SoFi – New Top Pick – Fintech’s Most Ambitious Entrant CML

Today we introduce SoFi (IPOE) as a new Top Pick and our first coverage of a FinTech company which is a hybrid bank but we do so with an add below price of $12.

That means if IPOE stock never goes below $12, it will never be added as a Top Pick (the current price is $17).

Once the stock ticker switches over to SOFI, we will use a $10B market cap as our add below price (which is what $12 in IPOE stock price gives us).

If the company doesn’t hit that number, we really are OK with missing out on this one.

Please be aware that there is no guarantee that the SPAC merger goes through — it should go through, but the SEC has the final say so a purchase of IPOE before it flips to SOFI has that embedded risk as well.

With some technology companies we are happy to stretch, but with a company that is currently generating 85% of revenue as a bank (although it guides to far more lucrative segments in tech platform and financial services by 2025), we’re just not in the stretching mood.

As a Top Pick without a Spotlight designation, the company lives in the outer most circle of this logic diagram.

The company recently agreed to a reverse merger through a SPAC (IPOE) and will soon be listed under the stock ticker SOFI.

The transaction is expected to close in the second quarter this year and deliver close to $2.4 billion in proceeds to SoFi which includes $1.2 billion through a private investment in public equity (PIPE).

What is SoFi?
Financial technology, better known as fintech is the application of technology in the financial services industry to offer digitally enhanced products in the areas of Digital Payments, Alternative Financing, Alternative Lending, and Personal Finance.

SoFi is a fintech — an online personal finance company based in San Francisco. The company offers various financial products, which include student loan refinancing, personal loans, credit card, mortgages, investing, and banking. SoFi has 1.7 million customers as of the merger announcement date. The company is set to reach 3 million customers by the end of 2021.

CEO Anthony Noto has a strong background in financial markets as the former CFO of the National football League (NFLK) and Twitter (TWTR). He also served as the COO of Twitter.

Noto also served as the head of communication media and internet equity research business unit as a managing director at Goldman Sachs.

He has been the CEO of SoFi since February 2018.

SoFi takes on a rather aggressive approach to the industry it has entered attempting to a holistic all-in-one service provider and fintech rather than focusing singularly on any one part of the business.

The company began with a communal focus on student loans and rose to prominence after the Great Recession by refinancing at cheaper rates for promising graduates.

The company has since grown quickly into mortgages, personal loans, credit cards, high yield savings, investing, robo advising, insurance, and through an acquisitionof Galileo, into the payment processing business with 50 million accounts.

SoFi wants to be the bank of the future, not just a fintech add-on, and in that vein it has received received preliminary, conditional approval from the U.S. Office of the Comptroller of the Currency (OCC) over its application for a national bank charter.

The bank charter would allow SoFi to borrow at better rates, forgo intermediaries, and therefore (purportedly) would give the company higher margins.

A banking license would enable SoFi to hold customer deposits and make loans, without having to rely on a bank partner as it currently does.

We note that in year the FDIC approved a banking charter for Square (SQ), so the move to formally become a bank is not without precedent in the fintech space.

Thematics Before Details
Before we get to details, let’s take a step back and turn to thematics.

We can start very broadly by examining the number of fintech startups from 2018 through February 2021, by region. This chart comes from Statista:

We can see growth across all regions and the trend points to the massive opportunity that venture capitalists and entrepreneurs alike see in the broadly defined space.

The point of this chart is to demonstrate the belief system of the investing world in the opportunity and the incredible competition to come.

We can next move to consumer fintech adoption rates globally from 2015 to 2019, by category. This chart comes from Statista.

Consumer adoption of fintech companies and products has grown rapidly worldwide between 2015 and 2019.

As of 2019, 75 percent of consumers globally have adopted some form of money transfer and/or payment service. Insurance (insurtech) adoption has seen a significant growth from 8 percent in 2015 to almost 50 percent in 2019.

The point of this chart is to examine the robust growth across multiple categories in the fintech space. It is the breadth of the opportunity in fintech at large that SoFi is pursuing rather than just one category.

With SoFi’s recent application and preliminary conditional approval for a bank charter, the company is clearly focused on the “borrowing” category as it expands into other fields.

Finally, we can turn to a specific subsection of “borrowing” in the fintech space called personal loans. Our next chart shows us the share of personal loans granted in the United States from 2013 to 2018, by source.

We have focused on just two categories for this chart, namely banks and fintechs.

The dual trends are clear — banks are seeing their share of personal loans drop and that market share is going, at least in part, to fintechs.

It’s easy to miss, but the growth in market share for personal loans provided by fintech’s is now more than seven-fold where it was in 2013 by just 2018.

The point of this chart is to examine how rapidly and abruptly the fintech disruption has manifested.

With these thematics as a back drop, let’s turn to SoFi.

SoFi Details
Much of this section does rely on reported ambitions and guidance from the company and is therefore uncharacteristically soft on outside data source.

Since the company hasn’t even officially gone public, we can do all of the thematics work we want, but there is a slightly uncomfortable reliance on what is, for all intents and purposes, a company pitch deck to investors.

As we share the information, we do make a concerted effort to poke holes in the guidance while also holding the possibility that it is in fact all achievable.

At its core, SoFi’s ambitions are very high, seeking to not just participate in the fintech revolution, but to wholly lead it as a winner take most entrant.

In fact, when we did some digging into SEC filings, we found an early documentthat clearly urged investors to consider the possibility that SoFi would be the “Amazon of fintech,” and even harkened comparisons to Tesla’s meteoric rise.

This is bold, which means in this company we get both the ambitious upside and the risk that comes with it.

It also means, pardon me, that the pitch deck could full of you know what…

SoFi considers its ideal customer HENWS — high earners not well served, which are people with high incomes and high FICO scores.

SoFi often refers to the financial services productivity loop (FSPL), and we will do so as well with that acronym.

This FSPL for SoFi means attempting to capture the borrowing, saving, spending, investing, and protecting aspects of its members’ financial lives and it leads with that holistic approach as a differentiator.

Since the ambition is so wide, the guiding light for SoFi investors, as set by the company, is a promise that everything it does, offers, or invests in should be focused on a member-centric approach as opposed to an application based approach.

In that space it says all of its actions must touch at least one of the four corners of:

* Fast: Making the aspirational platform the fastest way to everything (apply for and borrow money), open accounts, buy and sell stock, deposit and access cash, pay a bill or send money to friends.

* Selection – broad array of products across the member lifecycle.

* Content – content to support the get your money right (GYMR) mantra meaning education, information, advice, credit scores, budgeting, and investment resources like news and research.

* Convenience – easy, any time, any platform, any place, in a simple way.

Again, this is essentially a simple rehashing of SoFi’s investor pitch deck.

The purpose of sharing this portion of the pitch is yet again emphasize that the company has no ambition that is influenced by a singular portion of fintech, like PayPal with payments, but rather wants all of it.

Here is a chart that the company shares, which appears to be formal guidance:

The image, or ambition, shows well diversified revenue stream, where lending is the largest contributor to revenue (and thus the bank charter), but generic financial services and “tech platform” should be diversifying streams.

It turns out that this broad ambition isn’t just an ambition, but rather has serious and measurable impacts on business performance.

When the company discloses customer acquisition cost (CAC) examples, at the very least it reads like there is reasoning behind the “one-stop shop” approach.

Here is a chart the firm shared in its SEC filing (we have added the red circles).

This “illustrative example” reads that while a single product would bring anywhere from 34% to 45% variable profit margin per cent, that the combination would bring an 80% variable profit margin.

The reader is left to assume that this increase is due to the absence of CAC for product / loan number two.

While that was a little weak in that it is labeled as “illustrative example,” the company then makes a formal disclosure that more than 65% of home loans come from existing members and that it produced $30 million in Q3 2020 revenue while only costing $1 million in acquisition marketing.

This is the company willingly disclosing evidence that, yes, the “go big” approach is at the very least founded in logic.

Next we can share the charts the company likes to share on growth.

While the charts are soft on details, 77% growth in total products and 95% growth in multi-product members are huge numbers.

Finally, COVID has had an impact on the fintech space and it has been the same digital transformation (DX) that we have spoken about so many times with other Top Picks.

According to SoFi, 59% of people have increased their fintech app usage as offline management of finances has fallen. Even further, SoFi tells us that 87% of consumers say they won’t go back to offline.

This is another example of the permanency to new behaviors informed by cognition. For the vast majority of consumers, digital financing is better, and therefore they will not go back.

SoFi is willing to share what reads like formal guidance through 2025, which is bold, and if credulous very impressive, and if not, then… not.

The company sees adjusted net revenue growing from $621 million in 2020 to just under $3.7 billion by 2025.

It sees adjusted EBITDA going from -$66 million in 2020 to just under $1.2 billion by 20205.

Here are those words in a chart:

Again, this feels like formal guidance but we have no history with this company as a public entity and therefore no history of accuracy (or lack there of) in guidance.

This reads great, but maybe that’s all it does. Maybe in four years we will revisit this slide in scorn.

The company will raise $2.4 billion in cash from the SPAC merger and it will leave the company with $2 billion after it repays Galileo’s seller note:

With the merger agreement between SPAC IPOE and Sofi, the deal valued SoFi at $8.65 billion at par value for the SPAC, which is $10.

With an add below price to the Top Picks tracking portfolio of $12, that yields a valuation (12/10) * $8.65B = $10.4 billion.

SoFi sees adjusted net revenue of $980 million in 2021 and reaching $3.669 billion by 2025.

Along with that rather rapid revenue growth, the company has guided to $27 million in adjusted EBITDA for 2021 and to $1.177 billion by 2025.

So, how do we value such a thing, if we simply consume the guidance as true (which we may not)?

By 2025 SoFi sees 43% of adjusted net revenue coming from lending, which is really banking, 32% from financial services, and 25% from a tech platform.

Here are those words in a chart:

* Tech Platform

It’s difficult to find a pure play fintech with no banking operations anymore, as the entire industry is starting to morph in to “hey, let’s that too!” model.

But, we can start with PayPal (PYPL).

(We don’t use Square because it has bitcoin revenue which is zero profit and makes growth rates difficult to address.)

The data we use here is from 3-25-2021.

PYPL trades at 13 times 2020 revenue based on 21% revenue growth.

PayPal actually has lending revenue in there, but let’s treat as a proxy for our “tech platform.”

From 2024 to 2025 SoFi has guided to 31% growth and we’ll just apply that to all segments evenly.

That would give us 2025 “tech platform” revenue of $911 million, then using a price to sales of 13x we get a market value of $11.8 billion, but that’s in 2025 (so four and a half years from now).

We will deal with a discount rate back to today when we are done with all segments.

* Lending

We can start with the gold standard that is JPM.

The data we use here is from 3-25-2021.

JPM trades at 3.84 times 2020 revenue based on 4% revenue growth.

That would give us 2025 “lending” revenue of $1.6 billion, then using a price to sales of 3.84x we get a market value of $6.1 billion (in 2025).

But, there are countervailing adjustments, namely that SoFi will be growing much faster than 4% a year but also, SoFi is no JPM.

In what is surely a pretty dirty estimation, let’s call it a wash, and the $6.1 billion market value from lending stands.

* Financial Services

This is a pretty broad area which could lead us to Goldman Sachs, Schwab, Visa, Factset or most likely, some odd weighted combination of all of them.

For SoFi it is a focus on credit cards and its brokerage, both of which are tiny businesses.

We land somewhere in 7x trailing twelve months (TTM) price to sales.

With $1.2 billion in financial services revenue marked to 7x leaves us with $8.4 billion in market capitalization value in five-years.

* Combined

Taken together we get $11.8 billion + $6.1 billion + $8.4 billion, which is $26.3 billion in five-years.

With a current market cap, based on the add below price of SPAC IPOE for $12, we would see the stock rise from $10.4B today to $26.3B in five-years, or 20% compounded annual growth (returns) for five years assuming no dilutive capital raises, which is just an assumption.

Now, of course, we have done no work to discount the values due to risk. That is to say, just because SoFi says its going to happen doesn’t mean it will — the company would say that too — it’s just a forecast.

So, without doing that work to pluck a discount value out, we leave the very (very!) rough calculations as is: About 150% upside in 5-years, or 20% compounded annual growth with risk that it’s rather incorrect.

The company reported $621 million in net revenue for 2020 but it’s basically a lender (read: a bank), and bank multiples are lower than what technology investors are used to.

We’re not so compelled to reach for SoFi given the rather ambitious goals with little to no track record to justify the ambitions into tech platform and financial services.

It is with these measures that we add SoFi to Top Picks.

We want exposure to the “new” kind of bank, financial services, and tech platform and in living up to the ethos of CML Pro, yeah, it’s gonna be smaller and newer than a lot of the other opportunities in the market.

We like the thematics as shared above, and we like the opportunity we see in SoFi, while fully appreciating the risks.

There is some substantial upside to these guided numbers should SoFi secure its bank charter.

In a slide from the pitch deck, the company is rather explicit that the bank charter would add $299 million to adjusted EBITDA in 2025, or 25%.

That’s a big number.

Here is the slide:

We can rest on the bank charter as a counterweight to risks that the guidance may be too ambitious.

There are so many risks to SoFi before we even get to company specific execution that we will just call the first bucket “SPAC ‘n stuff.”

The company has no history as a public company, will not go through a formal IPO vetting process, and for all we know the SAPC deal falls apart.

That’s just risk, in many facets all originating from “SPAC.”

Beyond those risks we see risks:

* The tech platform business, which is the most lucrative with respect to market value could fail to gain traction. As of today, the tech platform business is just a $103 million business (for all of 2020) — what if it doesn’t go 9-fold to $911 million as guided?

* The financial services business also carries a much higher price to sales ratio, and as of 2020 this was an $11 million business. The idea that it will grow more than 100-fold (one hundred fold) in five years is… pretty bold.

Can we say it won’t happen? No.

Do we have any history that it has happened? No…

* Lending is core to SoFi and it made up fully 83% of revenue in 2020. The growth projections are lofty, going from $514 million in 2020 to $1.6 billion in 2025, but it is the most defined business and there is a history of growth.

We see the risk here that lending grows as planned but the higher margin businesses do not.

And, with lending comes credit risk — these loans sit on SoFi’s balance sheet, so that’s a risk if the lending safeguards are insufficient or if an economic distress hits the United States.

* Finally, there is always the unknown — the thing we didn’t see that we could not have seen but we see just fine when we see it. With a newly pubic company, that is in particular a sizeable risk.

A Word, Many Words, About the Market
Sideways trading since the tech correction is constructive.

2021 won’t be like 2020.

The moves won’t be as fun, as scary, nor as often.

Now is the time to research.

Market moves will come, but knowing what to do with them starts when there are no market moves, right now.

Your patience is your conviction.

Perspective means more than trusting in a recovery from a down trend or avoiding FOMO in an uptrend.

It means patience when 90% of the time, there is nothing to do.

We will continue to research when it’s ‘boring.’ We will allow investing to not be entertainment.

This thing, this market, participating in it, it’s on purpose.

Those with perspective are going to win and they don’t need anyone else to do so, even CML Pro.

This is work time.

Today we add SoFi as a Top Pick with a buy below of $12 in ticker IPOE.

Thanks for reading friends.

The author has no position in IPOE (or any other derivative of SoFi) at the time of this writing.

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