Justin Sullivan
Introduction
SoFi (NASDAQ:SOFI) has not been performing well for the past few quarters. The stock price fell dramatically on fears of tightening, valuation, student loan moratorium, etc. As such, in my previous article, I rated SoFi as neutral citing massive risks from the potential extension of the student loan moratorium, which was extended until August 31st. Now, however, I believe these risks are priced into the company’s stock. In fact, I believed SoFi is undervalued. The company is continuing its strong growth and product innovation showing the strength and resiliency of the ecosystem and growth strategy. Given this strength and a low valuation, I believe SoFi will be able to continue its strong growth in both top and bottom lines. Thus, SoFi is a strong buy.
Earnings Report
SoFi reported Q2 2022 earnings on August 2nd, 2022. The following shows a quick summary of the results:
- Revenue grew 57% y/y to about $362.5 million
- Adjusted EBITDA grew 81% y/y to about $20 million
- Net new members grew 69% y/y or about 450,000 new members for the quarter to about 4.3 million members.
- The total product grew 79% y/y or about 702,000products for the quarter to about 6.6 million products.
The company showed strength in all aspects. Product growth drew member growth, which ultimately led to revenue growth.
The second quarter marked the first full quarter after the bank charter approval, and as anticipated, the approval had a positive result on SoFi’s operation. The deposit grew to $2.7 billion during the quarter allowing SoFi to lower its cost of funding loans. As the revenue and the loan originations increased, the margin expanded as well.
Finally, SoFi laid out strong guidance hinting a strong growth throughout 2022. For the second half of 2022, SoFi is expecting an average of about 49-50% year-over-year revenue growth with an average adjusted EBITDA of about $75-80 million, which equates to about a 9-10% margin on average. Since Q2 2022 had an adjusted EBITDA margin of 6%, the rapidly growing margin suggests that SoFi has finally scaled to a point where profitability may be possible in the coming quarters.
Growth Flywheel
I believe SoFi’s strategy of growth is similar to that of Amazon (AMZN): the flywheel effect. The founder Jeff Bezos endlessly invested to lower the business’s cost structure to lower prices and improve customer experience, which ultimately led to more traffic. Then, more traffic attracted more sellers growing the size of products offered by Amazon improving the customer experience, and starting the wheel all over again for maximum growth. Jeff Bezos, founder, and ex-CEO, of Amazon, endlessly used this model to grow Amazon.
Like the above example, SoFi is implementing a model that is similar to Amazon’s flywheel effect. SoFi purposely loses money in its financial services product to attract and satisfy customers. SoFi invests to increase the amount of product offering while maintaining the quality of the products, which includes offering credit cards, high-yield checkings accounts, savings accounts, brokerage accounts, etc for free. Then, the increased traffic allows SoFi to easily cross-sell its high-margin loan offerings generating revenues with a low customer acquisition cost. Finally, the profits made from the loan originations will be reinvested into creating more product offerings to attract and satisfy even more customers creating an effective growth flywheel.
Through the Q2 2022 earnings report, SoFi was finally able to prove the validity of the above strategy. Cross-selling continued to increase, operating margins from the lending business increased, and SoFi’s overall product offering continued to expand rapidly. The business continued its strong growth while improving efficiencies.
Thus, the strategy will likely allow SoFi to maintain its strong growth going into the future. A single bank that offers intuitive, free, expanding, and competitive financial services covering most of the needs consumers face in their daily lives is destined to be popular. Then, when these consumers need to get a loan of any type throughout their life, SoFi is ready to capitalize on the demand. SoFi can rapidly and competitively offer rates using data it has collected throughout its relationships with customers in its financial services business. The application process will be quicker and rats may be more competitive because of the data points. Therefore, I believe the strong growth of SoFi will continue as it is only getting started.
Product Diversification
SoFi’s strength and future opportunities also come from its diversified product portfolio, which offers resiliency and growth.
SoFi offers 3 different types of loans. Home loans, student loans, and personal loans. In times of a strong economy and the housing market, home loans led SoFi’s growth. Today, as the economic growth and demand for student loans slow, personal loans are leading growth. As such, depending on the market situation, the diverse product offerings will likely continue SoFi’s resilient growth. SoFi is not bound to a particular economic cycle.
Further, SoFi has a B2B company called Technisys and Galileo. Technisys and Galileo are essential company that offers digital banking solutions allowing traditional banks to construct and provide digital banking services while also allowing new neo-banks to create digital infrastructure and scale efficiently. As the digital banking market continues its growth throughout the decade, these companies will likely be one of the biggest beneficiaries, which is already reflected in member, revenue, and margin growth today. Galileo accounts increased by 48% year-over-year to 117 million as the revenue increased 39% year-over-year. The contribution margin increased to 33% compared to 29% in the prior year. As such, the growth in members continues to outpace revenue growth signifying that further monetization may be possible after the initial growth phase. Therefore, I continue to believe that SoFi’s technology platform business will see strong growth. Not only is the underlying secular trend benefiting SoFi, but future monetization potential also exists as well.
Valuation
SoFi stock saw a dramatic decline in the past year. As of post-market price on August 2nd, the company has a market capitalization of about $6.3 billion with a forward price-to-sales ratio of about 5. Although the company is yet to be profitable, I believe SoFi is cheap at these prices today. Growth expectations continue to be strong from resilient and diversified product offerings. I believe SoFi will report a profitable quarter by the end of 2023, ahead of current estimates. The bank charter approval has allowed SoFi to improve its margins on interest incomes, which will likely accelerate going forward as more deposits allow SoFi to lower the cost of funding the loans. Further, business expense growth is slowing. Total noninterest business expenses grew far slower than the revenue growth for two consecutive quarters at about 17% per quarter compared to about 50% revenue growth in each quarter. SoFi, starting in 2022 has been able to control its costs while maintaining growth and growing operating margins. As such, I believe SoFi is undervalued looking at its growth opportunity and the company’s potential to report a better-than-expected bottom line.
Summary
SoFi’s stock price has been beaten down in the past few quarters. Valuations were too high as macroeconomic conditions worsened, and the student loan moratorium extension made investors doubt whether SoFi could maintain its growth rate. However, today, I believe the company’s trajectory is changing. Not only is SoFi’s valuation attractive, but SoFi’s long-term goal of creating a flywheel effect and constructing a strong ecosystem is finally coming to fruition. Therefore, I believe SoFi is a strong buy today.
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