SoFi: Cathie Wood's next big discovery?
Business ModelWith the quick launch of a variety of goods and services, SoFi has amassed over $25 billion in just three years. Its growing balance sheet has, however, made it more vulnerable to consumer credit risk. The purchase of Galileo, whose platform has seen a sharp rise in accounts, might have been a big victory.Who Owns Sofi
At the moment, no deep value investor seems to have SoFi Technologies, which is understandable as SoFi has not generated a single dollar in free cash flow since its IPO in 2020. Also its PEG ratio of 2.40 makes it unattractive to deep value investors. However, hyper growth investor [url=”]Cathie Wood [/url]has stake in SoFi, although that represents only 0.24% of her portfolio. This implicitly touts SoFi’s growth potential and its technological caliberCompetition SoFi: Cathie Wood’s next big discovery?SoFi members face competitors from multiple realms. Chime is SoFi’s direct competitor in the banking area with its fee-free model that attracts many bargain hunters pushed to the edge by traditional bank charges. In the investment area, Betterment is SoFi’s rival gaining ground with robo-advisory services aimed at consumers who want to maximize their profits with the help of low-cost asset management. LendingClub is a peer-to-peer trading model competitor in the field of lending, and traditional banks have their strong points like a lot of resources, a big customer base, and a well-known name in the market. These companies are quickly going digital, which reduces the gap between them and fintechs, which were previously driven by innovation solely by companies like SoFi.SoFi seizes the distinction with the help of its vast range of financial products, all of them available in the digital realm. Whereas Chime merely banks, or Betterment just invests, SoFi not only has loans but also securities, savings accounts, and spending tools. The “one-stop-shop” strategy operates well for financial interests of the customers and as a result their loyalty to the company increases. Consider a student loan broker coming back to the firm with a fee for choosing loans with SoFi, that person later could continue to explore SoFi’s investment or banking services which increases the probability of cross-selling.Tech is the key to holding a competitive edge for SoFi. This firm utilizes data science for deliberating loan risk assessment which lets the firm to apply market rates and approve loans which only traditional banks might say non. It is particularly proven in the middle of a student loan refinance business focusing on the group of graduates who earn a lot and have the risk of defaulting low. Furthermore, SoFi bought Galileo, a technology platform provider, in 2020 which puts it at the forefront of enabling fintech solutions for other companies like Chime and Robinhood. This B2B diversification not only boosts its revenue streams but also goes beyond direct consumer services.Like Chime, SoFi also has banking service features that include no overdraft, maintenance, or minimum balance fees. Through this initiative, they are trying to meet the expectations of the consumers who want affordable, long-term alternatives to traditional banks. When added to the digital-first platform the configuration of SoFi to the younger generation is finished. They choose to manage their finances with a computer or a mobile app, which is a process that traditional banks have not yet mastered.Key Growth DriversAn unmet product need in the market has been recognized by digital bank SoFi, which may give it a sustainable competitive edge. The business only uses its website and mobile app to reach young, well-off people who might not be adequately served by traditional full-service banks. In contrast to other digital banks, SoFi has developed a wide range of lending products and financial services that motivate its clients to organize all of their financial affairs around the business. By serving as a one-stop shop for its clients’ financial needs, the business hopes to develop strong cross-selling benefits that will lower its acquisition costs and increase the stickiness of its current relationships through implicit switching costs.The majority of SoFi’s income comes from its lending business, which uses an originate-to-distribute model in which its loans are either sold for a profit or transferred through securitization. In order to become a one-stop shop for its clients’ financial needs, the company plans to quickly increase the size and scope of its financial services offerings. Growth has recently accelerated as a result of SoFi’s ability to develop a broad enough suite of products and services over the past few years to achieve that objective.In 2019, SoFi launched investment and cash management accounts; in 2020, it launched limited estate planning and credit cards; and in 2021, it launched auto loans. The business anticipates that its wide range of services will enable its customers to combine all of their financial assets and liabilities onto its platform, thereby spurring expansion. Despite the significant incentives provided, the majority of clients only purchase one or two products from the company, and a large portion of its product offerings are still relatively new.After establishing a multifaceted relationship with a client, SoFi anticipates that the client will have to deal with implicit switching costs, which will make it more difficult for them to leave the company. Other than price and reward spending, there isn’t much to keep customers loyal to the company. Furthermore, the rate at which SoFi has been able to develop new goods and services is reciprocal. Through strategic partnerships with banks and other providers, the company has been able to accelerate development; however, there is nothing stopping another company from following suit, which could lead to the rapid entry of new competitors into the market.SoFi’s student debt business is heavily weighted toward refinance over new loan origination, with less than 2% of its more than 400,000 student loan products being in-school student lending at the end of 2020. The space is highly competitive, with interest rates being offered to the debtholder being the primary form of competition. As a result, SoFi is assigned a no-moat rating due to the lack of a clear durable competitive advantage present in its existing business.Valuation
Failure to generate any free cash flow, significantly holds back SoFi’s terminal value, leading to a downside for investors.However, after student loan forbearance ends in 2025, SoFi anticipates an increase in student loan originations. Since SoFi’s student loan business is centered on loan refinances and benefits from declining interest rates, lower interest rates will help to fuel this trend. Although the volume of personal loan originations in 2024 exceeded expectations, growth is probably going to stay below the rapid pace observed in 2022 and 2023.As a result of expanding its product line and customers’ growing comfort level with online banking, SoFi will continue to see strong growth in both its customer base and revenue. This is especially true for the financial services sector, which has seen a notable increase in revenue per product in 2024. SoFi’s financial-services division is anticipated to become a more significant source of returns over time due to the numerous chances it has to keep boosting monetization.Over the next five years, revenue is expected to grow at a 13.6% compound annual rate as the business gains from its distinctive product offering. SoFi has stepped up its focus on its cost structure and anticipates a steady increase in its operating margin over time, even though this growth comes at the expense of aggressive marketing and reward spending. Additionally, by passively cross-selling a large range of products through its website and mobile app, SoFi can lower acquisition costs and gain cost advantages. SoFi will ease its aggressive marketing and reward spending programs as growth eventually slows, which will result in additional margin expansion.Key RisksSince switching from an originate-to-distribute business model to a more diversified one, SoFi, a banking charter company, has been able to hold more loans on its balance sheet, which has led to a rapid growth in net interest income. This approach raises SoFi’s exposure to credit risk while enabling it to make decisions about loan retention and sale based on market economics. SoFi’s total loan book grew to $27.5 billion as of December 2024, but a higher loan write-off expense resulted from an increase in industry-wide credit costs. In spite of this, SoFi is well-capitalized, with a common equity Tier 1 ratio of 16% at the end of 2024, and its loans are performing well.Although SoFi’s credit quality is a cause for concern, significant financial strain is not anticipated anytime soon. Refinancing student loans and increasing student debt levels are among the few environmental, social, and governance risks the company faces. Despite these obstacles, SoFi has added new goods and services to its portfolio over time, increasing the diversity of its revenue.ConclusionDespite being a young company, SoFi has made large investments in reward spending, product development, and marketing. However, since the business is still losing money, it is unclear how these relationships will pay off. SoFi needs to effectively cross-sell into its expanding membership basethe majority of which still only use one product or servicein order to recoup its investments. Although the company’s clientele and average number of products per client have increased, its investment strategy is still in its infancy. The 2020 acquisition of Galileo, which has experienced rapid growth since the acquisition, is advantageous because the $1.2 billion purchase price probably underestimates the company’s actual cost. Despite the dilution, SoFi’s first-quarter 2021 annualized revenue of $184 million and 130% year-over-year account growth indicate a good deal for the company.This article first appeared on GuruFocus.