects $980 million in revenue, which would represent 58% growth, but just $27 million in adjusted EBITDA – so, basically flat EBITDA relative to the past 12 months. That means the stock trades around 14.5 times this year's sales, and about 3.3 times its book value as of March 31. Of course, book value will likely decline this year, since the company is likely to continue racking up GAAP losses in 2021.
As with all fintech stocks, there's a debate as to whether SoFi should garner a valuation of a high-growth, high-priced tech stock or a lower-priced bank stock. After all, SoFi does make most of its profits today from lending.
With Palihapitiya's backing and a high-profile technology executive at the helm, SoFi appears to be trading more like a tech stock today. That can be very dangerous, should growth slow, charge-offs increase, or if another macroeconomic shock hits the economy. If investors were to suddenly view SoFi more like a bank, a valuation rerating could be painful.
So while SoFi may have a bright future and it's run by a talented team, the stock is too expensive for me, at least at the moment. Yet I'm not dismissing SoFi outright; I would keep my eyes peeled on new product developments, along with how well the company's platform and ecosystem strategy comes together as the economy rebounds. With its current impressive leadership, I wouldn't be surprised if SoFi investors do well; it's just not an ideal risk-reward over alternatives for me at the moment.
