Chit Chat Stocks - SoFi (Ticker: SOFI) with Brad Freeman

Episode Date: September 21, 2023

SoFi Technologies, Inc. (SOFI) is a fintech company offering a broad range of financial services, including lending, investing, and banking solutions, with a strong focus on leveraging technology to provide innovative and user-friendly financial experiences for its customers. Listen as Brett and Ryan ask questions about the company, its business model, and valuation. Enjoy the show! ***************************** Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney  Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Interested to see more of Brad's work? Find their Twitter here: https://x.com/StockMarketNerd?s=20 Contact us: [e-mail] Timestamps SoFi | (2:18) Lending | (14:35) Valuation | (33:40) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. This is our Thursday deep dive episode where we interview an analyst to discuss a single stock or industry. And today we have on the show, Brad Freeman. He used to be a recurring guest here on Chit Chat Money. So our longtime listeners might be familiar with him. But today we're talking about SoFi, short for social finance. He's been a shareholder here for a while, and he goes through all the elements of the business. I guess you could regard him as the FinTech, a FinTech disruptor growing their deposit base really quickly. And we'll get into all that during the interview. If you like what Brad has to say, feel free to check out his sub stack, stockmarketnerd.com. There's a lot of good stuff in there. He works really hard

getting a lot of content out and he has a nice little weekly review come out every Saturday. So recommend giving that a quick look. I think it's well worth checking it out. It's free too. So no cost. But without further ado, here's our interview with Brad Freeman. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast.

Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. All right. Welcome to Chit Chat Money. We are joined today by familiar face, familiar voice, longtime listeners may remember Brad Freeman. We've got him back on the show to talk about a company that Brett and I discussed on a not so deep dive, I want to say a couple of months ago. and we went through the basics, but Brad has been a shareholder for a while and we kind of

wanted to get his thoughts on some of the stuff we discussed. So we're going to go through a full deep dive on SoFi. Hopefully he can answer some of our questions, but I guess to start things off, I always find it kind of interesting to discuss the Genesis story, I guess, of how people come up with ideas. So how did you first find SoFi as a potential investment? yeah i mean it really is using twitter as inspiration and and treating 99 out of 100 of the the ideas that are sourced via inspiration is is maybe not the best but but treating but treating all respecting all of them and exploring all of them and um i'm and hamatha was just such a big vocal pundit on on fin twitter i'll leave it at that uh in 2020 and 2021 and just i mean i i

I had deep respect for him. I still have respect for him. I don't know how polarizing of an opinion that is at this point, but I was very interested in digging through all of his facts, the IPO A through Z or whatever it was. And there was one that stood out and one that actually looked somewhat compelling, not just from a, what are my 2029 estimates and how pretty can I make that look on the SPAC presentation, but actually fostering the kind of success that could actually be rewarded by shareholders over the long term and doing so with a leader in Anthony Noto that I've respected for a really long

time and not personally known, but just have followed his career through Goldman Sachs and the NFL and Twitter and just deep respect for him. So that really led me to digging in deeply. And clearly as a shareholder today, I liked what I saw and excited to get into all of that during this call. Yeah. And it is, it's I would say of the SPACs that social capital ended up taking public. This one certainly seemed the most put together as opposed to some of the others, but let's go through, I guess, let's walk through the business. Obviously for anyone that knows SoFi, there's a lot of different elements here. And I bet this just causes chaos for a lot of the people that try to analyze this because there's a lot of different ways you can look at it.

So what are the segments and kind of how do you think about the business? Yeah, I love chaos and I love confusion because it leads to people just saying, I'll go somewhere else. And that fosters the kind of inefficiency that I covet. So there are three main product revenue buckets for the company. The original product, which has since morphed into a full suite, was its student lending product, which I'm sure we'll get more into that as it's been a big headline for the last three years, but that kind of expanded into personal loans. They bought a company called Wyndham Capital to vertically integrate their mortgage loan stack, which is now rolling out pretty nicely with a few products that were

announced in recent months. And they do a lot of personal origination. They do a lot of assuming credit risk. And then they have this product called Lantern that they use for when this person doesn't qualify within our credit band or with the loan that they're seeking out, we'll send you to a bagaya or someone like that, um, to take a referral fee and get paid, um, the other two segments. Um, so financial services, um, think about, so everyone posts about, uh, so if I just raise their APY and a savings count by 10 basis points, so that that's the, that really is the top of funnel, uh, financial service products to get people in the door to cross sell. Um, uh, they, they have credit products, the high yield savings product and investing products are the

investing product. Um, I won't pick on too much because we're supposed to be a surface level for this question, but it does need work. It has gotten a lot of work, but it needs a lot more love. And then the third section, which I think is the most interesting for SoFi, both in terms of potential differentiation and revenue diversification, is their tech segment. So they bought a company called Galileo a few years ago that really specialized in payment processing APIs. They then bought a company called Texas for multi-core banking, which has a whole other range of APIs to really kind of shed these third-party costs that SoFi was paying in terms of licensing fees for private label technology, and really leaning fully on Technisys and Galileo,

not yet, but they're integrating the tech stack pretty rapidly. It's going to take a little while longer. And really, not just shedding costs via third-party licensing, but taking that technology and licensing it to the Robin Hoods of the world who need affordable APIs and who can be considered competition in fintech, which really makes SoFi, in my mind, not just a brand and not just a fintech player, but part of the plumbing of this industry where it can really take advantage of rapid sector growth, even if its brand doesn't thrive like I think it will and has so far. Okay, I guess one question or one way that we maybe characterized this was that we thought

about it in basically three segments, personal finance, which is that core business you talked about, banking, which kind of is all encompassing, but they got that bank license, I think in 2021. And then enterprise tech, I can see the overlap between the banking and the personal finance and how those two kind of benefit each other. But on the enterprise tech, do you kind of think about that as its own independent operation Or does that kind of tie in with any synergies to the rest of the business? Yeah, I think it's multi-pronged.

So a big part of the tech segment is, again, shedding those licensing fees for all these third parties. They were paying for payment processing, for user interface and user experience, and for the APIs that were enabling all these functions on the app to actually exist. So it does, in a way, make them a lower cost provider by being able to vertically integrate and bring in-house this technology so they're not actually paying. And that was the Galileo business, right? Galileo got them sort of part of the way there in terms of they can do that with payment

processing and some P2P products and things like that. But Technisys, which again, they're still working on integration and it's going to be a multi-year process, really pushes them the rest of the way. But the other thing that makes the Galileo and Technisys unique again, and sorry to sound a bit redundant, but it's an important point, is that again, banking and bank brands are somewhat commoditized. Financial services are somewhat commoditized. You can stand out with making your APY a little bit higher. You can stand out with offering a cart or an Instacart or an ARM IPO when some others can't. You could talk about the actual value of doing that for the retail community, but I guess that's a discussion for another day. But really what this does is it allows SoFi not to just be participating in this brand-based

commoditization financial service, digitization, sorry, that was a mouthful, sector, but it allows them to call Chime and call H&R Block and call these other customers their clients so that they can package this tech and sell it to them so that they can extract more value from this fixed cost base and not just treat it as sidestepping costs, but treat it as a revenue augmenter, which I find quite compelling, where I'm not solely reliant on, okay, how big of a household name brand is SoFi going to become over time? Because that really is, aside from just the fortress banks of JP Morgan and Bank of America, where people just know their money is safe and that in itself is a bit of a differentiator, that really is the only massive way to stand out.

It's brand notoriety. You can separate yourself a little bit with user interface like Robinhood it's been able to do, but really how permanent of an edge is that? And I don't see it as that permanent of an edge, but this, this kind of offers in a very cliche term, that margin of safety where they're going to participate in FinTech proliferation, regardless of how well the brand does. All right. Yeah. And I'm ready for a football season and seeing all of the SoFi commercials on my TV screen, they are stuck in my head. So I think, yeah, you know, I think the advertisements are working, but for the listeners, you know, there's a lot of different segments here. Basically throughout this episode, we're just going to go through each segment and kind

of see what Brad's opinion is on it and maybe have some follow-ups. So the first one we want to hit, and this is maybe the most important from a margin of safety perspective and from a risk perspective is the banking side. So where are they getting their deposits and what are the areas that they lend to? I know we can probably get the personal loans here. We did get some follow-ups on Twitter about the growth of that segment. Yeah. So where are these deposits coming from and who are they lending to? That's one of my favorite things about SoFi because a lot of these fintechs, and I've unsuccessfully invested in some of them over time, really are trying to make the pursuit of subprime borrowers and less affluent

cohorts more, I guess, more feasible and more economically rational to pursue at scale. And SoFi is not playing in that game. It is directly competing with JP Morgan and Bank of America and those types of competitors in terms of taking deposits from them. Now, they have over a trillion in deposits each, I believe. And the CEO acknowledges on the call, we're taking share from them. They have no idea we're taking share for them because we're at 12 billion in deposits and they're at a trillion, but that really is where it's coming from. So a very relatively affluent customer, which translates or meshes very well with who their lending customer is and why they've held up so well over the last 18 months when others haven't.

So I don't have the exact number off the top of my head, but for both student and personal and in-home is still a very small portion of their originations, but their FICO is well over $750,000, their average borrower income is well over $160,000 a year. So they are really pursuing this affluent customer, which is why when you look at net charge-offs and delinquencies, as we see all these charts about loss rates re-approaching and surpassing pre-pandemic levels, they're not noticing any of that. There has been no discernible impact on their charge-off rates or loss rates. They're still well, well below pre-pandemic levels. And that's because not only have they foregone expanding their credit bands

and trying to chase maybe more risky borrowers for the sake of growing market share, they've actually tightened them in recent quarters, which again is why I love that Lantern product so much, which is, okay, we're turning down a lot of borrowers because we have a very strict credit underwriting standards but we're still getting that referral fee from others who are willing to originate this um so yeah what what percentage of their um their i guess total deposit or their total funds are from direct to consumer deposits so like people just putting their money storing their money with sofi for that you know i think i think they offer one of the highest apys so i think it's probably four or five percent four and a half percent i think they and i'm sure they

changed it right as I said that. So it'll be wrong. But direct deposit rate for them is well above 90%, which is very important for them. The more financial data and the more financial ownership they have over their customer's life, it's the same playbook for somebody like a PayPal. If I know you better, I can underwrite you and approve you more frequently. I can probably offer you cheaper access to capital. I can bundle all these products together and offer you rewards and perks via incentive program. And that is really how they're going to motivate retention and minimize churn in this somewhat commoditized and hyper-competitive field. Today's episode is presented by the Science of Hitting Investment Research Service.

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equities analyst role for just $349 per year. Brett and I both paid for the service on our own, and we can tell you that it's honestly worth the money. Some of the companies that Alex covers includes Microsoft, Netflix, Meta, Roku, Costco, Match Group, Berkshire, tons of others. So if you're interested, check out the TSOH Investment Research Service today at thescienceofhitting.com. All right. And let's hit again, because I know this is a lot of the risks that people talk about is the lending side. So they're attracting all these customers. One thing that pops up to me is the personal loans. You did mention that they're making solid progress there and they have been trying to be stringent. You mentioned that if someone doesn't pass their credit standards,

they pass them on to someone that is willing to take that risk. But what do you think of the balance sheet or this would be the asset side of the balance sheet? Have they set any plans here? Are they trying to grow the mortgage side, the student loan side, or the personal loan side more? What is their plan for the trajectory of the loans over the next few years? So part of the convenience and the timeliness of this rapid deposit growth that we've been talking about, and they're adding $2 billion per quarter, is that they get to rely less heavily on more expensive warehouse facilities and less expensive warehouse credit that they've, in recent years, think 2018 before the other charter, were 100% relying on. So the single

to investors of how stressed out is our balance sheet is how much are we shrinking our reliance on warehouse facilities, because we have access to cheaper equity capital and cheaper deposit capital, which even with a 4% APY, they're saving almost 200 basis points in terms of weighted average cost of capital when they're using deposits versus when they're using warehouse facilities. And over the last several quarters, their overall capacity or their flexibility with warehouses facilities has merely grown because they're leaning more and more on cash on the balance sheet, they're leaning more and more on deposits, and they're leaning more and more on their finite equity capital, and having to utilize these warehouse facilities less frequently. So

a big part of that is that asset-backed securitization and wholesale loan markets have remained open to this company. And there was some drama a few quarters ago about how they didn't access those markets. And okay, so can they access those markets, but they kind of symbolically passed or passed through a deal at really favorable spreads in this most in this most recent quarter. But that that really gives them the flexibility to, OK, if we do need to start leaning on warehouse facilities, maybe we can just sell some of these lower yielding student loans and replenish the cash in our balance sheet. So it's a combination of the fact that they're not choosing to do that. They're continuing to grow the balance sheet and grow the loans on their

balance sheet when this is available to them. Therefore, they're foregoing that option because their net interest income and their net interest margin is so much better for them holding these loans to maturity or holding them for a longer period of time and selling them outright. And then the second part of that, again, is that they're leaning less and less heavily on more expensive capital because they have these fresh sources of cheaper capital that they have if you listen to their CFO on every single call. I know bank balance sheets are a bit of an adventure, but if you listen to him, he says over and over again, yeah, X is capital. We're going to keep originating loans. We have all the flexibility in the world. But I know for software as a service

investors, and I'm sure as heck one of them, when you see a bloated debt position and not that much cash, so when you see a large net debt position, it is a bit of a concern, but it's intentional for this model. And just one of the unique pieces of bank models and the fact that they can connect these deposits to originations where it really makes no sense for them to be keeping cash in the balance sheet. And it makes more sense for them to just be using all of this excess cash and going to chase high quality, um, credit products, um, and to reinvest in growth. So, uh, the balance sheet is, is immensely complex. Um, it's, it always takes me several hours, not several hours, but it takes me, it takes me a long time when, when earnings releases

come to kind of get through it and, and, and, and feel confident that I got through every single item that's important. Um, but, but their, their balance sheet's in good shape. Um, and, and, and what makes that even less of a concern is that, uh, their, their, their, their, their credit is performing so well and that their loss rates and the provisions are so modest and that they're unrealized losses. And I know that's a buzzword that everyone thinks of with the regional banking crisis. Their unrealized losses are so minuscule because their overall position in terms of holding federal bonds in their balance sheet is so tiny. So relatively good shape, but it has to stay in pristine shape if we'd like to keep enjoying this rapid origination growth that

has really powered the company's success over the last several quarters. I'm alongside a few other things. Yeah. So that kind of brings me to my next question. We have two questions here, but I'll just lump them into one. So when we looked at this, we saw for SoFi that it has this really high APY or when the average person goes and they put money into a SoFi account, they can I think, maybe I should check it, but probably 4.5% annually interest on their money. On one side, I think, wow, that's high, especially relative to the typical brick and mortar banking. I think brick and mortar is the right term, but physical branch banking. But at the same time, I think it feels like a bit of a risk.

So I guess from your perspective, do you think they're going to be able to maintain that high level of APY relative to their peers? And the other thing I wanted to ask is we own Ally Financial who does something similar just in terms of the non-physical branch banking model. Is there any risk that their deposit base is like rate chasers where if SoFi – maybe they're not as sticky as the Chase deposits. So if SoFi brings down their yield that they're offering to customers, because maybe there's some pressure on the loan side of things, do you see those deposits fleeing? I know that's a ton of questions, but basically, do you think they're going to be able to keep growing their deposit base or is there any risk there? Sure. And if I miss any part of that, please let me know. And I'm happy to answer it. But this really is where an ally enjoys part of the same benefit as well. But most, I mean, the Robin Hoods of the world, they don't in terms of connecting this deposit product to the origination product. And I'm actually paraphrasing leadership on a recent investor call. And that is such an important idea, again, because they have this bank charter in hand,

even though they're paying four and a half percent APY, they would be paying six or seven percent in terms of cost of capital by accessing these warehouse facilities. So as these deposits come at 4.5% APY, they actually are expanding their net interest margin and becoming more efficient and more profitable. But it's very easy to raise your APY when the Fed funds rate is just soaring through the roof and when benchmark yields are kind of following suit. But it's a lot harder to maintain that lofty APY as rates start to fall and as those net interest margins naturally start to shrink. And again, that's why this banking charter is just so important because it's pocketing 200 basis points in incremental spread versus other fintechs who don't have this charter

in hand and who do need to lean solely on warehouse facilities. They have so much more flexibility and so much more leeway to maintain that rate and to maybe take, okay, now we'll have 150 basis point advantage instead of a 200 basis point advantage. And that really is what we've been told to expect by leadership in terms of when the Fed funds rate falls, our APY will be maintained significantly more durably than any other fintech on the market because we can connect this deposit product to the origination product. And there was one more piece of your question in there that I really wanted to answer. I guess just why are they growing it? Is it because they can offer this APY? Is the stickiness and the attractiveness kind of come in the same way?

Like, okay, we can offer this, but we can actually do it profitably and they're going to stick around because we can have that slightly higher, obviously higher than the big banks, but higher than a lot of the fintechs out there too. Yeah. And Ryan, I think you're right. There are a lot of yield chasers on SoFi's platform, but if they're going to want to chase yield in a year when the Fed funds rate gets cut, they're going to go to SoFi. And I think that's actually going to be a net benefit to them as, and I don't want to keep picking on Robinhood because they have stock lending and they have all, but they don't have a mortgage product. They don't have a student lending product. They don't have a personal unsecured lending product. They can

not take these deposits and turn them into basically money printing credit products with extremely affluent borrowers. And SoFi can. So there are definitely going to be yield chasers who are moving around and trying to find that best deal as the rate environment's falling. And I think that's going to push people to SoFi more times than not, just because of the APY durability is just going to be so much more sustainable. All right, let's move to another topic, and that is student loans. So there's a lot of confusion out there, I think, for someone that doesn't study this business closely. There's all these headlines, all the delays on the resumption of payments in the United States. What are your thoughts on the resumption of student

loan payments and how can that impact SoFi financially? Sure. I think there's two parts to it, and I'm going to intentionally avoid taking political stances because I think that's just always a distraction for, for investors. But in terms of student loan products and what does it mean? So one of the main, so heck, let me get into progress so far. So the, the, the moratorium is over. Now there's that 12 month payment on ramp that the Biden administration has rolled out. But the important thing to remember is that interest will be accruing as that, as that passes on. So people actually have a vested incentive to start repaying their loans now, which hasn't been the case for three years, which is why on the last call we heard, or not on the

last call because it was too early. It was last week actually, I think it was a Goldman Sachs conference or something where Noda was talking. It might've been Chris LaPointe, but they both spoke very recently saying that the student loan volume ramp has been very much so as expected and in line. And then the other part of that is, okay, these student lending borrowers haven't been paying loans in three years. Now they're going to have another hefty expense. What is that going to do to loss rates? What is that going to do to their overall budget and their discretionary income? And that goes back to the important point of how relatively affluent and rich, for lack of a better term, SoFi's customer base is, which is another big reason why their credit book has held up so

well. But they are going to deal with that increased costs and increased headwind just like everybody else. But again, because $160,000 average borrower income FICO score well over 750, I think they're going to be relatively better off as that headwind kind of hits the economy. Yeah. I think there's, what's nice about student loans and, you know, it's been a tough market to be in over the last three years is they're much more reliable than say a personal loan or, you know, the loss rates are much, much lower. It's, it's a very steady business. Unless you have a follow up there on? No, it was actually an interruption. So if you want to finish your point, feel free. No, I was going to transition to management. So if you have anything else before

we hit management, go right ahead. Sure. And just kind of framing the opportunity for student loans, and there's been a lot of skepticism surrounding SoFi's kind of $200 billion volume origination estimate, which gives them a several year runway because they haven't originated more than $20 billion in a year ever. So there's a lot of that $200 billion estimate. We got more clarity in recent weeks, that's actually loans at today's Fed funds rate that they can actually shrink the rate of so they can actually refi at lower rates to cut your interest payment. But there's also another tier of this demand that's going to kind of ramp up over the next several quarters of people wanting to lengthen their payment terms. So pay it out over double the period of time so that their

principal payments get shrunk just so that they can financially manufacture a little bit more flexibility in their day-to-day lives. So those are going to be really the two levers to kind of focus on. And as the Fed funds rate drops, which is going to be a personal lending headwind, it's going to be a student lending headwind, it's going to be a home loan tailwind. But for those two products, those two variable refi products, that's going to be a very important growth lever to kind of keep the student lending origination humming. People looking inherently, they want to pay lower principals. So who can do that? And SoFi will be aggressively telling you as they always do across social media and across marketing and across this big SoFi stadium banner that they

have. They will be aggressively telling you that they're the person to do that for you, or they're the company to do that for you. Yeah. What do you think of the stadium deal? Yeah. So it's actually funny because Noto talked about this two weeks ago as well. He was explicitly asked, why did you do this? I mean, you came into SoFi as the CFO of a few very highly renowned organizations, and this doesn't feel like a financially proven thing to do. But he gave some math. They were sponsoring, I think, the US Open and the Olympics and X Games or something like that. And they were paying that $20 million fee that they're currently paying for about 20 million unique viewers. And SoFi Stadium is actually 4Xing that. So they're paying 20 million for 80 million

unique viewers and they shedded that other 20 million to kind of 4X their reach. But he said, I don't really believe this, but whatever, you could believe it if you want to, that they only paid for primetime football games and the Taylor Swift concert and the Olympic opening ceremony and the FIFA World Cup events were all icing on the cake. I would harshly criticize the SoFi stadium or that stadium's financial decision makers or their management team if they weren't including that in the overall price tag um but i guess if they weren't then good for sofi but um but the the important thing is that that 20 million dollar fee for 80 million viewers is is a large upgrade versus what they were spending before it is yeah i think the deal kind of makes sense to be honest

yeah i agree than like the cable company in seattle that sponsors the stadium that one makes zero sense but right you have some yeah and i don't know if this is actually how people think But if I were looking for a new bank or I was looking for something that gives me potentially a higher yield, my first thought is like, okay, is this bank safe? And I don't know why this is probably not how things actually work out. But if you look at the SoFi Stadium, you see this massive structure. It's really kind of futuristic looking. You think, wow, they must have tons of money. They must be safe, even though it's probably maybe wasn't a financially prudent decision.

It has the kind of the, I don't know, people probably think like, well, yeah, they're probably loaded. Yeah, the FTX and the crypto.com does make you scared. But I mean, if you look under the hood, this is a better run company. Yeah. I might ruin that, but yeah, I think this one will go a little bit better, but you mentioned management. You mentioned, you think highly of them. So what are your general thoughts on management as it'll follow up? What are your thoughts on Noto buying shares? I believe in the open market. Yeah. I'll never complain about that. So Anthony Noto, if you want to buy

a lot more shares that, that, that would work for me. And he spent a pretty decent chunk of his estimated net worth online on shares. So it's been somewhat meaningful in terms of his open market purchases. But I mean, SoFi, they needed a former army captain and someone with a very disciplinary and focused background and also former head of TMT at Goldman Sachs, CFO of the NFL and Twitter. They needed a dynamite resume because the founding leadership team had, and I'm quoting articles that I've read in the past, had become kind of like a frat, a fraternity environment where sexual harassment was running rampant and they were originating student loans at rates and at offers that were never even going to have a remote chance of making any kind of positive net

interest income. So they were burning through cash. They weren't kind of chasing, or I'll start there. They were burning through cash. There were several cultural issues that needed to be turned around to a point where they almost sold before NODA was brought in and kind of righted the ship. But part of what I've liked so much about Noto's tenure is that he's transformed the company in a very short period of time. And again, some products need a lot of work, but they've come a long way very quickly and they'll work on them and they'll get better. I'm thinking of the Invest product and I know fellow listeners are complaining about that frequently and they're right to do so. But he really turned it in from a student lending shop to a cliche term, one-stop shop. And why that matters is, first of all, they get this cross-selling and inherent LTV decat advantage over a lot of companies. But not just that, but there are a lot of legacy banks who are just unwilling to offer lower return on equity investment products. They forego them and they focus on higher return products. And that makes a lot of sense.

But by SoFi being there for lower ROE products, which I mean, a lot of their financial services are, some of their lending products are, some of the credit origination bands that they originate in aren't super high ROE, but they're getting there. But it allows them to kind of be that omnipresent force for someone's day-to-day financial lives where, okay, yeah, I got this product from you, it went really well, so why would I go anywhere else? and clearly some obviously some of them will go somewhere else but more times than not they're they're going to they're going to retain and they're not going to churn um and and they're going to be cross-sold um with with virtually zero incremental added customer acquisition cost which i use the acronym ltb to cac that's just lifetime value to customer acquisition cost i know you two know i know 99 of the listeners will know but now everyone knows um so they really they really get this unit economics advantage over over pretty much everyone else now now there are other banks who are willing to step into lower ROE products, but they get this advantage of

getting their foot in the door and then either getting their foot in the door with high ROE products initially, but getting it in the door and then cross-selling over and over again to really enhance their unit economics to a point where if you're foregoing offering these lower ROE products, you can't match that. And they offer some math on their SPAC presentation, but they've since reiterated it over and over and over again, which is the only reason I'm citing it, where just their LTV astronomically rises by several factors without their CAC moving, which makes these lower ROE products make a lot of sense. But you have to offer all of them to get to that point.

And they've really been willing to offer all of them recently. Do you bank with SoFi? I do not bank with SoFi. I am a self-employed writer who cannot access that juicy 4.5% APY. so i'm a sucker being paid one basis point by bank of america that's what that aren't we all so so i think yeah but to be fair for the people i guess that throw all their money into their brokerage account it's a little you know it's not the same yeah yeah my disposable income pretty much oh yeah but like you said yeah but yeah the checking account we we like to uh i like to keep

at lean i think brad and ryan are probably the same for sure yeah maybe a little leaner than i like sometimes but the uh okay i forgot to throw this question on the little question document that i sent you but valuation how do you value this thing and this was kind of one thing that it was sort of a hiccup that brett and i had when we looked at it was like oh okay like it feels like they have an advantage in attracting deposits it seems like where they're putting that money makes sense and they're doing it at attractive yields, but I have no idea what they're going to earn. So it's hard to value them. So I guess, how do you look at it? And maybe this goes into that question we got on Twitter, which is, what do you think of their use of

adjusted EBITDA? Yeah. Banks shouldn't use adjusted EBITDA. So it's being used by necessity because, well, they're using contribution profit and they're using adjusted EBITDA. Those are the financial metrics that they're really pointing to. But again, that's by necessity. And it's extremely hard to value SoFi right now, but it's going to become a lot easier in about three months, six months when they turn GapNet income profitable and when you can actually evaluate them somewhat more similarly to a normal bank. Now, it's going to be way more expensive than a normal bank because revenue is going to keep growing in the 30% range. So there's going to be bears forever until SoFi is a mature, hopefully a mature, very successful, very large

company who are saying it's stupidly expensive, but really going to have to focus on peg ratios versus PE ratios and just account for that growth because it's going to be growing gangbusters, especially on the bottom line for at least the next three or four years, just because of all the incremental operating levers they have in the model. And you can really see that in incremental margins that they're putting out. So their goal is to, and I'm going to use the justice of it, even though I said, don't use it because this is how they frame the conversation is we want a 30% EBITDA margin. So we're going to invest 70% of our potential profits back into the business. We're going to let 30% flow to the bottom line. And from that 30%, we're going to

convert about two thirds of that into gap net income. So they're shooting for a 20% gap net income margin, which gets them to about 20 to 30% return on equity. So the fact that they're incremental margins in terms of EBITDA and gap net income have been, I think it was over 40% for both of them in the last quarter. So they're running well above those targets, which is why they've been delivering such rapid operating leverage. But that really is the most polarizing thing about SoFi is no other bank uses adjusted EBITDA. And there's a reason that no other bank uses adjusted EBITDA. It's a little bit more appropriate for them because they don't have all these branches around the United States. And so depreciation expense is a little less

of a concern that should be accounted for, for them versus a Bank of America or somebody like that. But that really is the most polarizing aspect of SoFi. And I'm very much still looking forward to the day where I can say it trades for X times earnings instead of X times adjusted EBITDA with X earnings growth rate, because it's a pretty large book of revenue. So when they inflect the positive gap net income, the ramp should be pretty brisk, especially with the incremental margins they're running at. But that is my least favorite part of the company, that I have to say it trades for this EBITDA multiple. And I gross myself out when I'm saying that because this business model should not be valued based on that. And fortunately, it's not going to be very soon.

Yeah, that's a great summary. Now, when I hit the tech platforms again, if you look at their charts in recent quarters, you kind of look at it first and say, hey, they're not growing the technology partners anymore. The accounts have stagnated, but they did have some good, and I'll let you explain it, some good explanation there. So why is that? And what value do you think? Well, I guess you already talked about the value, but why is that? And why is it not a concern for you? Yeah, I think, so there's been a large philosophical or strategic shift. I think that really stems from the fact that this platform and this product, its first initial growth phase under SoFi was born during a time when growth at all costs was what everyone cared

about. And how many customers did you add this quarter and how fast did revenue grow for this segment? And especially on the customer point, that really, and PayPal is another example of this. Several companies in my portfolio were examples of this, just going after these very low value, not even having any established member-based clients, because we want to say our client base went from 20 to 30 quarter over quarter. And that means we're doing well, clearly. Um, as I say, sarcastically, so, um, they, they really shifted from, um, from pursuing these, these large, large clients with very short sales cycles to going after bellwether top 10, top 50 financial institutions, both financial service companies and non-financial

service companies they're going after now, um, for these integrated banking services that they can offer on a B2B basis that these, these companies, the H&R blocks of the world can offer products to their customers, to their employees, to their members, um, whoever their stakeholders are. So that shift has really led to slowing revenue growth for most of 2023. We're supposed to get a sharp acceleration starting in Q4 and continuing on thereafter because the sales cycles for onboarding these larger clients are a lot longer. And because it really had no larger clients in the pipeline that were wrapping up the onboarding cycle that were ready to start contributing revenue. So it's been a period of growing pains on the top line

that is supposed to wrap up, supposed to, Q3, that they've been pretty good at guiding to things like this. So I'm confident they're right. But I mean, when you're saying things are slowing down, but they're going to speed up, there's always uncertainty associated with that. So something for investors, for people contemplating this idea, for skeptics, everyone to pay very close attention to when they report Q4 earnings early next year. So that's the top line. On the bottom line, we've seen contribution profit for this segment kind of go from roughly 30% to 20% in a very quick period of time. That is all technicist integration related. They've had to do a lot of work to combine tech stacks, to unify functionality of APIs,

to get themselves ready to be able to package all of these products in an RFP to actually go chase these top 10 institutions. So that work has been ongoing throughout 2023. Again, should wrap up early 2024, right when these clients should start translating into more revenue, which is why they're telling us that it's going to, the contribution margin is going to ramp back up to 30% over time. But that, that has been the sore spot of the company's last several, last several reports. We've seen member-based decline because I think, because they lost Chime as a customer, They had a large customer return, but there are reasons to be optimistic. I'm kind of sick of them saying that the top 10 institutions are coming.

They're really close. They've been saying that for a few quarters. So just really ready for that to be announced and to start translating into financial success. There's reason to believe that we'll start in Q4 and really ramp up materially in 2024. And it needs to, I think. Would you rather see SoFi with or without the enterprise tech segment? Like, would you prefer that they didn't have it at all? No, I really like, I love the vertical integration just because they're saving so much money

and out-of-pocket costs on third-party vendors. And because again, an investment case based solely on a consumer-facing brand, unless you're investing in like a Lululemon or an Apple or Nike or something like that, just massively popular and ubiquitous, it is somewhat risky and it is extremely abstract. Like how does added brand recognition and added unaided brand recognition translate into more members and more revenue? And there's not a formula for describing that. So because they are going to participate with the Robin Hoods of the world in fintech proliferation one way or another, I do think that provides a little bit of downside safety in the unexpected scenario where SoFi's brand just does not resonate. I mean, the terminal value would not be zero in that case, and it could very well be close to zero if, again, unexpectedly, SoFi just stops working for whatever reason on the consumer facing front.

All right. This has been a great update on SoFi. For anyone that wants even more updates, I'd recommend subscribing to Brad's free newsletter, The Stock Market Nerd. And we'll let you talk about that when we finish this last question. But to wrap things up, any long-time listeners know we ask the same question every time, and it's the pre-mortem. So what could go wrong here?

Why would an investor lose money in SoFi over the next three, five, seven year time frame? Yeah. And I do think, again, downside risk is not zero because of this tech segment, but I do think it all comes down to the abstract idea of how well does this brand work? And you can see in their marketing payback periods that they're starting to shrink their time to value in terms of spending on external marketing, but they're going to have to keep spending on external marketing. I mean, SoFi is not going to be a household brand overnight. They're going to keep having to deliver compelling LTV to CAC ratios. They're going to have to keep

delivering very compelling incremental margins. And I think kind of where excitement is in terms of the retail community and everyone, that the bar is high for them to continue succeeding. I mean, again, it's not like the company's tripled from its public debut. I think it's, yeah, it was a spec. So it was a $10 debut and it's at like nine something right now, but it's, it's held up far, far better than the Clovers of the Clover healths of the world. And I won't pick on any other names, but, um, it, it, it is quite, or it's not, it's not a concrete idea. Like, um, yeah, we, we have H one hundred chips that, that train generative AI models significantly more cheaply than everyone else. Like there's no, there's no concrete tech or

statistical advantage that, so if I can point to besides we'll pay you a little more on the APY front or, um, or we'll offer you more products. So it really is, um, it's, it's, it's a somewhat abstract idea of, of how well is the brand going to resonate, um, with, with the world, with the United States first and, and, and hopefully the world after. Uh, but that's, uh, the focus is on, you can't, or is on the United States right now and not globally, even though they've done a few things in a few countries, but that needs to keep working. Their unaided brand awareness needs to keep translating into 30% growth. It needs to keep translating into operating leverage. And there's never any guarantee that that's going to happen. I mean,

it would be a pretty abrupt shift if their marketing just stopped working and people said, F SoFi, I'm going somewhere else. But they could. Or what if some other competitor comes by and has maybe he's partnered with Amazon or partnered with Apple or something like that and can offer all these products at irrationally great deals and undercut you because we're not relying on this profit center or whatever for our own success. So there's the fact that I don't want to say there's low barriers to entry because really no one has digitally emulated what SoFi has built in terms of their full suite. But there's always that ability. And there's all these legacy banks that are trying very hard to emulate what SoFi is trying to build. And they

could. Maybe they'll figure it out at some point. So there's a lot of competitive pressures. There's a lot of moving pieces in terms of the competitive environment. And there's a very abstract concept in leaning on brand equity to kind of power the success of this company going forward alongside their product suite and alongside their leadership team. But brand is a big part of this. And in the world of banking, that's unique. That's a little weird and it's a little uncertain. So I think that's what keeps me up at night. Okay. Well, that is all the questions we have. Brad, where can people find you? Stockmarketnerd.com. All right. Perfect. Before we sign off here, we should throw a disclosure on this. Brett and I are not financial

advisors. Anything we say or discuss here on Chit Chat Money is not formal advice or recommendation. brad unless you got your uh uh credentials here lately you're not a financial advisor either so okay he's in my opinion yes it is his personal opinion it's not formal advice or recommendation brett and i are however general partners at arch capitals clients may have positions in the securities discussed in this podcast thank you all for listening thank you brad for coming on the show again and uh we'll see you all next time We'll be right back.