2023-10-30 16:15:51 ET
Summary
- Despite reporting a significant double beat for Q3 2023, SoFi's beaten-down stock failed to hold onto a 15% pop from earlier this morning.
- In this note, we shall break down SoFi's Q3 2023 report, and re-evaluate its fair value and projected returns.
- Given the attractive long-term risk/reward on offer, I continue to rate SoFi stock a "Strong Buy" at $6.78 per share.
Introduction
On the back of reporting yet another blowout quarter, SoFi Technologies, Inc. ( SOFI ) stock popped ~15% in early trading this morning; however, investors have faded this bounce quickly, with the stock down -1% as of writing.
In this note, we will discuss SoFi's Q3 2023 earnings report. Furthermore, I will provide my fair value estimate and expected return (5-yr CAGR) for SoFi using TQI's Valuation Model.
Analyzing SoFi's Q3 2023 Report
On October 30, 2023, SoFi released terrific numbers for Q3:
- Adj. net GAAP revenues of $531M (up 27% y/y) [vs. est. $512M]
- Adj. EBITDA of $98M (up 123% y/y) [EBITDA margin: 18%]
- Diluted non-GAAP EPS -0.03 [vs. est. -0.09] ( excluding a goodwill impairment charge of $247M )
- Members: 6.957M [up 47% y/y, 717K added in Q3 2023]
And this robust quarterly performance was driven by broad strength across all three of its business segments - Lending (Personal, Student, Home), Technology Platform, and Financial Services.
In the face of macro pressures, SoFi's lending business remains resilient [adj. revenue: $342.5M (up 15% y/y), total originations up +48% y/y] and continues to serve as the primary profit center at SoFi for the time being. Within lending, Personal Loan originations grew +38% y/y to $3.89B on the back of strong demand, whereas Student Loan originations rebounded +101% y/y to $0.92B in Q3 2023. With the end of the student loan moratorium in October 2023, SoFi's core student loan refinancing business is likely to continue expanding at a rapid clip in Q4-2023 and 2024.
While SoFi is still primarily a lending business, the revenue mix is quickly shifting towards its faster-growing, higher steady-state margin, less capital-intensive businesses, especially, the Financial Services segment.
The structural driver behind SoFi's strength (versus fintech peers) is its national bank charter, which has allowed the fintech company to raise deposits at low(er) interest rates [reducing capital costs for its lending activity]. As of Q3 2023, SoFi's deposit base stands at $15.7B, and with 90% of SoFi Money deposits coming from direct deposits, SoFi's deposit franchise looks highly attractive. As we know, this deposit capital has been providing SoFi the impetus for growth in its lending business plus added flexibility for holding loans on its balance sheet for a longer duration (as necessitated by a freeze-up in credit markets due to rapid changes in interest rates).
During the Q3 earnings call, SoFi's management outlined future lending growth as additive in nature and projected the Technology Platform and Financial services segments as the future growth drivers of SoFi:
The one thing I will say as we look into 2024, to reiterate what I said earlier, 67% of the growth in absolute dollars in revenue year-over-year were from non-lending businesses. As you go into 2024, you should assume that personal loans and student loans will be additive to growth, not the drivers of growth. Our Technology Platform business and our Financial Services segment business will be the drivers of growth, and we'll supplement that on the lending side.
- Anthony Noto, SoFi CEO
Interestingly, SoFi's Financial Services segment delivered a first-ever positive contribution profit in Q3, and in my view, this business is going to be SoFi's primary profit center in the long run. Given that cross-selling financial products and services is the crux of our investment thesis for SoFi, I am pleased with the progress SoFi is making in this area of its business. If you are interested in reading my investment thesis for SoFi, please feel free to read this note:
While SoFi's Financial Services segment is firing on all cylinders, the Technology Platform business still looks like a weak link in the story given its lukewarm revenue growth numbers.
However, I think management's strategy to focus on large, durable clients is starting to pay off, with a big uptick in client accounts and significant improvements in contribution margins in Q3 2023. Furthermore, Anthony Noto sounded very bullish on the prospects of this business on the earnings call:
In Q3, Tech Platform made significant strides against this strategy with the majority of new signed clients bringing existing customer bases and portfolios, which drives much faster time to revenue generation compared to a startup, along with a growing pipeline of joint opportunities selling combined Galileo and Technisys offerings into an expanded customer base. The demand from traditional financial institutions and new categories is the most robust that we've seen. While the lead times for winning RFPs and ensuing integrations are long, measured in many quarters, not months, their transition to modern processing and modern cores is playing out in real time the way we envisioned it would.
For FY-2023, SoFi increased its revenue guidance from $1.974-$2.034B to $2.045-$2.065B and lifted the adj. EBITDA guide from $333-$343M to $386-$396M [19% adj. EBITDA margin]. At the midpoint of these guidance ranges, SoFi is projected to deliver revenue of $575M (up +29.79% y/y) and adj. EBITDA of $140M (up +100% y/y).
Amid the Fed's aggressive rate hiking campaign, credit markets froze in 2022, and are only starting to open up as the rate hike cycle reaches its conclusion. During this period, SoFi's rapid deposit growth allowed it to expand loan origination activity and retain almost all of its originated loans on the balance sheet. As of Q3, SoFi's lending growth has been driven solely by its deposit growth and robust balance sheet.
While strict credit standards at SoFi (very high FICO scores and annual incomes) have ensured that the default (delinquency) rates remain low [still below pre-pandemic levels], a slowdown in deposit growth rates has naturally increased the fears of an impending slowdown in SoFi's lending business.
To alleviate deep reliance on deposit growth, SoFi's management is finally making some balance sheet moves - selling $475M in loans during Q4 [already sold $100M at 105.1% (on an unhedged basis) and there's an agreement with Blackrock to sell another $375M of Personal Loans by mid-November ], with an additional $2B funding secured via a forward flow agreement.
In my view, securitizing loans in such a fashion will help SoFi unlock future growth in its lending business and reduce balance sheet risk to an extent. On a positive note, the credit markets seem to be opening up, and I can see a re-acceleration in SoFi's non-interest lending revenues in upcoming quarters.
Given current guidance, SoFi is set to exit this year with a growth rate of around 28-32%. And as long as the macroeconomic environment doesn't worsen drastically, I think SoFi should be able to continue growing at a similar rate in 2024. As per SoFi's management, the company is all set to turn GAAP profitable next quarter and remain profitable beyond that point.
Now, let's re-run SoFi through TQI's Valuation Model to determine its fair value and expected returns.
SoFi's Fair Value And Expected Return
Using conservative assumptions for future revenue growth and steady-state margins, SoFi is worth $13.85 per share, i.e., ~104% higher than the current market price of $6.78 per share. Here's my valuation model for SoFi:
According to TQI's valuation model, SoFi's stock could be trading at ~$22 per share five years from now, implying a 5-year CAGR return of 26% from current levels. Since these projected returns are well above our investment hurdle rate of 20% for high-growth stocks, SoFi is a "Strong Buy" at $6.78.
Final Thoughts
Social Finance [SoFi] is an emerging force in the banking & financial services industry and has been an outlier in an ailing financial services sector throughout 2023. In a challenging macroeconomic environment for financial institutions, SoFi continues to deliver rapid member and product-driven growth at the expense of traditional/legacy banks, proving itself to be a secular growth story.
Overall, SoFi continues to execute at a high level across all of its business segments as evidenced by its robust Q3 earnings report. The early morning bounce in SoFi was faded by market participants (not the first time we have seen such price action in SoFi stock), but I think this sell-off is good news for long-term investors.
With a fair value of $13.85 per share, SoFi is offering an attractive entry point for long-term investors willing to accept short-term volatility for exceptional long-term returns. Personally, I like the idea of using a 6-12 month DCA plan to build any fresh long-term positions in SoFi. At my investing group, we already own SoFi, and in light of this incredible Q3 showing, we will continue to accumulate more shares in this company over the coming weeks and months within TQI's Moonshot Growth Portfolio.
Key Takeaway: SoFi is a "Strong Buy" at $6.78 per share
As always, thank you for reading, and happy investing. Please feel free to share any questions, concerns, or thoughts in the comments section below.
For further details see:
SoFi Stock Pops Then Drops As Investors Digest Q3 Earnings Report