SoFi Technologies: Big Banks' Days Are Numbered
- The writing is on the wall for the traditional banking system.
- Millennials and Generation Z are the rising consumer class that thinks little of traditional financial institutions.
- SoFi Technologies has an exceptional net promoter score, is growing an all-in-one stack of financial services, and is pursuing a bank charter.
- Digital banks are the future, and SoFi will be among the winners.
The financial system is one of the largest frontiers in the global economy. So much so that we have heard terms like "fintech" for years, yet the "big banks" and traditional financial institutions continue to hold control over the financial system. That could soon change. Fintech companies continue to gain momentum and are just now reaching the point of directly competing with traditional banks.
One example of this is SoFi Technologies (NASDAQ:SOFI). The fintech player started in the student loans space but is evolving into a full-stack ecosystem that can serve a consumer's financial needs from top to bottom. SoFi's consumer-friendly reputation, digital footprint, and functionally make it a contender to take market share from big banks over the next 10 plus years. We will review our investment thesis for SoFi Technologies and show why the writing is on the wall for legacy lenders.
The Problem: Young Consumers Hate Big Banks
Just because something worked in the past doesn't mean it will work in the future. This is especially true when large shifts in sentiment occur within a consumer demographic; as Boomers and Gen X age, the economic "power" shifts to the younger demographics in Millennials and Gen Z. Investors would be wise to be on the side of the rising party and not the declining side.
Young consumers have grown up differently than previous generations. They have gone through the financial crisis of 2008-2009 and have inflated costs such as high student loans that previous generations didn't have to deal with as much. Studies have shown that these "milestone" expenses such as education and housing have outrun inflation relative to what previous generations have paid.
When it comes to banking, there is an interesting dynamic at play. Major banks remain the leading lender for young consumers. But is this the case because of desire or necessity?
In actuality, it's been studied that young consumers really don't like big banks. The types of complaints voiced (below) imply that most big banking experiences are clunky, unpleasant, and frustrating.
If we zoom out and look at Net Promoter Score among the lending industry, we see that big banks, in general, are held in low regard by the consumer.
The most likely explanation is that consumers are caught between a rock and a hard place. Big banks provide enough features (mobile banking, broad ATM footprint, etc.) that they would rather choose the big banks over a local lender that may cater to them but lack key convenience features. In summary, there is no "ideal" solution, a convenient bank that satisfies the consumer.
SoFi Offers A Solution
However, SoFi Technologies is attempting to change this. First, SoFi Technologies cut its teeth in the student lending business. This is the company's original business, and it's done a good job. Despite being associated with a pain point for young borrowers such as student loans, SoFi has earned rave reviews for its customer experience. The company carries an NPS score of 90.
SoFi is building out a consumer-facing, full-stack financial services offering through its SoFi app. On the SoFi app, consumers can borrow, save, invest, deposit checks, send and receive money - all in one place. It also integrates financial education and other content to provide a consumer-friendly experience.
SoFi is positioned well for strong growth in the near term. The company has seen its member growth accelerate for the past seven quarters, and the ability to cross-sell across its platform should help further push revenue growth.
The Path To Profitability
Right now, SoFi's lending business is driving the vast majority of SoFi's business. In Q1 of 2021, the lending arm generated contribution profits of $87.6 million, while its technology platform (Galileo) generated $15.6 million. The financial services segment (the app) lost $35.5 million. Still, SoFi expects to break into profitability this year on an adjusted EBITDA basis.
SoFi expects margins to improve across the business as it scales larger and is pursuing a bank charter to improve its unit economics further. The company acquired a community bank as part of its application process to speed up the review process. If SoFi is awarded the charter, management expects material profit contribution as the company grows larger. The charter would enable SoFi to operate as a traditional bank does, its digital footprint would create a sizeable overhead advantage, as legacy banks have vast amounts of costs tied up in brick-and-mortar branches.
Galileo Is A Differentiator
SoFi's digital banking evolution makes it an intriguing player in the fintech space, but its 2020 acquisition of Galileo really is a differentiator from other fintech investments.
Galileo is a technology company that provides an API and payments platform so that technology companies can offer the banking services of traditional lenders from a digital footprint. It's essentially the infrastructure that powers fintech companies.
Some of Galileo's customers include Chime, Monzo, Robinhood, TransferWise, and others. The company had a total of 70 clients in Q1 and has rapidly grown over the past 24 months. SoFi's ownership of Galileo gives it "tollbooth" like exposure to many of its industry peers.
Looking At Valuation
SoFi is a former SPAC that went public after its formal merger with IPOE last month and has had a volatile existence to date. The stock currently trades in the middle of its 52-week range at just under $17 per share.
With analysts expecting SoFi's revenues to come in at $982 million in FY2021, the stock is trading at roughly 13.5X forward revenue. Valuations for fintech companies are all over the place, so it isn't easy to apply a firm lens on SoFi's valuation. For example, Square (SQ) trades at 5.4X but is a much larger company. PayPal (PYPL) is larger but trades at more than 13X. These companies all have differences in their business models, their growth rates, market cap, etc.
So here is where I stand with SoFi. If we look at the company's growth projections moving forward over a multi-year holding period, the company expects 30% or higher revenue growth through 2025. With SoFi expected to generate positive adjusted EBITDA this year, I think investors will do very well over a long-term holding period if SoFi executes what it's laid out to investors already.
Great opportunities can come from solving long-standing consumer problems in big markets. Fintech is a theme that will play out globally for many years to come, and digital banks pose a legitimate threat to legacy lenders. SoFi's diverse offering and the addition of Galileo make it a standout in the crowd, and if it's awarded a bank charter, I will become even more bullish.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of SOFI either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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