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 is Bitcoin Going?

There’s recently been a whirlwind of activity in the cryptocurrency space that could begin to shape its very future. Both the Fed and the SEC have started to weigh in heavily on potential regulations, China is charging ahead with its own digital currency, El Salvador is very close to accepting Bitcoin for basically all government services, and Venmo will let you convert your US Dollar cash balance to crypto for a ridiculous fee. There is significant expansion and regulatory attention being paid to the cryptocurrency markets right now and that can only mean one thing: prices will go up, down, stay the same, or go up and down and back to the same.

According to the Economist, there are three types of crypto investors: Fundamentalists, who believe a non-governmental currency has long-term societal benefit and value above the daily network transaction costs, Tacticians who basically think the price will go up because more people will buy it in the near or medium future, and Speculators who respond to Elon’s Twitter account faster than their latest Tinder match. Take a moment to reflect and put yourself in one of those buckets. Now try that same exercise with a few different asset classes. I bet you never pegged yourself as a Speculator. That’s unfortunate. That’s where all the upside is.

Before we chart out a path for the price of Bitcoin, let’s take an aside to talk about Stablecoins and GovCoins. In theory, these classes provide all the value of a cryptocurrency with none of the dreaded price swings. A couple of weeks ago Yale in combination with the Fed released a well researched paper about the place of stablecoins and its impact on the US Dollar. It’s a good read if you appreciate the history of money.

What Are Stablecoins?

Stablecoins, as the Economist put it (but I’m rewording), are the proverbial grease for the crypto wheels. They are a form of private money that is backed one-for-one with government fiat currency. Of course it’s not that simple. Economists generally agree that money has to satisfy three properties: money is a store of value, a unit of account, and a medium of exchange. However, there is a fourth property known as the ‘No Questions Asked’ property, which means that money is accepted in a transaction without due diligence on its value. This ill-defined property is where there be dragons.

We all know banks do not actually hold onto your money when you deposit it; they lend it out. If there is a run on a particular bank because customers do not trust its ability to pay back its deposits at par, the bank’s federal insurance policy would kick in and pay back its customers at par. Since the creation of the FDIC, no person in the US has ever lost money putting their money in a checking account. Regulations on how banks can invest demand deposits, Federal insurance on these deposits, and the backing of the US Government and its army creates the stability of the dollar that we all take for granted.

The advantage of Stablecoins is portability, openness, and low fees (known as gas for all you Ethereum fans). You can send a Stablecoin to anyone in the world without the use of a financial institution. Banks charge customers monthly account fees, minimum balance fees, overdraft fees, overdraft protection fees, returned deposit fees, check fees, ATM fees, debit card transaction fees, lost card fees, foreign transaction fees, wire transfer fees, savings withdrawal fees, inactivity fees, account closing fees and even reserve the right to charge negative interest. Those fees hit hardest when your account is at its nadir; digital currency and wallets remove this burden and open up the world of finance.

Now that we’ve established a place for Stablecoins, here’s the catch. They’re not backed 1:1 by a US dollar and they’re not regulated. If you’ve ever seen an advertisement from BlockFi, Linus, Gemini or even Coinbase offering a 10%+ yield on USDC (a Stablecoin), this is an example of unregulated money market fund. And if left unchecked, can have dire consequences for the entire US economy.

I would go into the intricacies of GovCoins, but is literally a government’s currency converted to cryptocurrency. Nothing really changes except the medium of exchange and even that looks the same. Banks can still be custodians of your cash and can even shield every day customers from even knowing the US Dollar is now a cryptocurrency. Institutions can still transfer money between themselves to represent customer digital transactions. I don’t know, but it’s probably a good, if not a necessary, idea to hop on.

Will GovCoins Usurp Bitcoin?

I think there will always be a place for a currency not tied to a government. There’s more than enough people in this world who do not trust any government entity with their wealth. The intrinsic value of any digital currency is the total sum of fees charged for processing and recording transactions. If transactions seize up, the currency is no longer a medium of exchange and the value of the currency should go to $0. The value of any currency is tied to its ability to fulfill the three properties of money: a store of value, a unit of account, and a medium of exchange and of course the fourth property ‘No Questions Asked’.

Today it takes about 10 minutes to send money via Bitcoin, but can take as long as an hour. Sometimes days. Also, the fees are variable. It can easily cost $20 to send $1. A lot of work is being done on lots of different crypto currencies to reduce both fees and transaction time, but I hope we can agree Bitcoin is hobbling in its attempt to look and feel like money. That said, today the average transaction fee is $2.23, which is a far cry from the $35 international wire transfer fee. Not so great for buying a cup of coffee though. – look at that $65 transaction fee though!

Side note: I hate sending money on crypto rails. It’s terrifying and irreversible. Banks can reverse ACH transactions and can generally work with other banks to return errant wires. What I’d really like is the ability to ‘ping’ a wallet’s address across the network. The ping should probably go through faster rails so it is received in minutes, not hours and it should cost about $.01. So next time you want to pay for your house in BTC, you at least can be confident you’re sending it to the right person.

So let’s just agree the current value of Bitcoin is speculative. Gold, Bitcoin’s physical counterpart, is part tactical and part speculative. The dollar is fundamental. Stablecoins are in a murky area, but leaning towards fundamental assuming there are no bad actors. Speculative value is ok, but if you invest in something speculative, you should expect speculative returns. This post isn’t about how high Bitcoin can go or the chances it disappears (which is very low, but also its disappearance would literally be without a trace), but its about whether or not you should ‘invest’ in it.

My simple advice is ‘no’, Bitcoin is not that interesting of a speculative investment, but if you do, do so without paying any fees. Venmo recently opened up ‘investing’ in crypto currencies and charges a 1.8-2.5% fee for doing so. What really grinds my gears is hedge funds whose sole strategy is to buy and hold Bitcoin. The literal point of Bitcoin is that is universally accessible to anyone with a computer and internet connection. How on earth would anyone pay fees, let alone a 20% promote for an asset designed to serve every human on earth in an open and equitable way? Classic sales adage: if you customers are struggling to see the value of your product, just charge more.

Here’s a look at who is trading Bitcoin, brought to you by the Economist and further brought to you by Chainanalysis. Algorithmic traders dominate crypto markets, grinding out profits from bid-ask price discrepancies and exchange price differences. Wealthy people all over the world started parking some of their money in Bitcoin and a few very loud Reddit traders starting posting gain and loss porn on the Internet. Frenzies ensue, followed by periods of cooling off where those late to the game are left holding the bag. Invest if you will, but certainly not because you must.

But Do You Believe?

So I’m clearly not a fundamentalist investor. I don’t belong to any financial church and I believe in things that exist. So if asked if I ‘believe in Bitcoin’, yes, of course. It exists. Do I believe it will stick around? It’s been around since 2009, so, yes, it will probably stick around for the foreseeable future. Will I park my money in it? No. It doesn’t create any value and in my opinion it’s not a scarce resource because by some measure by Statista there are over 6000 crypto currencies in existence. DogeCoin was created as a joke and has captivated the world’s attention and achieved a market capitalization of over $55bn. Woof indeed.

So am I a speculative investor in Bitcoin? Not since 2017. When it comes to speculation, I prefer to be doing things other people aren’t doing. Everyone knows about cryptocurrencies. So, I must be a tactician! Tactician is rather generous term, but, yes, I believe that offering cryptocurrencies as a product and reward to existing financial customers, such as Venmo or Visa, means the pool and awareness of cryptocurrencies will increase in the near future. I only like to write about speculation, so I’m not going to actually act on any tactical Bitcoin investments. If I were to invest in Bitcoin, I would do so tactically.

The headwinds are plentiful. China is doing its best to remove both investors and miners from its country. Money laundering is still rampant, though only represents about 2% of all Bitcoin and the rise of Stablecoins or Govcoins might usurp the medium of exchange and No Questions Asked part of money. The price is so heavily influenced by Bitcoin celebrities like Elon Musk that it dwarfs any intrinsic or fundamental value created by widespread awareness and adoption and will probably also overshadow any tactical gains by crypto permeating into the every day financial lives of billions of people. There is currently little to no regulation, but that will certainly change. Oh, and Bitcoin mining accounts for 35.95 million tons of carbon dioxide each year. Honestly, if you care about the environment, don’t buy it, hold it, or even talk about it.

I don’t have any interesting big bet ideas today. Crypto is a fine place to take a risk, but the returns aren’t what they used to be. Even if you 3x your money. So what? You can just as easily lose 70% in a few days. I’m staying away, but I don’t necessarily disagree with anyone taking the other side.

What’s Next and What’s Happened?

I haven’t written much recently. Honestly, my last few posts summed it up. I dumped all my Robinhood speculative stocks, bought some real estate and put the rest of it in ETFs and Big Tech. Nothing interesting, but it was a bit nerve racking buying real estate, mainly because I hate paying fees and even though buyers don’t technically pay the fees, I know they are there.

The next idea I’m toying with is patience. There’s a strong correlation between broader market bull runs and derivative asset, like BTC, ETH, $MEME, and $WSB. Unfortunately we are at the tail end of a few-times-in-a-lifetime bull run from trough to peak, but that shouldn’t stop speculation. A few solid days for market indices could mean high volume stocks and crypto could have a short-term pop. Think of it like a pass line bet in craps; you’re supposed to bet the house max. But this isn’t Vegas and the house is anyone showing up late.