The Rundown – Your weekly SPAC Deep Dive (09/25/21)
SoFi Technologies Will Lead the Next Banking Revolution
For those unfamiliar with the origins of the company, Social Finance or SoFi was founded back in 2011 by students of Stanford, Mike Cagney, Dan Macklin, James Finnigan and Ian Brady. The founders envisioned that the company could provide an affordable alternative to student loans.
SoFi’s initial pilot program was crowdsourced through 40 Stanford alumni, with $2 million raised for 100 studies, with an average of $20,000 disbursed per student. Following the resounding success in its initial test run, the company pushed for a national expansion and offered around $200 million in student loan financing to 2,500 students in 100 eligible universities.
Crowdsourcing was so far ahead of the rest of the competition and left traditional banking in the dust. Raising money from Alumni had three unique advantages when compared to traditional student loan financing.
First, crowd-sourcing eliminated the bloated administrative fees of a bank, which translated to a dramatically lower interest rate compared to what was offered at the time. SoFi offered student loans at a rate of interest of 6% which was 40-50% cheaper than what banks were offering at the time.
Second, the company improved risk scoring during underwriting by pairing students with alumni lenders. This ensured that default rates were close to 0 when the national average was closer to 12%. Third, Repayment was swift, with an average of 3 years for repayment after leaving college with factors such as lower interest rates and the influence of alumni network playing a big role.
The low default rate, coupled with rapid repayment meant that SoFi was also able to create a bond backed by the peer-to-peer student loans, which would create the first securitisation of these loans to receive a credit rating. Since then, the company has continued to innovate and has raised over $3 Billion in funding from the likes of Peter Theil, SoftBank, Silver Lake and the Qatar Investment Authority.
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A Little Bit of Everything
While SoFi started with student loan lending, it has now expanded to a broad array of financial services including home loans, loan refinancing, investing services, cryptocurrency trading, credit analysis, insurance and banking. Essentially, SoFi is building an ecosystem of financial products and wants to be the one-stop solution for all things Finance.
Such a strategy can either be beneficial or detrimental to the company’s success and largely depends on the company’s execution. So far, the company has remained nimble in its approach and has largely prioritised customer acquisition growth over profits. SoFi currently categorises operations broadly into three segments that include Lending, Technology and Financial Services.
Lending accounts for the lions share (80%+) off the company’s profitability and includes student loans, homes loans, auto loans and loan refinancing services. Lending continues to grow and benefit from diversification with strong originations even as the economy continues to recover. Even though student loan originations were down year-on-year as students differed a year to experience in-campus learning, home loan originations saw strong growth with the housing market surge as homebuyers took advantage of the low-interest-rate environment.
SoFi’s Technology segment is primarily driven by Galileo, which was acquired last year for $1.2 Billion. Galileo handles the backend experience for Neo-banks, cryptocurrency exchanges and decentralised finance companies. Galileo manages a ledger, authorisation settlement, automated clearinghouse, credit card issuance and fraud management. Most of the worlds fintech firms rely on Galileo, with high profile clients including Robinhood, Chime and Monzo.
Then there’s the company’s financial services platform, which is the only segment that continues to remain unprofitable. Financial Services is entirely consumer-centric and includes SoFi Invest, Sofi Protect Insurance, Credit Score Monitoring with Relay and SoFi Money and Credit Card. While financial services currently account for only 2% of the company’s current revenues, it is projected to account for 25% of revenues and 47% of profits at maturity. SoFi believes that Financial Services will grow at an astronomical pace of 153% CAGR between 2020 and 2025.
Bank Charter Will Level the Playing Field
The most anticipated driver is SoFi’s application to secure a bank charter. The company currently relies on warehouse financing facilities to originate loans that it sells to customers. The process involves borrowing money from large financial institutions for lending.
The process reduces the interest income earned as the intermediary (Large Financial institution in This Case) provides the cash management facilities. By obtaining a bank charter SoFi will be able to earn a higher relearn on loans through greater interest income.
Galileo will also complement the charter and make it easy for SoFi to partner with other companies to offer sweep accounts, FDIC insurance warehouse facilities and so on.
The banking charter will open up a whole new category of products for the company to offer to its customers and will help further reinforce its mission to be the only destination for financial services.
Strong Growth Ahead
Companies like SoFi, Square and Paypal continue to expand their suite of products on offer and have become a serious threat to legacy financial institutions of the past. Millennials and Gen-Z, who are more accustomed to the convenience of banking at home while being frustrated at the bureaucracy and bloated nature of traditional banks may indeed decide to only turn to one of these companies in the future.
This is exactly the kind of future SoFi envisions and is now prioritising User growth over everything else. The sticky nature of the ecosystem suggests that once users get accustomed to a particular provider, a) they are unlikely to switch and b) revenues are likely to scale over time. Over the last three years, revenues have increased from $241 million to $621 million.
Furthermore, this explosive growth is set to continue as the company is on target to hit $980 million for the year. This implies a 14x P/S multiple for FY21, which is not too big a premium considering that revenues are projected to grow at 50% CAGR between now and 2025.
SoFi shares slumped after Q2, where investors were disappointed that the company wasn’t profitable and continued to widen losses in some segments. But SoFi stock has rallied 25% in the last month, as investors are now choosing to focus on customer acquisition growth and revenues as a proxy for the execution of management’s strategy.
SoFi is part of the big three new-age Neo-banking firms that aims to disrupt legacy financial institutions. There are several short-term catalysts for SoFi stock, including approval of the bank charter, increased loan originations in the student loan and housing segments as schools reopen and the housing market remains red hot. With the right execution, SoFi is capable of overtaking rivals Square and Paypal in the financial services industry.