SoFi Is a Bank With the Valuation of a Tech Unicorn

FinTech leader SoFi Technologies (NASDAQ:SOFI) recently completed its merger with special purpose acquisition company (SPAC) Social Capital Hedosophia V. This caused IPOE stock to convert into SOFI stock, beginning SoFi’s official run as a publicly traded company.

the Social Finance (SoFi) logo is displayed on a smartphone.

Source: rafapress / Shutterstock.com

SoFi was an impressive merger partner for the “King of SPACs,” Chamath Palihapitiya. The private markets gave SoFi a healthy valuation for years as investors anticipated that it could turn into the next big fintech company like Square (NYSE:SQ) or PayPal (NASDAQ:PYPL).

Potential investors should be aware, however, that SoFi isn’t necessarily on the same path as those other two companies. SoFi is much closer to being a traditional bank or financial services conglomerate than a payments company.

And, as a result, it is likely to generate much lower profit margins than many fintech firms. What makes PayPal special is its payments business which has high profit margins, not its other, low-margin services. SoFi, at least so far, doesn’t have a similar gold mine from which to profit.

Admittedly, there’s a lot to like about SoFi. However, investors should have reasonable expectations of the company and understand it before they buy SOFI stock.

SoFI’s Business Model

SoFi has been in business for a decade. It initially focused on student loan financing, seeking to offer a lower-priced alternative to existing options. For example, early on, SoFi was charging an average 6% annual interest rate on student loans, which was several points lower than the average rate.

In 2017, Sofi’s then-CEO stepped down due to a scandal and allegations of an unsavory workplace environment. SoFi brought in Twitter’s (NYSE:TWTR) chief operating officer at the time, Anthony Noto, to run the company. Under Noto, SoFi has significantly diversified its business, and it has expanded  into other types of lending, such as automobile financing.

Meanwhile, it has launched new features such as its SoFi brokerage that compete with traditional banks such as Merrill Lynch and with online brokers, including Charles Schwab (NYSE:SCHW).

SoFi is starting to launch cool features, like allowing investors to participate in initial public offerings (IPOs). However, those are not revolutionary concepts. Brokerages’ top customers have been able to participate in IPOs for over two decades. SoFi is betting that putting a bunch of normal bank and brokerage concepts together in a flashy app will ensure that its customers remain loyal.

Despite SoFi’s broadening business model, it still gets the sizable majority of its revenues from vanilla lending products. And lending to students is still its biggest business.

A publicly traded student loan company would normally trade for something like ten times its earnings and one time its sales. But when that student loan originator is presented as a Silicon Valley miracle, it’s supposedly worth many times more than that.

The Verdict on SOFI Stock

The fundamental problem with SOFI stock is that investors have overly high expectations for the shares. The stock is priced as though SoFi is a high-flying SaaS-type business. But it’s not.

Behind all the gloss and glitter, SoFi is a really expensive bank. SoFi may be doing a lot of things using an interesting app, but it’s done little to reinvent either banking or brokerage services so far.

For the stock to be seen as attractive at its current levels,  the SoFi brand has to be viewed as a big competitive advantage. That may end up being  true, but it’s too early to say whether it’s the case at this point.

Can an expensive stock get even more expensive in the short-run? Of course. it can. For the long-term, though, given the low profit margins of SoFi’s bank operations, it’s hard to justify the valuation of its stock.

Bulls think that SoFi’s annual revenue can reach $5 billion in 2025. That sounds great. But what is a bank with $5 billion of revenues worth? SoFi’s shares are worth $20 billion now. That’s four times its expected 2025 revenues.

Goldman Sachs (NYSE:GS), for example, which has long had a reputation for being the most shrewd investment bank, sells for two times its trailing revenues. It reported 2020 revenue of $60 billion, and the market capitalization of its stock is $120 billion.

Goldman is the best  IPO underwriter. SoFi’s IPO business looks like child’s play compared to what Goldman Sachs or Bank of America (NYSE:BAC) can do.

Goldman Sachs has a fantastic lending operation; it made money during the housing crisis by shorting the loans that all the other banks were stuck holding. SoFi, by contrast, makes boring old student loans. Goldman is good at what it does, so it’s worth two times its sales.

SoFi, by contrast, hasn’t shown much expertise in lending or investment banking yet.  Maybe it will do so eventually.

Or, judging by the history of many failed fintech firms such as LendingClub (NYSE:LC), maybe it won’t. In any case, it’s really hard to justify paying four times SoFi’s 2025 revenues for SOFI stock. At minimum, the company will need a few years to grow into today’s valuation.

On the date of publication, Ian Bezek held a long position in GS stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.


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