Summary
SoFi's Q2 earnings caused a surge in its stock price, leading to downgrades and upgrades from analysts.
CEO Anthony Noto and CFO Chris Lapointe emphasized the company's path to GAAP profitability by Q4 2023.
SoFi's membership and deposit growth exceeded expectations, demonstrating strong consumer demand for its financial products.
Rich Fury
Shares of SoFi Technologies $SoFi Technologies Inc.(SOFI)$ exploded after Q2 earnings, jumping over 20%, then a retracement occurred along with downgrades and upgrades. Keefe, Bryette & Woods downgraded SOFI to underperform, while Mizuho maintained its buy rating, and Truist Financial $Truist Financial Corp(TFC)$ increased its price target from $11 to $16. SOFI has been a battleground stock throughout the investment community, and the bears have not gone into hibernation, as the short interest remains above 15%. Despite irrefutable metrics, some refuse to acknowledge that SOFI is becoming the financial solution of tomorrow or that they have an underlying technology platform that their competitors lack. SOFI delivered a strong earnings report, and Mr. Noto delivered definitive comments at the end of the conference call, which defined his vision of SOFI's potential in the financial sector and as an investment. I believe SOFI will be an investment that retail got right while the large institutions are left having to upgrade SOFI and assign a larger multiple on its valuation and higher price targets to its shares in the future. While many could argue that the turning point for SOFI came in May, I would say Q2 earnings are the real turning point as SOFI has thrown down the gauntlet for the future.
Seeking Alpha
There were two critical words that the CEO and CFO used on the Q2 earnings call that should get bulls excited
There were many critical aspects to SOFI's financial results and underlying businesses in Q2, but on the earnings call, Anthony Noto (SOFI CEO) used the words by and in, while Chris Lapointe (SOFI CFO) used the word "in" when addressing GAAP profitability. If you haven't listened to the earnings call, I suggest you do, as their energy on the call was off the charts.
GAAP profitability has been a sticking point that some have called into question or used as part of the bear thesis. Noto and Lapointe stated that SOFI would be GAAP profitable starting in Q4 2023. The keywords are "in" and "by" along with the context they are used in. This is why earnings calls are critical to any due diligence when allocating capital toward an investment. There are pieces of information that you can't get from reading through the press release or 8-K filings.
I will start with Anothy Noto. Mr. Noto specifically said that SOFI remains on track to deliver GAAP profitability by Q4 during his remarks. He also made the statement again during the Q&A segment but used the word in, rather than by. Please see below for the two quotes:
We remain well on track for GAAP profitability by Q4.
In terms of profit trends, we're going to be front-loading marketing investments with sequential EBITDA expected to be marginally above where consensus is today for Q3 at $58 million. And we expect to see more of a ramp in Q4 EBITDA and achieve GAAP profitability in Q4.
Now, moving to Chris Lapointe. When Mr. Noto turned the call over to Mr. Lapointe, he made the statement that management's expectation is to reach GAAP profitability in Q4. At the end of his segment, prior to the Q&A, Mr. Lapointe also discussed stock-based compensation and the expectation of GAAP profitability in Q4. Please see below for his quotes:
Incremental GAAP net income margin was 36% for the quarter, which represents further progress toward our expectation of GAAP net income profitability in Q4 of 2023.
As we move toward expected GAAP net income profitability in the fourth quarter, we expect stock-based compensation and depreciation and amortization expenses to be slightly higher than reported Q2 levels in both the third quarter and fourth quarter of the year.
In my recent articles covering SOFI, I have discussed the road to profitability and how Mr. Noto indicated on the Q3 earnings call that SOFI would be GAAP profitable by Q4 2023. On the recent earnings call, both Noto and Lapointe were adamant about this accomplishment as it has been part of the bear thesis. The CEO and CFO have the best information about their company, and when they are both adamant about becoming GAAP profitable, I will put a stronger emphasis on that than comments from people who are bearish debating this achievement. For me, Noto and Lapointe have thrown down the gauntlet and put the entire financial industry on notice that SOFI is a force to be reckoned with. I have done an immense amount of research on SOFI, and I have always said that SOFI is a long-term investment for me, and I am looking at least 5-10 years forward. I can't time markets, but I have been very bullish on the way down and on the way back up. In my view, SOFI still has the potential to deliver some of the largest returns from any position I am invested in, and I can't wait for the story to unfold.
Seeking Alpha
Mr. Noto clears the air on what his interpretation of a top-10 financial institution is and where he feels SOFI is headed
If you have read my previous articles on SOFI or listened to their earnings calls, then you are familiar with Mr. Noto indicating that SOFI will become a top-10 financial institution. Previously, he hadn't clarified if he meant by total assets, deposits, equity, or market cap. That changed on July 31 as Reggie Smith from J.P. Morgan $JPMorgan Chase(JPM)$ directly asked Mr. Noto to define being a top-10 bank. Mr. Noto replied that top-10 is a top-10 financial institution by market cap. Please see below for Mr. Noto's quote:
"Sure. Top 10, its top 10 financial institution, and it's measured by market cap."
This is where things get interesting. Time and time again, Mr. Noto has discussed being a top-10 financial institution. Since SOFI has a national bank charter, some automatically associate this statement with being one of the largest banks. There are eight types of financial institutions that provide various services, from insurance to investments. The major categories include central banks, retail and commercial banks, credit unions, savings and loan associations, brokerage firms, investment banks, insurance companies, and mortgage companies.
On Seeking Alpha, I ran a screen and looked at the largest financial institutions, then sorted them by market cap. If Mr. Noto is correct and SOFI becomes a top-10 financial institution, SOFI would need to see its market cap grow by roughly $124 billion as it would need to exceed the Royal Bank of Canada $Royal Bank of Canada(RY)$ at $134.32 billion. That would be 13x SOFI's current market cap of $9.57 billion. To get into the top 10, SOFI needs to get into the top 20 first. The 20th largest financial institution is Mitsubishi UFL Financial Group $Mitsubishi UFJ(MUFG)$, with a market cap of $94.33 billion. For SOFI to crack the top 20, its market cap would need to increase by 8.86x. If SOFI isn't acquired, I believe it will become a top-10 financial institution over the next decade. If Mr. Noto pulls this off, shareholders will be handsomely rewarded.
Seeking Alpha
SOFI's Member and Deposit growth continues to exceed expectations
The opinions that matter most are the ones of SOFI's end users. In business, the consumer votes with their wallet, and if a company brings value to an industry through its products or services, it will be rewarded financially. I am extremely bullish on SOFI for many reasons, but the strongest reason is that SOFI's membership is speaking loud and clear with their wallets. The bottom line is that if SOFI didn't provide value to an individual's life, they wouldn't use the platform. SOFI is growing its deposits, its member base, and the amount of products used.
Seeking Alpha, Steven Fiorillo
I track large financial centers, regional and other bank inflows, and outflows. SOFI had another strong quarter in the face of the regional banking crisis, adding $2.65 billion in deposits. From a percentage basis, SOFI grew its deposit base by 26.28% QoQ which was the largest amount from the banks I track, and on a dollar basis, they took in the 11th largest amount from the 24 banks I track.
Steven Fiorillo, SOFI
Since becoming a nationally chartered bank, SOFI has seen exponential growth in deposits. More than 90% of SOFI's deposits are from direct deposits, which are extremely sticky, and almost 98% of its deposits are insured. People are showing the market that SOFI is relevant because they are entrusting the platform with money. If SOFI wasn't providing a positive experience, we wouldn't see the trajectory in deposits or member growth that is being displayed.
SOFI's membership continues to grow rapidly. SOFI just delivered its largest quarter of member growth on a number basis, adding 584,000 members. This is a 44% increase QoQ. SOFI finished Q2 exceeding six million members, and they have put themselves in a position to exceed 10 million by the end of 2024. If Q2 2022 doesn't become an anomaly on member growth, and SOFI adds 584,000 members from Q3 2023–Q4 2024, they will end 2024 with 9.72 million members. If 584,000 becomes the new floor for quarterly member growth and we see an acceleration, 10 million members is achievable by the end of 2024. I am not saying this will definitely occur, but SOFI has put themselves in a position for this to be a possibility.
SOFI
Many people look at deposits and member growth and stop there. I go a step further and look at how the average member deposit is performing. In addition to membership and deposit growth, SOFI's average member deposit has grown also. The average deposit each member has at SOFI has grown to $2,041.68. This is a 14.47% QoQ growth rate and a YoY growth rate of 225.11%.
Steven Fiorillo, SOFI
SOFI's members are sending a clear message, and it doesn't stop at deposits and member growth. SOFI's flywheel is very strong. The average SOFI member is now using 1.51 products, with 24.10% of its membership using SOFI's lending services, and each member is using 1.26 financial service products. SOFI's ecosystem is very sticky, and we are seeing it in the utilization numbers. People aren't just moving their money to SOFI, they are embracing the ecosystem for their financial needs, which gives SOFI a head start for being the financial institution of choice for their future financial needs.
SOFI
The lending segment continues to flourish and SOFI made a huge statement in Q2
In Q1 2023, there was speculation that SOFI didn't sell loans because there wasn't a market for them. Mr. Noto and Lapointe have both discussed that their job is to maximize the return on equity (ROE) generated from the loan segment, and if they can hold loans at a 6% yield vs. selling at a 4% yield, the shareholders are best served by holding the loans and generating an additional 2% spread. Bears continued to attack this methodology, and in Q2, the bear case has been shattered.
In Q1, SOFI had a charge-off rate of 2.97% and built a 4.5% loss rate into its model to account for losses in the economy. Due to SOFI's selective process and rejecting 70% of loan applicants, their charge-off rate decreased in Q2 to 2.94%. In addition to the charge-off rate declining, SOFI started selling loans in a market that the bears questioned. In Q2, SOFI sold portions of its personal, student, and home loan portfolios. SOFI executed a sale at 104.1% excluding hedges and 104.5% including hedges in personal loans. In the student loan segment, SOFI executed sales at 101.5% excluding hedges, and over 104% including hedges. Their home loans were sold at 101.2% excluding hedges and above 102% when hedges are included.
All aspects of the bear case regarding SOFI's lending segment have been dismantled by SOFI's execution. The speculation that defaults and bankruptcy would impact SOFI's loans in a rising rate environment continues to be disproven due to the quality of the borrower. SOFI's personal loan borrowers have an average weighted income of $164,000 and a FICO score of 768. In addition to these metrics, SOFI underwrites to 680 FICO score and above, but they don't provide approval solely based on a 680 FICO score. SOFI underwrites the cash flow. Anyone who falls below a 680 FICO score automatically gets denied. For anyone above a 680 FICO score, SOFI accounts for their current cash-to-debt ratio and makes a final determination based on their strict internal model. SOFI declines roughly 70% of people who apply for personal loans. The bottom line is that SOFI's on-balance sheet 90-day personal loan delinquency rate was 40 basis points in Q2 2023, while their annualized personal loan charge-off rate decreased QoQ to 2.94%. The lending business is healthy, and its metrics fall well within SOFI's acceptable losses.
Steven Fiorillo, SOFI
SOFI continued to grow its loan originations and came in with record quarterly originations over $4 billion. Personal loan originations continue to flourish, and this doesn't account for new student loan originations SOFI will start to see in Q3. The St. Louis Fed indicates that rates will decline to 4.6% in 2024 and 3.4% in 2025. I am expecting 2024 to be a very good year on the origination front because student loans will be back in full swing, and interest rates are projected to decline, which should cause a resurgence in mortgage lending.
St Louis Fed
SOFI is not a one-trick pony, management continues to deliver for shareholders
SOFI has been synonymous with student loans, but it's truly a diversified financial institution. This management team deserves tremendous credit because they have accomplished something that few management teams could deliver. Student loans were SOFI's bread and butter pre-pandemic, and without time to prepare, the moratorium was put into effect. For anyone who has run or operated a business, imagine your largest revenue generator and profit center was slashed in half without time to prepare. It's been over three years, and the moratorium is about to be lifted. Given these circumstances, not many management teams could look adversity in the eye and prevail.
Anthony Noto is a West Point graduate, an Army Ranger (thank you for your service), an ex-Goldman investment banker, and has held C-level positions at the NFL and Twitter prior to becoming the CEO of SOFI. If you don't believe he had an outline of critical success factors to deliver and contingency plans for disastrous scenarios, your mistaken, and the numbers prove it. Its almost as if he has been training for this scenario for his whole life. From the beginning, he understood that to get SOFI to become a top-10 financial institution, the business needed to transcend student loans, and the SOFI team would need to deliver on many critical success factors.
Below is a chart I created outlining the revenue generated from each business segment from Q1 2019 – Q2 2023. Going into the pandemic, in Q1 of 2020, lending represented 96.29% of SOFI's revenue, and it was about to be impacted by student loans. Mr. Noto has grown the loan book by diversifying into personal loans and mortgages, but more importantly, he diversified SOFI's revenue base outside of lending. In Q1 2020, technology and financial services generated $3.15 million of revenue, accounting for less than 4% of the quarterly revenue. Since Q1 of 2020, quarterly revenue from lending has grown by $240.48 million (294.15%), but it now represents 63.44% of the net quarterly revenue compared to 96.29%. In Q2 2023, the combined quarterly revenue from technology and financial services grew by $152.69 million or 4,846%, representing 36.56% of the total quarterly revenue.
Steven Fiorillo, SOFI
The AWS of Fintech is happening
Contrary to what some of the readers in my last article believe, SOFI is delivering the AWS of Fintech. The combination of SOFI's bank charter, Galileo, and Technisys puts SOFI in a position to offer a full product suite for financial businesses to build out a robust product stack utilizing every component of SOFI as a service platform. Galileo was acquired so SOFI could replicate the end-to-end integration they created in lending with their checking and savings business. The Cyberbank platform from Technisys is cloud-native and supports the integration of third-party technologies via the Technisys marketplace. Acquiring Technisys allows Galileo and Technisys to create synergies throughout their infrastructures and build cloud-native architecture on a single core that supports multiple financial products and innovate at a moment's notice.
While some believe other financial institutions have this capability, they don't. JPMorgan (JPM) is a prime example as they recently announced they are deploying cloud-based core systems for its retail banking utilizing software developed by Thought Machine. Eventually, every multi-product financial services company will need to transition off outdated systems to cloud-native multi-product cores. SOFI owns the entire backend, from the cyberbank platform to digital solutions ranging from B2B payments to virtual card issuing. From 2023–2025 SOFI will generate $75-$85 million in cumulative cost savings by transitioning SOFI's checking, savings, and credit card to the Technisys technology stack, then generate roughly $60-$70 million of cost savings on an annual basis. In addition to the internal efficiencies and savings, SOFI can white label the technology stack for other financial institutions and generate on-going reoccurring revenue.
In Q2, we received confirmation that these aren't talking points, the AWS of fintech is a reality. Galileo signed five new clients and grew the pipeline of joint opportunities by selling combined Galileo and Technisys offerings to an expanded customer base. Technisys continued delivering as it brought four clients live within the quarter. Mr. Noto was asked by Timothy Chiodo of Credit Suisse about the new client wins on the Galileo side. Mr. Noto disclosed that SOFI has been selected to compete in a number of requests for proposals ((RFPs)) from large institutions. This is critical because there is a possibility these institutions are under pressure from regulators to upgrade their technology and that there is also a need to modernize their technology to stay relevant as consumer requirements change. Companies do not waste their time and internal resources going through an RFP process if they're not committed to making a selection and going through an implementation. SOFI is in a prime position to grab a significant amount of customers over the next several years and generate reoccurring revenue from their competitors by powering their backends. If this plays out, SOFI should be viewed as a hybrid company and be given a valuation that falls somewhere between a financial institution and a technology company.
SOFI
SOFI still has untapped potential to grow all while driving top and bottom-line metrics
I believe SOFI has the potential to become a top-10 financial institution over the next decade. SOFI is run by a relentless management team that continues to deliver on its product differentiators and critical success factors. SOFI just provided its second upwardly revised guidance for 2023 with improved margins, and the expectation of ending Q4 in a GAAP profitable position. SOFI is still in its infancy, and I feel that we are watching the next large financial institution coming into its own.
SOFI has a history of underpromising and overdelivering, and I wouldn't be surprised if we see another upward revision going into Q4. SOFI is also nowhere close to finished, and there are more critical success factors to deliver that can drive top and bottom-line growth. SOFI can build out a business banking segment to take deposits, run payroll, issue corporate credit cards, issue corporate purchase cards, and provide business loans through a new lending segment. SOFI can also grow its investment platform and utilize the exposure Liz Young gets every time she appears on CNBC, The Compound and Friends, or on one of the Risk Reversal Media shows. SOFI has an array of ETFs and can grow this product suite to generate additional asset management fees. SOFI can also grow out a wealth management division in addition to becoming a retirement plan sponsor and generating revenue from asset under management (AUM) fees. The party is just getting started, and after SOFI becomes profitable, they will likely continue to establish their presence in other areas and chip away at the legacy banking sector dominance.
SOFI
Conclusion
I am very bullish on SOFI, and I am looking at this investment from a 5–10-year time horizon. The analyst community is really starting to understand the value proposition, and those that continue to stay bearish will likely be proven wrong. SOFI is starting to get upgrades with a $16 price target from Truist. If SOFI does what Mr. Noto says it will do, this investment will be at least 13x the current valuation based on current market caps in the financial institution. In a previous article, I went on record and said SOFI would hit at least $10 in 2023, and that was achieved. I am going to make two new predictions. I believe that SOFI will hit at least $15 per share by the end of 2023, and all-time highs will be reached sometime in 2024. I could be incorrect, but all the data points to SOFI continuing to expand its brand. The AWS of fintech could be an opportunity that delivers reoccurring revenue by powering the backend for its competitors and leads to a tech valuation. From a long-term perspective, SOFI is one of the most exciting companies I follow, and I think Anothy Noto and his team will deliver for shareholders.
Source: Seeking Alpha
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