To The Moon

The deal is expensive but is expected to significantly grow revenue in SoFi's tech division in future years.

The one-stop-shop financial services company SoFi$SoFi Technologies Inc.(SOFI)$ made a splash coming back from the holiday weekend by announcing that it had agreed to acquire the core processing company Technisys in an all-stock deal valued at $1.1 billion. Core processing systems are the back-end infrastructure that enables banks to carry out a broad array of their daily operations, such as managing deposits, loans, and other types of transactions. Not only does the price amount to roughly 13% of SoFi's current market cap, but it rivals its previous acquisition of Galileo, which SoFi $1.2 billion. Galileo has been a big selling point among investors. Will SoFi's acquisition of Technisys prove to be the same?

The "AWS of Fintech"

When many people see SoFi, they see a digital banking app that offers different kinds of lending and depository products and investing capabilities all packed into one. But SoFi also has a technology platform division, which houses Galileo. Galileo looks a lot different from SoFi's other offerings. The company provides back-end infrastructure that powers the operations of many fintech companies and neobanks. Specifically, Galileo helps give fintechs -- many of which don't have bank charters and primarily work on the front-end user experience -- the ability to process payments like those for debit card transactions and traditional direct ACH transactions.

Technisys should complement Galileo. A good way to think about Galileo and Technisys is that they both provide the plumbing needed to power the banking system. Technisys, however, is really a next-generation banking system. It's hard to believe, but many banks today use legacy data processing technology that could have been developed as early as the 1970s. This can limit a bank's ability to innovate as much or quickly as it might like.

For instance, many banks need an individual core system for different products, like deposits or lending. Technisys can support multiple products all on one core system, and it can run in the cloud, which allows banks to process and analyze data in real time. Furthermore, Technisys systems emphasize application programming interfaces (APIs), which essentially connect different kinds of software to one another in a more seamless manner. With better API capabilities, banks can roll out digital banking products much quicker.

Pairing Galileo with Technisys could create a very strong combination and help SoFi on its mission of becoming the Amazon$Amazon.com(AMZN)$ Web Services of fintech, in which it could provide all of the plumbing necessary to meet any of the needs of a fintech company or bank. One synergy pointed out by SoFi Chief Executive Officer Anthony Noto on a conference call is that SoFi can cross-sell Technisys products to Galileo's 100-plus partners and vice versa with Galileo to Technisys' 60-plus customers. Noto explained that there is good reason to believe that these partners would support one another because both are focused on back-end infrastructure:

In evaluating SoFi's needs, we concluded that many Galileo partners would also need an extensible, customizable multi-core product. The vast majority of Galileo's existing partners want to offer lending, credit cards, rewards and many other products but they can't extend their current core. Building separate cores for new products risk the same siloed issues we see in legacy banks and architecturally would be a step backwards.

Noto also said Galileo plans to build new capabilities on top of Technisys, such as secured and unsecured credit cards, rewards programs, and buy-now-pay-later capabilities. The combination of Galileo and Technisys should be attractive for banks and fintech companies because they potentially can get all of their core and payment-processing systems from a single vendor.

The complexities of the core processing industry

With the decision to purchase Technisys, it would appear that SoFi is getting into the core processing space. In 2020, Galileo CEO Clay Wilkes said Galileo powers 95% of digital banking transactions in North America and that 70 of the top 100 fintech companies were clients, so SoFi seems well positioned to provide back-end infrastructure to fintechs. But now, it looks like the company will expand beyond the fintech frontier.

The core processing industry is funny because despite all of the complaints about the legacy companies over the years, the same handful of them, including Fiserv, FIS, and Jack Henry, control about 80% or more of the global market share.

Core processing is a tough business with lots of barriers to entry. Pitching core systems to banks is a long sales cycle and results in long-term contracts. And the task of switching core systems is onerous, largely because banks need to navigate the transition while not disrupting daily operations too much. However, Noto said every company is in a different situation when it comes to its core systems -- some want a new one just for new customers, while others will transition existing customers over to a new core.

Beyond the difficulty of entry, the biggest player in it, Fiserv, recently announced that it plans to acquire Finxact, another innovative cloud-based core processing company. While I don't know all the details, Finxact likely offers many of the same capabilities as Technisys.

Will the acquisition pay off?

Looking at the financials, SoFi is paying $1.1 billion in stock, which will dilute shareholders. SoFi expects the acquisition to generate between $500 million and $800 million of additional revenue by the end of 2025, the majority of which management is expecting to come from selling Technisys services to traditional banks. In the 12 months ended Sept. 31, 2021, Galileo generated about $178 million in revenue, so the addition of Technisys will substantially increase the contribution of SoFi's tech segment to the bottom line.

Furthermore, SoFi expects to move its SoFi checking and savings account products as well as its credit card product to the Technisys and Galileo platforms over the next two to four years. Putting multiple products onto one core system and integrating Technisys with Galileo will result in about $80 million of cost savings between 2023 and 2025 and about $65 million of annual savings afterward. So, overall it looks like the deal could increase revenue substantially.

However, it's not like SoFi had to buy Galileo and Technisys to use their products. I never really envisioned a financial company doing both bank plumbing and consumer banking, but they do complement each other in some ways. With Technisys and Galileo in-house, SoFi will have control over what kinds of new products are made and then could roll them out to its members before any of its bank or fintech clients. Having an active consumer base will also give SoFi better insight into product improvements and may serve as a place to test them out. Plus, the tech component and associated revenue streams offer revenue diversity that few of SoFi's competitors will have.

While the core processing market is highly competitive, SoFi will have an innovative tech lineup as well as a very solid base of clients to sell to, so I think there is a good chance the company will have a product that many banks and fintechs desire. Ultimately, I feel fairly optimistic about the acquisition.