MQ - SoFi Technologies Heavily Undervalued According To Our Model

Summary

• SoFi Technologies came off a hot quarterly earnings call, with the stock gaining +15% since reporting earnings.
• We project SOFI revenue of $1.972 billion and adj. dil. EPS of -$0.09 for FY '23. This compares to consensus estimates of $1.97 billion and adj. dil. EPS of -$0.26.
• The SoFi financial services segment represents 10% of the company’s total revenue and is the fastest-growing segment in the business. It’s not profitable, with -$199 million cost headwind.
• SoFi is undervalued and could appreciate by +70% on the basis of a 45x earnings multiple, 24x EV/EBITDA multiple, and 6x sales multiple to FY '25 results.
• We offer a strong buy recommendation on SOFI and offer a price target of $12, which implies considerable upside from where it's trading currently.

SoFi Technologies, Inc. ( SOFI ) came off a hot quarterly earnings call , with the stock gaining +10% on the Monday session following the announcement of Q4 earnings . While the numbers were phenomenal, we wanted to differentiate ourselves by discussing the quarterly earnings from the context of fundamental drivers, and the strength in its consumer lending segment. We also embed the outlook figures to our financial model.

Throughout the course of the year, we traded SoFi stock and found ourselves confused by the divergence in the stock price and the performance of the business. We think the company has started to find some really solid footing and is in a position to communicate a profit inflection point that's digestible and easier to understand. As a consequence, we can provide a financial model that better captures the underlying investment thesis we've been trying to follow for the past year.

We anticipate that given management outlook and growth drivers, and upon combining those figures into our financial estimate, we project revenue of $1.972 billion and adj. dil. EPS of -$0.09 for FY '23. This compares to consensus estimates of $1.97 billion and adj. Dil. EPS of -$0.26. We believe our estimate most closely conforms with management guidance on expenses, and it's why we're a bit more optimistic than consensus analysts. We value SOFI stock at 21x FY'25 forward earnings per share and arrive at a $12 price target by leveraging a blend of sales, EBITDA, and earnings. We anticipate SOFI to appreciate by 70%+ this year, assuming the company continues its pattern of beating and raising estimates.

Risks to our thesis: SOFI is interest rate sensitive and assuming they hedge interest rate risk incorrectly or carry originated loans for longer as interest rates trend higher, the firm could experience some markdown value adjustment risk. These risks were largely disregarded or weren't mentioned on the quarterly earnings call, though the management team suggested a different scenario. If interest rates go up, they'll launch a commercial lending business and build a portfolio on the back of businesses paying loans with higher interest rates. So, if interest rates keep trending higher, they're going to start lending to SMBs in a bid to generate more cross-sales per registered member on SoFi and generate even better net interest margins or NIMs.

Key drivers to our SoFi investment thesis

1) Expansion of financial products and great net interest margin metrics implies revenue growth on the basis of higher margin loans, and also expansion of financial products.

2) Differentiated financial apps with user-friendly tools that appeal to millennials who prefer robo-advisors and digital banking such as SOFI, Chime, among others.

3) Interest rates remain high leading to sustained net interest margin expansion though if rates get too high in this cycle the recessionary risk could put some pressure on the credit portfolio.

4) Expansion into commercial lending and financial products creates bias for an all-in-one bank that's mobile and very intuitive to early adopters.

5) Deposit growth and total client deposits have been trending considerably higher, and we argue that the metrics are some of the best in the Fintech space.

SoFi Technologies differentiated FinTech

We anticipate that SoFi Technologies, Inc. stock can continue to appreciate in value, though the difficulty of understanding the business may have made it difficult for markets to latch onto something tangible. We believe the stock is heavily undervalued, and the value of its product offering isn't well understood outside its core customers. Conventional consumer clients looking for a combination of financial tools, and support, basically robo-advisory and access to financial management tools, should find SoFi to be a great mobile banking app.

The company also offers its users financial brokerage products like cryptocurrency, stocks, options, and ETFs. We find the efforts to be a great consumer bank first where it prioritizes a great consumer banking experience to be the key differentiating factor followed by the launch of investment products, which could take share away from rivals in the space.

SoFi Technologies, Inc. has uncovered a humongous niche in banking, and as a consequence, the banks may feel more threatened by a robo-bank, that's mostly a mobile-centric bank app that seems to work just like a bank but without human touch. As a consequence, SoFi's main value proposition is its mobile app, in which various banks have bigger balance sheets, better financial metrics, but provide worse banking apps for customers and offer very few services that help with the management of saving and investing money, which is where SoFi steps in.

Understanding the drivers to the business

When SoFi Technologies, Inc. refers to business results on the quarter, or its differentiated financial metrics, the company refers to total products, and also the number of members on its platform. Those two metrics paired with the expansion in net interest revenue tied to interest rate spreads is what has helped bolster the firm's financial results.

We anticipate that, given the heightened interest rates in this environment, that SoFi's various credit-bearing accounts will perform better depending on origination date. Furthermore, the company refers to SoFi product growth on the earnings call repeatedly, where the number of SoFi products grew to 7.9 million representing 59% y/y growth versus the prior year.

Well, to understand those metrics, we refer to SoFi accounting notes:

"If a member has multiple loan products of the same loan product type, such as two personal loans, that is counted as a single product. However, if a member has multiple loan products across loan product types, such as one personal loan and one home loan, that is counted as two products."

Basically, what this metric tries to capture is the total number of originated financial products that got sold in the reporting period. If a single member were to use multiple SoFi products, the total number of loan products sold that still remain on SoFi's books tends to remain on SoFi's books for a certain period of time, roughly 9 months. Typically, SoFi's loan origination segment comprises 70% of the company's revenue where SOFI typically carries its debt portfolio of originated loans before selling the loan to a broader basket aggregator of mortgage loans, i.e., where mortgages become securitized into mortgage-backed securities or MBS. We think the performance of this segment hinges on its ability to hedge interest rate risk in the short-term, and earn some appreciation on the mortgage loans it originates.

20% of revenue, tied to its technology platform, makes it competitive with legacy card issuers and Marqeta ( MQ ). We think the technology revenues from providing its tech platform compete with legacy payment card issuers like Fiserv ( FISV ) and others. Galileo and Technisys platform is how the company defines its platform revenue, which grew sales by +61% in Q4 '22.

Figure 1. Segment breakdown (simplified)

Financial Services, net revenue of $65 million increased 195% year-over-year, with new all-time high revenue for SoFi Money and continued strong contributions from SoFi Credit Card, SoFi Invest, and Lending as a service.

The SoFi financial services segment represents 10% of the company's total revenue and is the fastest-growing segment in the business. It's not profitable, with -$199 million cost headwind, though we think there's meaningful upside to top-line growth tied primarily to credit cards, private loans, stock and options brokerage, along with cryptocurrency exchange.

Given all these new product initiatives and introduction, we anticipate that SoFi Technologies, Inc. will report a financial loss in FY '23 though to a very limited extent, and that the adjusted. EBITDA figure will deliver above the management outlook range on better than expected sales growth and margin/profit contribution from its core business segments.

What's a fair value estimate for SoFi Technologies?

Based on our methodology we think SoFi's undervalued and could appreciate by +70% on the basis of a 45x earnings multiple, 24x EV/EBITDA multiple, and 6x Sales multiple to FY '25 results. We anticipate that the blend of these multiples translates to an average value of $15 per share, which we discount using the firm's discount rate of 8.4% to arrive at a $12 price target.

Figure 2. SoFi Technologies Financial Model

We anticipate that the financial services segment will continue to drive growth off of a large base of users, which is why we embed more aggressive revenue estimates throughout the model. Assuming SoFi Technologies, Inc. gets the benefit of added deposits and interest income from carrying higher balances tied to brokerage accounts and introduces higher commission trades like margin trading, SoFi Technologies Financial Services business could really take off.

We also notice that Sofi Technologies is competing for private loans, which is most similar to the market addressed by LendingClub Corporation ( LC ). We think the emphasis on new financial products and on-going organic growth tied to its core lending business keeps us optimistic. Basically, there's a lot to like with Sofi Technologies, which is why we think the stock should be intrinsically valued higher, as we anticipate long-term adjusted profit margins to be stable at 20%.

Also, SOFI's large user/member base of 5.2 million active users could grow over time, as the banking sector is heavily fragmented. Mobile banking is the key differentiating factor between banking apps, and because SoFi offers so many services and robo-advisory features from budgeting to managing credit cards, to handling student loan debt, and even buying stocks and cryptocurrencies we find ourselves exasperated by the inclusion of technology platform fees and payment network fees. The company is pursuing so many market opportunities concurrently while maintaining cost discipline, which is why we like the stock a lot in the FinTech space.

Why SoFi should be in your portfolio

SoFi Technologies, Inc. positions shareholders in front of so many opportunities that it's worth considering the upside of those businesses in isolation. But, why own businesses in finance that aren't innovating, aren't re-deploying capital on Fintech infrastructure? Some of these businesses could be around for a number of years, but they certainly don't resemble the future all that well.

It's why, even if SoFi Technologies, Inc. is a difficult business to understand and follow along with, we find the promised growth and prospective margin expansion tied to all of its business units more compelling. We think banking + user growth and decoupling from conventional banking services is bound to continue, which SoFi Technologies will be the beneficiary of.

However, the key is knowing what that's worth? And based on the long-term profitability of similar businesses with similar units, and management outlook, we arrive at a profit forecast based on industry margins and discount those estimates to arrive at a fair intrinsic value estimate of $12 per share. We think the stock could meet this price target assuming they continue to deliver above quarterly estimates, making this a stock worth accumulating on sustained growth/momentum when compared to other fintech names in the space.

Furthermore, we like the underlying business itself. They're innovating, and they're pursuing a lot of categories at the same time while improving cost structure. Many fintech names have ignored cost in favor of sales growth. This is how SoFi Technologies, Inc. sort of differentiates itself as it's bound to grow really quickly while illustrating cost improvement over time. We've seen the opposite happen for a number of other financial sector stocks, and it's why we recommend SOFI to our readers.

Unlike other companies that burn capital through difficult business environments, the company is actually poised to improve on profits while driving mobile banking to new limits with the adoption of cryptocurrencies, and various other payment transfer technologies. As a consequence, SOFI becomes both profitable and even more innovative, which is why investing into SOFI while it's a smaller company makes sense, and it's why we recommend SoFi Technologies, Inc. stock at a strong buy.

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