MichaelRLopez
Thesis
SoFi Technologies (NASDAQ:SOFI) could be a great high-risk/high-reward investment choice for 2023. There are multiple catalysts that could benefit SoFi’s business as soon as next year, and the company is establishing a track record of strong performance in this difficult macro environment. Although SoFi is a high-risk stock with a range of possible outcomes, I believe it’s more likely than not that SoFi is materially undervalued today.
SOFI Stock Key Facts
SoFi Technologies is a one-stop shop for financial services, similar to large banks like JPMorgan Chase (JPM), Bank of America (BAC), and Wells Fargo (WFC). Like its incumbent competitors, SoFi’s key products include loans, checking and savings accounts, credit cards, and stock and crypto investing. SoFi also offers technology products to other financial services companies.
The key differentiator for SoFi is that it’s entirely online, which allows SoFi to provide service outside the traditional 9-5 hours of physical banks. All else being equal, it also represents a structural cost advantage that can be passed on to members to undercut competitors on pricing.
It’s an exciting time for SoFi right now, because there are multiple catalysts that could indicate SOFI stock is currently too cheap. I’ll highlight three of them now.
What Are SoFi’s Catalysts To Watch For In 2023?
Catalyst 1: Higher APY
I first discovered SoFi when looking for online banks that would offer better savings account APY than the brick-and-mortar bank that I previously used. All three of the incumbent big banks in the US are currently offering savings account APYs between 0.01% and 0.04%. With interest rates now touching 4%, that’s pathetic.
Banks mostly need money in savings accounts to fund loans, and they currently have more than enough. Per FRED, deposits have grown over time due to inflation and other factors. But they experienced an unprecedented spike in early 2020 and are only starting to level off now. Even if the amount of money in savings accounts declines meaningfully, that will likely correspond with fewer loans being underwritten as higher rates reduce demand for credit. Either way, there’s not much incentive for big banks to meaningfully improve their savings account APY any time soon.
On the other hand, online banks like SoFi don’t have as many overhead costs as their incumbent competitors. And they are incentivized to offer higher rates in order to compete for market share. SoFi has offered consistently higher APY as rates rose throughout 2022, recently upgrading members to 2.5% APY in checking and 3.0% APY in savings. Personally, I moved the emergency fund that I keep in a savings account to SoFi, and I’m not the only one; in their recently reported earnings, SoFi reported that total members increased 61% year over year.
If rates continue to rise, the gap between SoFi APY and traditional bank APY will likely continue to grow, incentivizing more members to move to online banks like SoFi. To be fair, there are many online banks offering APY similar to SoFi, with a few even offering slightly better rates. However, I believe that SoFi is differentiated due to the brand recognition it has from SoFi Stadium and other advertising deals, combined with its industry-leading breadth of products that’s on par with the offerings of incumbent banks.
Catalyst 2: A Student Loan Surge
SoFi got its start by offering student loans, and it wasn’t that long ago that most of SoFi’s revenue was generated from student loan origination. Even today, lending represents about half of SoFi’s revenue.
However, the student loan business was ruined by the Covid-related pause on student loan payments enacted by the federal government. Although the current administration has cancelled some student loan debt, they’ve also insisted that the current extension of the repayments pause will be the last; those with student loans should prepare to begin repayments in January 2023. If congress ends up controlled by Republicans after midterms, it will result in gridlock and would reduce the chance of any major legislation getting passed, including a larger cancellation or pause of student loan debt. That’s another potential catalyst for SoFi.
Based on how SoFi lowered its guidance after an extension of the student loan pause in April, a resumption of student loan repayments may represent only about 5% of revenue. However, this is one of SoFi’s most profitable segments, and I believe that getting it back at full strength could increase SoFi’s EBITDA by about 50%, off of what is admittedly a small base.
Historically, SoFi generated most of its student loan revenue from originations rather than interest income. That’s because it would re-sell the loan to other banks. Now that SoFi is officially a bank, its strategy may shift towards holding more loans itself. However, in the medium term, I still expect a substantial amount of origination-based revenue. If that’s the case, this segment would actually benefit from a Fed pivot, which could happen in 2023.
Although my base case is for interest rates to peak in 2023, that doesn’t have to be part of the SoFi bull thesis. Sure, falling rates lead to more demand for loans and more loan origination revenue. But rising rates lead to more interest income and more growth in banking products like savings accounts. Clearly, SoFi has built a resilient business that has the potential to thrive regardless of which direction interest rates are moving.
Catalyst 3: Strong Financial Performance
At the end of the day, the most important factor that determines the long-term performance of a stock is its ability to increase its earnings per share over time.
SoFi stock is down 67% year to date, similar to many other high-flying growth stocks. But unlike many other software and FinTech names which have experienced rapidly slowing growth, SoFi’s business has continued to perform very well. In the recently reported quarter, SoFi achieved:
- Record revenue up 51% year over year
- Financial services segment revenue up 288%, driven partly by revenue per product increasing 112%
- Lending segment revenue up 38% driven by personal loans
- Technology segment revenue up 69% year over year, with 40% of new deals happening outside the US
- Total members up 61% year over year
- Raised guidance
That looks like a company firing on all cylinders to me. The only downside was a GAAP loss, translating to profit margins of -17%. SoFi will ideally become profitable soon, perhaps as soon as next year, if the student loan business recovers. But in the context of 51% growth, a profit margin of -17% is respectable as measured by the Rule of 40 (which, to be fair, wasn’t intended to be used on cyclical lending businesses).
If SoFi continues to beat earnings estimates, raise guidance, and grow quickly in 2023, then its stock price could react positively. Unlike at the start of 2022 when SoFi commanded an elevated multiple, SoFi will enter 2023 with a P/S multiple lower than that of the big three incumbent banks despite growing substantially faster than them. This means that investors either don’t believe that SoFi’s growth is sustainable or don’t believe that SoFi can ultimately attain the lucrative profit margins of incumbent banks (despite its comparatively asset-light business model). If SoFi continues to beat expectations for another year, that perception could change, allowing SOFI stock to experience multiple expansion.
What Is The Long-Term Prediction?
I somewhat dislike the “how will X do in 2023” format because it can be the case that SOFI stock continues to perform poorly in the short term due to investor sentiment, even if SoFi’s business continues to perform very well. The stock price will eventually follow the business performance, but that may not happen in 2023 despite the multiple catalysts I highlighted.
That’s why I typically invest with a 10-year time horizon. Based on the model that I shared with Tech Investing Edge members, I believe that SOFI stock could return nearly 10x in the next 10 years, giving it lucrative multi-bagger potential and making it materially undervalued today. Looking beyond 2023, SoFi can continue to grow quickly for a long time by introducing new products to cross-sell, taking market share from incumbent banks, growing its technology offerings, and expanding internationally.
That said, it’s important to know that SoFi stock isn’t risk-free. Like any company that’s involved in lending, SoFi is actually a high-risk investment. SoFi’s customer base has very good credit and SoFi’s balance sheet is strong. However, SoFi is not GAAP profitable yet, so lending-related risk is certainly something that investors should consider, especially if economic conditions materially worsen in 2023. It’s also fair to argue that SoFi’s management team and culture are not yet proven to be best-in-class. That would be especially concerning if it turns out that SoFi’s product suite and brand aren’t yet differentiated enough to warrant a competitive advantage against other online banks, some of which are still founder-led.
Considering both the risk and upside, I believe that it’s worth owning SoFi today. However, it is a volatile and risky investment, so investors shouldn’t use money that they will need in 2023 or can’t afford to lose.
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