SoFi – Making Its Footprint Bigger Than Its Foot

It’s been a while since I’ve been excited about a stock, but over the weekend my friend Jack mentioned he is very bullish on SoFi and he made quite the convincing case. Intrigued, I spent a few days doing some research. My conclusion on SoFi is that it is the best emerging FinTech company to challenge the legacy FDIC banks and their 500 million customer accounts. While not without its risks, SoFi is a true growth stock that has a strong and differentiated product offering, a moat around its revenue not shared with competitors, strong and proven leadership, and a clear, simple vision its employees and customers can rally around.

Here’s what SoFi, or Social Finance – the full name no longer seems to be aligned with the company – does in their own words:

SoFi Technologies, Inc. is a financial services platform. SoFi was founded in 2011 to offer an innovative approach to the private student loan market by providing student loan refinancing options. The Company conducts its business through three reportable segments: Lending, Technology Platform and Financial Services.

SoFi 10Q

SoFi launched in August 2011 and currently offers digital financial services to 3 million members, including student loan refinancing, mortgages, personal loans, credit, cards, investing (equities and crypto), and banking services. SoFi’s sales pitch is that they are the only one-stop-shop where all their products are better than single offerings by competitors. They offer no fees, partial shares, crypto, no-fee ETFs, and offer IPOs. Funds are available the day you open your account. I will say, I didn’t find another fintech company that offers their breadth of services and definitely didn’t find one that puts all of them right on their customer’s home page.

Commercialization of direct to consumer technology has unfolded in media, video, and e-commerce, but it hasn’t happened in direct to consumer financial services company.

In plain english, the above sentence that I lightly lifted from SoFi’s CEO means digital banks who interact directly with customers investment, loan, and payment products have not yet challenged legacy banks that can profit by buying up loans from intermediaries and providing backend services to frontend facing companies.

SoFi thinks there is potential to take a shot at the big guys and their 500mm customer accounts in the US, and from the outside, it looks like they have the right selection products, fast customer onboarding, and convenient apps facilitating casual usage and research.

From Non-Bank to Bank

Digital Wallets are not banks. To use digital wallets and avoid fees for sending money, you can connect your bank through debit card or banking information. The key difference between non-bank digital wallets and banks is that non-banks cannot hold a balance. Funds held in a digital wallet are actually held by a bank that partners with the wallet for financial benefit. For example, the Venmo Debit Card is issued by Bancorp Bank. Digital wallets, in general, cannot offer interest on funds held in the wallet. Digital wallets can still facilitate alternative financial services, such as investment, risk pooling, financial consulting, and so on. They cannot hold balances or loans for gain.

Most of Millenials and GenZers use peer-to-peer payment facilitated by digital wallets like Venmo, CashApp, and PayPal to send money to friends and hold a balance. Digital wallets easy to use, fast to get started, and widely accepted for payment. All you need to get started is a debit or credit card. These wallets partner with banks; they can originate loans, but cannot benefit from hold for investment. They do not have direct access Fed money nor direct access to FDIC insurance.

In March 2021 SoFi purchased Golden Pacific Bank financed by $750mm in capital. Last month SoFi received approval to become a national bank from the Office of the Comptroller of Currency and the Federal Reserve. SoFi can now accept deposits from customers and offer interest and there is currently a wait-list to open a checking account offering 1% APY, no account overdraft fees, 2-day-early paycheck, no ATM fees and other smaller benefits.

SoFi’s financials, along with its customers, can also benefit from the bank charter. CEO Anthony Noto says SoFi will now operate a hybrid of gain on sale and holding for investment; SoFi will increase the average time loans spend on its books from 90 days to 180 days because they have access to more funds and they will earn more holding for investment. This is meaningful in a rising rates environment, but it shouldn’t be overstated because they are just getting started whereas the legacy banks have massive balance sheets and are much better positioned to make profits on spreads.

As a bank, deposits can fund loans. Loans on SoFi will include a stand-alone offering and a direct deposit offering. Big banks like BofA can shave off a few basis points on loans if you have a checking account with them. Customer data from one financial product can inform risk assessments and more accurate pricing for other financial products. Starting now, SoFi can utilize its customers data to facilitate better offers across its suite of financial products.

Leadership, Vision & Execution

Anthony Noto is the CEO of SoFi. He is 53 years old. He worked at Goldman Sachs from 1999 – 2008 where he joined the NFL as CFO until 2010. He then went back to Goldman Sachs to co-head the global media group where he won the role of lead underwriter on the Twitter IPO. In 2014 he joined Twitter as the CFO and later COO. Finally in 2018 he joined SoFi as the CEO. He’s been successful and clearly built great relationships. I specifically like the fact he returned to Goldman after his stint at the NFL. He also formed a good relationship with Twitter CEO Dick Costolo. He seems like he has the right combination of finance and tech experience to lead SoFi in the right direction amidst significant competition.

After watching a few interviews with Anthony Soto, it is clear he exudes strong leadership and is laser-focused on execution. As Anthony Soto says multiple times, “Selection, Fast, Content, Convenience, Better Together”. Every employee should be able to say on command what the mission of the company is and what they need to execute to be successful. While this is true for any company, it’s especially true for a fast-flying technology company. You can go to the company’s homepage and basically build an org chart. I don’t know anyone who works there, but I assume everyone who works there has crystal clear direction.

Pivoting Away From Student Loans

SoFi’s first major product offering was student loan refinancing and was responsible for their initial success. However, in March 2020 President Trump announced a pause on all payments on federal student loans due to the onset of the pandemic. After multiple extensions, that moratorium is set to expire in May 2022. In an interview with Yahoo Finance, Anthony Noto said “our student loan business got cut in more than half” and “that business has been running at about 50% of the pre-COVID volume for the last 20 months.”

Federal student loans over the past decade have grown from $642bn to $1.566tr, according to a report from the Bipartisan Policy Center, and the average debt per borrower increased from $23k to $37k. While this was a profitable entry-point, the student loan payment moratorium brought that to a grinding halt; no one needs to refinance a loan that they don’t have to pay.

On February 8th, Anthony Fauci claimed the ‘Full Blown’ pandemic phase of Covid was nearly over. I think it is unlikely the pause on student loan payments will continue past May of 2022 and many Americans will be looking for refinancing options. SoFi seems poised to benefit, but its success isn’t dependent on an influx of student loan refinancing.

Here’s a comparison of SoFi’s last 3 years, including last 12 months (LTM) of revenue and loan origination volume. Revenue is in millions and loan origination is in $000s

Student loan origination volume is almost half what is was in 2018 and there was a significant dip in personal loan originations in 2020 followed by a spectacular rebound over the last 12 months (this is from Q3, so data is not that recent). Also home loan origination has steadily been growing.

Revenue growth tells a different story; consistency. In April 2020 SoFi saw felt the headwinds of the pandemic and foresaw a huge drop in their main business of student loan origination and refinancing. SoFi pivoted quickly and bought a proverbial shovel during the rush into digital banking. Now emerging from the pandemic, Galileo provides a moat around longevity in the digital banking world.

Galileo Acquisition Solidifies SoFi in Digital Banking

In April 2020, SoFi bought Galileo, a banking infrastructure solution company that offers a payment processing platform and a variety of services for digital banking companies for $1.2bn. Galileo has been around for 10 years longer than SoFi and it works with many of its competitors such as Robinhood, Chime, Monzo Revolut, Varo and TransferWise. Galileo’s software connects credit card processors through APIs. It is painful for companies to switch payment processors and it is very, very difficult to build one from scratch. Galileo has grown its customer base from 49 in Q32020 to 89 in Q32021 and revenue from technology services has grown from $95mm in 2020 to $178mm in the last 12 months ending in Q3 2021.

The acquisition of Galileo provides SoFi with significant revenue diversity, in-house knowledge of core technology powering digital banking, and a chunk of its competitors now rely on its success.

Payment processing is at the core of Galileo. Vast majority of customers are using payment processing. Integrating with merchants, banks, ATM networks, ACH, etc. Galileo is like a data center. No one is building their own data centers. SoFi customers inform Galileo’s product offerings even before Galileo’s customers know what they want. Vertical integration at its finest.

Can SoFi Keep Growing?

SoFi has grown consistently since inception and successfully navigated multiple changing financial environments. Its Q3 Earnings Presentation clearly lays out a story of continued growth.

The highlights from SoFi’s Q3 earnings presentation shows year-over-year member growth of 96% to 2.9mm, of which 377k members were added since the prior quarter. Total Products increased 108% to 4.3mm. Total products means the aggregate number of lending and financial services products that members selected on SoFi since inception through the reporting date (so this would include loans that have been fully repaid).

The most interesting, and to me important, part of the growth story is SoFi Money, SoFi Invest, and SoFi Credit Card drove 79% of new member growth. These financial services are simpler and faster to use than refinancing loans or taking out a personal loan. SoFi’s offers easy-to-use investment and every day spending products that is desired by all GenZers and Millennials. It is much easier and cheaper for SoFi to offer its breadth of existing financial products to people who are already customers of SoFi. Moreover, and I’ll hint at my conclusion here, since SoFi can garner significant growth from multiple product offerings, it can use its status and access to capital as bank to offer better rates and lower fees to customers and then provide even lower fees to customers who use other SoFi products. BofA reduced my mortgage loan a few basis points because I already had a checking and savings account. All major banks that originate mortgages and loans do this and it works.

General Market Woes

There’s a lot of negative press about FinTech and $MEME stocks right now, which is dragging down growth stocks. Non-profitable technology stocks, including FinTech stocks, and $MEME stocks (SoFi is all 3) flew too close to the sun and crashed back to earth nursing their burns.

While the latest drop has been tough for a lot of investors, at least there is some rationality in the markets. The upside to these charts is that we are back where we started pre-pandemic. If you believe we are headed for a recession, macroeconomic forces will likely drag these stocks down with it, SoFi included. If you think things are back to normal, or at least not going to get worse, now is a great time to buy stocks with great fundamentals. That’s why I’m writing about SoFi.

What’s My Downside?

I believe SoFi could drop as much as 50% in the next few months. The main ratio I’m looking at is the PS Ratio, or the company’s market cap divided by the company’s sales for the previous 12 months. Here’s SoFi’s PS ratio since it went public via reverse merger in June 2021

While the PS ratio is the lowest it has been, and half what it was when it IPO’d, there’s still a lot of room to go down. To be clear, a low PS ratio means a) low growth potential and/or b) undervalued. A high PS ratio means the opposite. Here are some benchmarks of its competitors.

While these companies aren’t apples to apples, its worth noting that if SoFi’s long-term growth stalls, PS ratio could fall as low as 5, but probably not 2 unless there are some serious issues. Fintech is a crowded space and there’s a small window to prove profitability amidst slowing growth.

Customer Acquisition Cost: Here Be Dragons

The other main area that is concerning is SoFi’s incredibly high expense on Sales & Marketing. In Q32021, SoFi spent $115mm on Sales & Marketing against $272mm less $50mm in technology platform fees in net revenue, which equates to 51% of $222mm. SoFi added 377k new members in Q32021, which means they spent $588 / new customer. These numbers and any analysis regarding cost of customer acquisition are completely excluded from their Q3 earnings presentation.

Now, I’m sure the above numbers are not accurate, but I don’t think I can get enough information to determine whether or not its too high (it’s very high). Moreover some of these expenses could be one-time expenses that can’t be amortized over time. Some expenses could be fixed, such as the stadium naming rights, while others are variable, such as $15 referral fees and CPC advertising.

Since we (I) can’t really dig into the expense-side of things, we need to trust the company’s leadership. It is also my belief that SoFi is investing heavily in brand-marketing and, speaking from experience, it is very difficult to prove a causal relationship between decreasing cost of customer acquisition by increasing brand awareness.

If SoFi’s membership growth slows for their next earnings on March 1st, expect the stock to tank. As an investor though, slower growth in Q4 doesn’t worry me and I would probably add to my position. If, however, they slow again in Q1 after the federal student loan payment moratorium is lifted and the Super Bowl, it might be time to get out. A lot of companies go bankrupt trying to buy up customers in a heavily saturated market.

Focus on the Customer

SoFi owns the naming rights to SoFi stadium, the football stadium here in Los Angeles. Guess where the super bowl is? Guess who just became a bank? The largest annual television event in the US is being held at SoFi BANK stadium. That sounds like a big important company to me. I really hope SoFi marketing emphasizes they are bank. Chase Bank ($462bn market cap) is the name of the Warriors stadium. There are smaller banks that own naming rights to stadiums (not many), but SoFi Stadium is a global name and it’s hosting the super bowl. SoFi is (probably) the only bank that offers equity and crypto trading on an easy-to-use mobile app. I was able to sign up and get my first free stock in less than 1 minute.

After the Super Bowl, when people see an advertisement for SoFi Bank they are more likely to convert and create an account and when they create an account, they get a free stock. I love this product loop; sign people up quickly and give them something free that gets them hooked. Trading is much more engaging and leads to higher customer retention than lending products. By signing up more people to higher retaining product loops SoFi only needs to market its more profitable products internally.

The mobile app desperately needs Dark Mode. The UI is ok, but it’s not as good as Robinhood. Furthermore they should start offering options trading asap. Imagine being able to offer personal loans to r/wallstreetbets apes who lose money on credit making risky trades. Sounds terrible, but it’s a huge opportunity. It would be like if DraftKings became a bank and offered credit and personal loans to its customers, which they can hold on their own balance sheet. It’s not loan sharking if you’re a bank!

The Mobile App Converts Existing Customers

When you open up the SoFi app as an existing customer the home page provides enticing calls to action. Yes, I want a high yield banking account. I want 2% cashback on credit cards, and I’m sure a lot of people like tracking their credit score. All of these activities provide perceived value to the user, the products are features users will regularly engage, and the products are high value to SoFi. Here’s my homepage.

SoFi’s app provides more value to the user and itself than any of its other competitors. Venmo’s homepage is a feed of payments (no value, just amusement), CashApp is a calculator with a button for Pay and one for Request, RobinHood shows your investments (not something I want to look at right now), and PayPal wasn’t downloaded on my phone apparently.

In Summary

I like this stock and I bought it. I mainly bought shares because this doesn’t seem like a short-term play. I’ll continue to monitor the thesis laid out in this post, but there’s no point in timing an earnings release or some macro event. I believe this is a strong company that has the potential to 3-5x in a few years. I also bought a few call options expiring Jan 2023 at a $20 strike price.

SoFi is clearly executing its mantra, as the CEO puts it, “Selection, Fast, Content, Convenience, Better Together.” And just like it’s naming rights purchase of LA football stadium, SoFi is “making its footprint bigger than its foot”.

Where Are the Workers?

If you’ve ventured outside in the last few years, among other changes, you’ve likely noticed there’s a shortage of staff. Help wanted signs are outside of service businesses. Major hotel chains have stopped providing daily room service. Starbucks have shut down for days at a time and my very expensive gym has reduces its hours. Modern day anarchy. Let’s see what’s going on and if there’s anything we can do about it.

Here’s a qualitative summary of what we are experiencing: we cannot get the same services at the same quality and price today compared to before the pandemic. Moreover the narrative of unavailable services is accompanied by workers decrying working conditions, low pay, and inflexible hours, among other things. My favorite manifestation of the plight workers is the subreddit r/antiwork.

The membership for the subreddit r/antiwork has hockey-sticked in past year. While this subreddit recently suffered from a Moderator’s unfortunate interview with FoxNews (I’m not linking because Mods aren’t paid, they’re not supposed to be prepared for 15 minutes of fame, and they don’t represent a ‘movement’), the subreddit exposes predatory treatment of regular workers and the fact a lot of jobs don’t provide for any kind of human decency-type of features (not calling them benefits because in some countries they are rights) like sick leave, bereavement leave, safe working conditions, consistent working hours, and provide a sane way to spend 8+ hours per day. Here’s the subscriber growth:

This looks a lot like r/wallstreetbets during the $MEME stock craze of 2020 and 2021. $MEME stocks finally died; see my post that aptly preceded its inevitable decline (also see my note (1) about selling at the end of this post).

The growth of r/antiwork highlights the growing awareness in the US that some employers take advantage of their employees. Reading through the posts, as expected, most of the complaints arise from entry level, lower paid jobs created by small businesses. It makes sense that if small businesses are strained by a global pandemic they try and pass on as much of the strain to their employees, even if it doesn’t sound like the most humane response. In contrast, most tech companies sent their employees home in March 2020 and gave them a one-time payment to set up a home office and tacked on additional vacation days as the pandemic challenged mental health. As mentioned in my post about the shape of recovery, some industries have grown stronger while others such as travel, entertainment, hospitality, and food services are still struggling.

As we enter a new normal, we would expect to see a recovery in industries most affected by the lockdown. Consumer spending came roaring back, American savings accounts are the highest they have ever been, and a lot of states are acting like Covid is no longer a threat.

Overall employment is on track to fully rebound. Employment in the US will recover to pre-pandemic levels in 2022.

Statistic: Employment in the United States from 2012 to 2022 (in millions) | Statista
Find more statistics at Statista

The US population only grew .1% last year, thanks to Covid and Millennials preferring craft beer over babies, and we all got 1 year older. So why are we noticing a significant difference in the quality, quantity, and cost of literally any service?

The US labor force participation rate is not back to pre-pandemic levels. I think we’ve all seen the headlines that unemployment rate is 3.9%, which is historically low and some would argue below the natural churn rate. So, that’s why labor-force participation rate is such an important statistic to focus on. Couple a decreasing participation rate with an aging population and 0.1% population growth rate, we can clearly see there are fewer of the folks available to work pre-pandemic than current-pandemic state.

I’m going to make a few controversial points here. I’m open to criticism and changing my mind. Just don’t #cancel Adam Sutler. A lot of service jobs pay minimum wage or just above. Prior to the pandemic on-demand delivery and ride-share drivers accepted wages near minimum wage. Hospitality, food service, retail, construction, transportation, you-name-it workers accepted low wages. A lot of the lower wage workers are foreign-born. A lot of these services required people to show up in person to receive these services. Service workers in the US who were forced out of jobs that required in-person human interaction started different careers. Here are some trends around the change in population of foreign-born population in the US.

The US relies 10% more on foreign born labor than any other major economy, yet our foreign born population dipped sharply at the beginning of the recession triggered by the Great Trump Border Surge in March 2019. Yes, the US let in fewer immigrants, but it also had fewer jobs for immigrants during lockdown. After lockdown, applications for immigration spiked. Also job openings spiked in sectors where US-born workers already changed careers. Here’s a look at the backlog.

Ok, so we know there’s a backlog of folks that want to live in the US. I’m going to assume they want to work here as well. We know there are job openings. Tying back the earlier graph about r/antiwork, people want more money, more flexibility, and to just be treated better in general. I don’t think it’s a stretch to say if employers don’t want to do any of those things they need to hire people who are more desperate. While wages are going up, job openings are going up faster.

I hope it’s not too controversial to say that if employers don’t want to offer more to employees, they are going to need to hire foreign born employees. Please don’t think I mean it’s best for society that small businesses take advantage of people, quite the opposite. All I’m saying is looking at the data, companies struggling to hire need to either offer more or offer the same to folks who need it more. Also according to the Economist, quoting Giovanni Peri and Reem Zaiour from UC Davis, there are 2m fewer working-age immigrants in the US than before the pandemic.

At the end of December 2021, there were 1,596,193 pending immigration cases and growing at a seemingly exponential rate. Biden’s perceived softer stance on immigration, as well as the pandemic, have encouraged the highest immigration attempts in history. The average wait time is 2.5 years and up to 4 years for asylum seekers (I thought there was some kind of correlation between the word ‘asylum’ and ‘urgency’).

Let’s also look at what has been growing: Amazon. I can’t find recent employment data on Amazon, but this chart is through 2020.

During the Pandemic, Amazon added 500k workers while other industries lost workers. It’s safe to say the 2-day free delivery has taken a huge chunk of the labor force away from other industries.

So we have fewer foreign-born workers, a lower labor force participation rate, growing non-service-sector jobs and a whole movement dedicated to exposing just how bad employers in the US treat their workers. We also have a record-high number of people knocking on the US’s proverbial front door for a place to live and work. I’m not here to make policy recommendations, but there’s no sense in ignoring the supply-side. If society thinks we should fill jobs with the work force living in the country today, it’s clear the work force is demanding more.

I particularly love these types of conclusions that turn both Democrat and Republican headline ideologies against each other. I’m sure there’s smart policy folks on both sides that can reconcile this contradiction.

Well that’s all I got. There’s a lot more data and a lot more to this story, but hopefully this is a start. What are the solutions you may ask? The US has jobs, let’s let in folks to do those jobs. On a personal level, I’d like to see wages rise, particularly for teachers and nurses and anyone else who puts in a concerted effort to build the machinery that powers our society. I’d also like to see people be more grateful for service industry workers. I’d love to see a world where we move from the ‘Have a Nice Day’ service-sign-off to a ‘thank you for the help’. Personally, I don’t really need anyone to be unrealistically fake nice, just don’t be realistically mean. My employer pays for my help and I’ll absolutely never tell them to ‘have a nice day’. To be fair, I’m not going to say ‘fuck you, pay me’ either. I’ll land somewhere in the middle.

  1. Quick aside, a lot of folks are upset with me because I didn’t explicitly tell them I sold a specific stock. First of all, see my post where I announced I’m selling 60% of all $MEME stocks. If that’s not enough, feel free to make your own decisions about selling. Once you double your money I don’t care what you do next. Sell, hodl, whatever. I did my part. Every dollar that is invested should have an investment thesis and every day that thesis should be evaluated. I understand it’s not practical to do every day, but once the thesis is either achieved or no longer valid, sell. Simple. That’s how fund managers work. They set a target, say a 20% IRR and 2x multiple. Once they hit it their return in the set investment period, they sell. It’s mechanical. The only reason to hold would be if they reevaluated the current state of the investment and underwrote, say, a 20% IRR and 2x return in the next holding period, say 5 years. Also, this blog is about uncovering rare market anomalies controlling for the current macro economic environment sprinkled with a bit of technology because, hey, market anomalies arise because people don’t understand the implications of technological innovations. Its this very misunderstanding and uncertainty where you can make a short-term buck. As you all know, long term I’m holding a lot of Vanguard funds and BRKB (I’ll buy an A share before I die). I’ve never claimed to to know what will happen in the long-term.