SoFi Technologies Stock: We have a problem (NASDAQ: SOFI)

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SoFi Technologies Inc. (NASDAQ: SOFI) stocks are down 40% year-to-date and investors are wondering if now is a good time to buy. The company recently secured a national banking charter and regularly reports rapid customer additions, so investors are tempted to stay on the name for long at its discounted prices. However, SoFi also has headwinds that could damage its near-term growth prospects and further reduce its stock. Let’s take a closer look at all of this.

Growth catalysts

Let’s start with some of SoFi’s key growth catalysts at play. The company continues to add customers at a rapid pace, showing no signs of plateauing, indicating compelling product positioning. It also positions SoFi favorably for more cross-selling and up-selling opportunities, as it now has a diverse bouquet of offerings. For example, a customer may have joined SoFi to refinance their home loan, but they end up signing up for their credit card and a personal loan as well. So basically the company’s fast customer also adds points to the fast revenue growth in the future.

Number of SoFi Technologies members

Second, SoFi, historically, was not allowed by law to offer its customers interest rates higher than the interest rates it received from partner banks. This meant that SoFi had to rely on the usefulness of its app ecosystem, ease of use, product integrations and increased marketing spend to attract customers. From its September 10Q filing:

However, as we are not a bank holding company, we are not permitted to offer members an interest rate on their SoFi Money account balance higher than the interest rate we receive from our partner banks. Some of our competitors do not have the same restriction and we may lose current SoFi Money account holders to those competitors or may not sign up new SoFi Money account holders because our competitors offer a lower interest rate.

But that’s a problem of the past. SoFi obtained its national bank license earlier this year in January. This should essentially reduce its dependence on partner banks, increase its net interest margin, reduce its cost of funding and allow it to offer more competitive interest rates to attract customers. In total, SoFi management expects banking operations to grow adjusted EBITDA by up to 75% in FY22 and 48% in FY23. These are massive gains.

I also argue that with competitive interest rates, SoFi won’t have to advertise as much to drive user growth, which essentially lowers its customer acquisition cost. But that’s just speculation at the moment. It remains to be seen how competitive SoFi’s interest rates really are, once it fully integrates banking operations in the coming weeks.

Risk factors

In my opinion, the biggest overhang surrounding SoFi’s growth prospects is the extension of the federal student loan moratorium. The government has already extended the deadline twice, and the moratorium is supposed to expire on May 1, 2022, but we are probably considering another extension. Banks have reportedly received letters from the Department for Education asking them not to contact borrowers about the upcoming May Day deadline. Analysts now expect the moratorium deadline to be extended to 2023.

Now, SoFi offers a number of products to its end customers. These include credit cards, investment and fund management accounts, home loans, personal loans and student loans. Our database at Business Quant actually reveals that SoFi’s student loan business was quite large, accounting for 63% of its total loans in the first quarter of FY20. However, with the loan moratorium introduced in 2020 , students haven’t found an immediate need to refinance their loans with SoFi lately. This has hampered SoFi’s loan growth in recent quarters.

Origin of SoFi loans by product type

SoFi management revealed in its latest earnings call that extending the moratorium from January to May is expected to cut its revenue by as much as $35 million in the first quarter alone. They released their FY22 revenue guidance of $1.57 billion in hopes that the moratorium will be lifted in May 2022. However, if the moratorium deadline is now pushed back to mid-2023, SoFi could be looking at up to $140 million in lost revenue and it might as well miss its FY22 guidance.

Our first quarter forecast incorporates the negative impact of the unexpected extension of the federal moratorium on student loan payments through May 2022. We estimate the negative impact to be approximately $30-35 million in revenue and $20 million to $25 million in first-quarter contribution earnings, with full-quarter loan origination levels consistent with the first three quarters of 2021.

Importantly, SoFi is not profitable on a GAAP basis and its management was counting on rapid revenue growth to become profitable. But with significantly reduced revenue and the potential for contribution profit from the student loan business, at least for the foreseeable future, the company may need to raise more debt or dilute its shareholders in order to fund its operations.

In addition, if the federal government cancels or cancels student loans for a large amount, the market for student loan refinancing could also shrink. This would further weigh on SoFi’s growth prospects and worsen investor sentiment towards the company. From its 10K ranking:

If student loans were canceled or canceled on a significant scale, or if federal borrowers were allowed to refinance at lower interest rates, our profitability, results of operations, financial condition, cash flow or future business prospects could be significantly and negatively affected as a result. In particular, our student loan refinancing activity within our Loans segment, which is our largest segment, would be materially and adversely affected.

Compounding the problem further is the fact that SoFi shares are trading at high trading multiples despite the moratorium overhang. Let’s look at the table below to better understand the problem.

SoFi trading multiples

The Y axis highlights the earnings growth of 40 US-listed stocks operating in the credit services sector. Note how SoFi is vertically positioned at the same level as many of its peers. Now let’s move on to the X axis, which plots multiple price-sales (or P/S) for the same set of companies. Note how SoFi is isolated horizontally to the right. This chart, collectively, suggests that SoFi is growing at the same level as many of its peers, but trading at significantly higher P/S multiples.

On the other hand, there are at least 8 other stocks whose earnings are growing at more or less the same rate as SoFi, but they are still trading at significantly lower P/S multiples. That should make investors rethink their thesis for SoFi Technologies.

Investor takeaways

There’s no denying that SoFi has grown rapidly in the past and charter banking should boost its EBITDA. However, government policies could significantly weigh on SoFi’s near-term growth prospects. Also, its shares are trading at relatively higher P/S multiples compared to many of its industry peers, which doesn’t help. So, for these reasons, risk-averse investors may want to avoid the stock altogether for now. Investors who understand the risks associated with investing in SoFi and nevertheless want to bet on its long-term growth prospects may want to wait for possible price corrections before initiating long positions. Good luck!

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