SoFi the SPACED Fintech (analysis)

With the ticker IPOE, Social Capital SPAC announced they reached a deal to SPAC the fintech company SoFi. 

Overview

SoFi is a fintech company comprised of 3 different business segments. 

The first one is the Lending business. SoFi basically offers loans like Student loans, Personal loans, Home loans, etc. Its differentiator in the loan business is that they do not assess creditworthiness by the classic financial parameters but also take into account the softer parameters like education, the school you study, etc. They have built a reputation among the millennials community as they have been doing this Lending business for years. 

The second pillar of their business is the so-called “Financial service” segment. They offer a Financial service app similar to the well-known Cash app of Square. So, they have SoFi Money, SoFi invest, SoFi credit card, SoFi Relay, SoFi Protect, and SoFi Lantern. They are adding new features fast, and this part of their business is a very new business line. They launched SoFi money and SoFi invest in January 2019.  

The third pillar of their business is the Technology platform business. In April 2020, SoFi bought an API infrastructure provider for financial services called Galileo. Galileo offers fintech companies and neo-banks APIs that provide them infrastructure services for payment, investing, etc. Some clients are well-known fintech companies like Robinhood, Chime, Monzo, Dave, Moneylion, TransferWise... 

Before 2019, SoFi, with only its lending business, would not catch my eye. The more interesting segment for me is their Financial Service segment and Technology platform segment. 

Before we dive into the segments, it is important to note also the management. 

SoFi had a sexual harassment scandal in 2017. With that, there was a huge management shake out, and also the CEO left. This was probably one of the darkest periods for SoFi as they were even thinking of selling the company, but according to reports, could not get the price they wanted. In February 2018, famous CEO Anthony Noto joined the company, and we can now say that if before the management was a problem, now it is a big competitive advantage. Here is the management “superstar” line up: 

It is important to understand that SoFi before 2018 was a totally different company. We could say that even before 2019, when SoFi launched SoFi money and SoFi invest the company was a totally different company. Before 2019 the company had only 1 out of the 3 business segments that they have today. The last 2 years have been revolutionary for the company.  

The lending business

I won’t focus too much attention on the lending business as it is one of the least interesting segments to me.  

The lending business is a mature business for SoFi as they have been offering loans for years. Where they differ from other lending providers is that besides the common financial information needed for credit approval, they also take into account the “soft data” and, based on that, offer you a competitive rate. In 2019 they had $443 million in revenue from the lending business, and in 2020 they estimate this to be around $514 million. They also provide a number of the gross margin of this business, which is 58%. They estimate that for the next 5 years, the Lending business will result in a 25% CAGR. 

Looking at the big picture, the thing that is important to note is that because of their system and the financial service segment, they have lower client acquisition costs as there are many synergies between these two segments. This, together with the lower headcount and costs (compared to a traditional bank), makes their lending business more profitable. 

I also view the Lending business as a good offering for the Financial service business part as they are one of the rare Financial service apps that also offer loans (the bigger ones like mortgage etc.) 

Financial service segment

The financial service segment is basically the SoFi app. So, what does the “SoFi app” consist of. You have the option to deposit funds and earn interest, and you can invest in stocks, cryptocurrencies, ETF, etc.  You can also have a credit card. There is SoFi Protect, which means you can get insurance products such as life insurance, auto insurance, home, and rental insurance. Then there is also SoFi Relay, which allows you to have an overview of your spending and calculate your own credit score. Of course, since this is SoFi, you can also get a loan.  

SoFi also has a business offering in SoFi Work, which offers businesses financial aid and service for their employees as well as services designed for business financing through Lantern. Lantern can help with services like invoice financing, line of credit, etc. 

SoFi’s financial service segment is very similar to the Cash App by Square. In fact, it offers even more as because of SoFi’s main lending business, you can also get a loan. Square recently started testing loan features on their Cash App as well, but this was so far limited to a small number of customers, and the loans were small in size. 

Now with SoFi’s financial service segment, you have to keep in mind that this is a very young business. It was launched in January 2019. Here is the timeline of the product: 

While this is a young business segment, it is, in my opinion, one of the key segments for SoFi going forward. It is obvious also from SoFi’s investor presentation that they “bet” big on this segment: 

While Financial Service currently brings almost no revenue, they project the segment to bring in $1.164 billion in revenue in 2025 (almost 1/3 of the total revenue) with an average CAGR of 153%. 

Technology Platform

The technology platform represents a recent acquisition of SoFi made in April 2020. They bought fintech API provider Galileo for $1.2 billion. With it, they gained a segment that has one of the biggest fintech companies for their customers. The customer list has Robinhood Chime, Monzo, Dave, Moneylion, TransferWise, and many more. Galileo is one of the key API infrastructure providers on the market for fintech and Neobank companies. The main competitors are Plaid and DriveWealth. This market seems to be very interesting for bigger players as Visa acquired plaid in 2020 for $5.3B. Providers of API for banking infrastructure provide fintech companies with the ability to be flexible and fast in development. At the same time, they do not have to make big investments in banking infrastructure and with that, have the risk of constantly developing and keeping the infrastructure up to date. Having outdated backend infrastructure is one of the main problems for traditional banks as they try to compete with fintech companies on user-friendly and flexible frontend apps. They face big issues on the flexibility part with the outdated infrastructure. 

I think the acquisition was timed perfectly for SoFi as the market was just waking up from the COVID and lockdown shock in April, and many companies were valued at a discount. The Galileo acquisition seems to be paying off already: 

We can see that when SoFi bought Galileo, they had 30 million in total accounts from their customers, and this figure grew to 50 million in Q3 of 2020. The segment is also estimated to bring over $100 million in revenue in 2020. In the future, SoFi expects the segment to grow at a 55% CAGR for the next 5 years and have a 62% margin. 

Valuating SoFi

For the valuation part, I decided to evaluate each segment separately as they are quite different businesses but do have some synergies at the end. 

Value of the Lending segment

The lending business is the one that I focused on the least as I think the main advantage of this business is the know-how they build in the loan business, so this can assist their Financial Service segment. Their other competitors, such as Square, are so far behind the curve in the loan business, and having the know-how of this segment may prove valuable for SoFi. 

But if we go to the numbers: 

The Lending business is estimated to bring $514 million in revenue in 2020. Their margin is higher than what is traditionally in this business because of low headcount and infrastructure costs and a referral program and a financial app that makes their CAC low. According to the company data, their margin for the next 5 years should be 58%. They expect a 25% CAGR for the next 5 years. With that in mind, I think applying a 15x Sales multiple given the current market conditions seems reasonable, although there is a risk with the loan business since we do not know how good the quality of these loans is (default risks).  

Value of the loan business: $7.7B (given SoFi tried to sell itself in 2017 when it only had the Lending business for around $8-$10B but didn’t get the deal, the value seems reasonable. More on the sale: https://www.ft.com/content/5d5c8842-b5f5-11e7-aa26-bb002965bce8) 

Value of Financial Service segment

The financial service business is one of the hardest to estimate. For the valuation, we need to know how many users SoFi financial service app has.  

The company gives a number of unique members. But this number means customers that borrow on the SoFi platform as well as customers of the SoFi financial service app.

Maybe an estimation from app store ratings will give us a better picture. 

To better understand the user base and value, I compared Cash App to the SoFi app.  

Here are the numbers 

Cash App 

• Number of Ratings: 726k 

• Star: 4.6 

SoFi 

• Number of Ratings: 56k 

• Star: 4.8 

We know that Cash App has around 30 million MAU, so looking at the ratings, SoFi has 7.7% of Cash App ratings. If we applied this rate to the MAU, we would get a number that SoFi has 2.3 million users.  

This doesn’t help us much because they cannot have more than 1.718 million users. 

So I will try a different approach. Given current market conditions, Square’s market cap is around $110B. I calculate that $40B of that is based on their B2B segment, and $70B is the valuation of Cash App ( I can explain this calculation another time ). Cash App Ex Bitcoin revenue will make around $1.5B this year. SoFi estimates that its Financial service app segment will generate $1.164B in 2025. If that is the case, then we can say that SoFi Financial service will make 77% of the revenue Cash App is making now. If we apply the same % to the market cap, that would represent $54B. But we have to discount this to NPV (Net present Value) since this is the value in 2025. For the discount rate, I took 40% (since this is what often VCs use, and the SoFi Financial Service segment with almost no revenue currently and being “open” for only 2 years is similar to a start-up). We get an NPV of SoFi Financial Service of $10B. 

Value of Technology platform segment

The Galileo API segment was bought in April 2020 for $1.2B. But since then, we can see that Galileo almost doubled the number of accounts opened for their clients and is estimated to bring $103 million in revenue in 2020. It also has a 62% margin, and SoFi estimates a CAGR of 55% for the next 5 years. Since we have many API companies' publicity traded, we can apply a sales multiple. A similar company is Twilio, with a similar 50-60% gross margin. Twilio’s P/S multiple on 2020 estimated revenue is around 36x. If we apply that to Galileo, the value would be around $3.7B. 

Valuation

When we put together all the segments  

Lending business: $7.7B 

Financial Service: $10B 

Technology Platform: $3.7B 

The joined value stands at $21.4B

We also forgot to mention that SoFi is in the process of obtaining its banking license, which would benefit its Lending business, and also it’s Financial Service business. 

The company estimates this effect to be significant:

Current Market valuation 

Now, if we check the SPAC IPOE and the deal structure: 

IPOE shareholders will get 9.3% of SoFi together with 2.3% of the IPOE sponsor. IPOE's last closing price was $18.74 valuing IPOE public shares and sponsor shares at $1.88B. That implies the valuation of SoFi to be at $16.25B (but there are also warrants which may be exercised and are not included in this calculation - 28.1 million public and private placement warrants struck at $11.50). So be careful, there are a lot of warrants issued and they will further dilute IPOE shareholders and lift the market cap.

Summary

I opened a small position in IPOE to get exposure to SoFi. The main reasons are the Financial Service segment and the Technology platform segment. While the Financial Service segment competes with great monster apps like Cash App, the lending know-how could provide the SoFi app with a small advantage until the competitors start figuring out the loan business. The technology platform business is also one of the most interesting businesses for me. However, there is a risk if SoFi direct competitors mind being their client with Galileo and at the same time competitors on the Financial Service segment. 

A big factor in my decision to incite a small position in the company is the superstar management team with CEO Anthony Noto and their decisions. When we look at the last 2 years, the management took what was then a Lending business and grew 2 new segments, which now, for me, represent $13.7B in value. The Galileo acquisition was timed perfectly, and with the SPAC deal, SoFi receives $2.4B in cash to increase their war chest and continue to add value to shareholders. 

Sources:

• SoFi Investor presentation

Disclaimer: 

Nothing contained in this website and newsletter should be understood as investment or financial advice. All investment strategies and investments involve the risk of loss. Past performance does not guarantee future results. Everything written and expressed in this newsletter is only the writer's opinion and should not be considered investment advice. Before investing in anything, know your risk profile and if needed, consult a professional. Nothing on this site should ever be considered advice, research, or an invitation to buy or sell any securities.