Student Lender Sofi’s Growth Story Leaves Unanswered Questions

When SoFi Technologies announced its third-quarter results last October, the consumer lending company was crowing about a series of records. Net revenues climbed to $531 million, up 27%, year-over-year, new customers rose to 2.2 million customers, a 47% increase. Net interest income more than doubled after the San Francisco lender bought a bank that gave it access to insured deposits.

SoFi, (short of Social Finance) got its start in 2011, founded by Stanford University MBAs as a way for alumni to help finance the educations of current students at their alma mater. The company went public in 2021 raising $2.4 billion via a Chamath Palihapitiya sponsored SPAC merger, but it has yet to earn a profit. Its October 30 earnings statement said it expected “net income profitability in the fourth quarter” and its chief executive Anthony Noto suggested on the earnings call that the money would keep flowing “in the years that follow,” pointing to growth in the company’s financial-services and technology operations rather than its traditional lending business.

Despite high hopes and expectations for SoFi, the road to profitability has been filled with obstacles.The company managed to lose $266.7 million in the third quarter, four times more than the $61.5 million shortfall expected on Wall Street, according to Bloomberg. The loss itself was mostly on paper, the result of an accounting requirement known as a goodwill impairment that had to do with recent acquisitions. Still, the charge against earnings was not foreseen by the equity analysts who follow the company.

The results announcement did not identify which of the company’s holdings were the cause of the charge, and the issue did not come up on the conference call. SoFi seems to have communicated to at least one analyst, Jeffrey Adelson of Morgan Stanley MS , that the charge was related to the technology division and was attributable “to lower market valuations on similar assets/companies.” Adelson did not respond to emails and phone requests for more information about the statement, which appeared in a November 10 research note, and a Morgan Stanley spokeswoman said the company would have no comment.

The technology unit includes Salt Lake City’s Galileo Financial Technologies, a payments technology company purchased in April 2020 for $1.2 billion, and Technisys, a cloud-based online banking platform serving Latin America, acquired for just over $1 billion in March 2022.

Goodwill is a way to account for the premium an acquirer pays over tangible assets like real estate and machinery when it purchases another company. The idea is that the premium reflects such hard-to-quantify items as intellectual property and powerful brands. Like any asset, it is carried on a company’s balance sheet, and it can lose value if something bad happens, known as a triggering event. Since late 2021 the value of fintechs have fallen precipitously.

When SoFi finally revealed the reason for the charge, it did cite the technology division: “During the third quarter of 2023, the Technology Platform segment continued to experience slower growth rates than expected at the time of acquisition due to: (i) the uncertain macroeconomic environment, which has continued to impact customer spend volume, and (ii) continued longer sales cycles as a result of our shift in strategy to focus on diversified durable growth driven by potential new partners with scaled customer bases and interest in multiple Technology Platform products.”

Along with those factors, the company cited the effect on Technisys of inflation in Argentina, where consumer prices were up 138.3 percent year on year as the third quarter ended in September. The SoFi filing did not indicate whether the inflation issue would persist after Q3, but if it did, it could have gotten worse: The country devalued its peso in December and economists surveyed by Bloomberg are expecting 222 percent inflation for that month.

A SoFi spokesperson who asked for anonymity, said by email: “”To clarify, the 10-Q underscored historical performance through that time relative to initial expectations at time of acquisition. The impairment expense accounted for that in 3Q23. Separately, our forward-looking guidance stands as has been presented.” The spokesperson declined to respond to follow-up questions citing a company quiet period before its next earnings report.

So far CEO Noto is reluctant to admit to technology platform problems. Here is how he described SoFi’s growth prospects on its recent conference call: “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.”

SoFi’s shares ping-ponged between $6.50 and $10.50 since the earnings report as investors try to figure out what to make of the company’s prospects. They’re currently at $8 after a downleg that followed a negative outlook from Mike Perito, an analyst at financial-service specialist Keefe, Bruyette & Woods. KBW cut its price target by $1 to $6.50, citing slower-than-consensus loan originations and the lackluster technology revenue.

“The company hasn’t really shown the ability to grow technology segment revenues at a high rate yet, at least sustainably,” Perito says by email. “Most of the growth in 2023 was from intercompany revenues, which is SoFi allocating revenues to the technology segment for SoFi putting more of their banking platforms and products on Galileo infrastructure. There is a contra-expense in the ‘other’ segment offsetting the benefit of those revenues to the bottom line.”

SoFi was one of the first neobanks, internet-centric financial services businesses that kept costs low by doing business online and avoiding some of the regulations that cover traditional rivals. But along with its technology acquisitions the company bought a commercial bank, Golden Pacific, and now it is subject to capital-adequacy rules that put investments by shareholders and lenders at risk if the company gets into trouble.

The loans that SoFi makes to consumers are considered assets, and funds raised from investors have to be reserved against them. The company may run out of capital to back expanded lending by June 30, according to Wedbush analyst David C. Chiaverini.

“We expect overall revenue growth to slow materially driven by a slowdown in the lending segment as the company reaches balance sheet capacity to hold loans,” he says by email.

SoFi could raise new capital by selling new shares or borrowing in the credit markets, but either approach entails risk in an economic environment that the company itself described as uncertain. Instead, it is focusing on expanding the financial-services business, which makes money from fees on things like debit cards and brokerage operations, and the technology unit.

The goal is to winnow lending down to half of revenue, from about 63 percent in the third quarter. “In 2024, we expect 50 percent of our revenue to be from tech platform and financial services, and then the remaining 50 from lending,” CFO CFO Chris Lapointe said at the Stephens Annual Investment Conference on November 15.

Wedbush’s Chiaverini doubts SoFi can make it. He says the technology unit has grown “modestly” over the past year and the company would have to get the division’s sales to “accelerate materially to achieve a 50/50 split of adjusted revenue in 2024 between its lending segment and financial services/tech operations.” He adds, “Based on recent trends, we believe it could be a stretch to achieve the necessary tech segment revenue growth to get to the 50/50 split.”

SoFi has been telling investors the strategy shift in the technology unit—one of the things that led to the goodwill impairment—will substantially improve results. But the business showed growth of just 6 percent in the third quarter on a year-over-year basis. Noto himself said on the earnings call that lead times for winning business from new customers and integrating them into its systems is “measured in many quarters, not months.”

When SoFi announced its Technisys purchase in February 2022, Lapointe estimated that about 60 percent of the added $500-$800 million revenue it was expected to generate through 2025 would come from traditional banks, with the remainder from fintechs. But KBW’s Perito says a survey of small and mid-sized banks taken by his firm showed that 70 percent of them did not plan to change technology providers before 2026, indicating SoFi’s optimism was misplaced.

The company’s pledge to show a net profit for the fourth quarter of last year is believed, just barely, by Wall Street, which puts the number at 0.004 cent, according to Bloomberg data. The adjusted number commonly used by analysts is 2 cents. But for the year, the consensus is firmly in the black with net income of $95 million, or 6 cents a share.

Sofi’s stock has garnered seven buy recommendations, 13 holds and three sells, with two of the most recent reports—from Chiaverini and Perito—in the underperform camp. Price targets range from Chiaverini’s $3 to $15 at Jefferies and Mizuho, but even the low end reflects a price-earnings multiple of 30 times the consensus 10 cents per share on an adjusted basis for all of 2024, suggesting that Wall Street sees profitability eventually taking hold.

How much of that will come from the technology sector is a matter of some dispute. Among analysts with public predictions, KBW sees the platform earning fees of $350 million this year while Piper Sandler has it at $413 million.

When it was coming public via a special-purpose acquisition company deal in June 2021, SoFi sold itself to investors with the idea that its business is based on building lifetime relationships with its customers. The approach has worked in terms of gathering users, almost 7 million at the end of the last quarter, up from 2.3 million in March 2021, according to the company’s third-quarter results filing, and they tend to have good credit, with an average FICO score of 751—considered very good by provider Fair Isaac—across loan products in the period. Sales have grown by 29% or more each year since 2019.

At this juncture, however, with an uncertain future for interest rates, the threat of recession, competitive threats, a divisive U.S. presidential election and rising global strife, there are a lot of unknowns. Adelson, the Morgan Stanley analyst, who has a $7 price target, said he expects a “near-term stock pullback” for consumer-finance companies he covers, and the firm released an industry earnings preview that said most of the group would miss fourth-quarter estimates, with SoFi one of the most at risk, Bloomberg reported.

SoFi plans to report earnings for the fourth quarter of last year on January 29 at 8 a.m. New York time. KBW’s Perito, whose questions are more about the company’s valuation than business operations, wrote in his report that “achieving (and sustaining) profitability in 4Q23/2024 could be possible; however, we believe there are more downside scenarios to this outcome than upside, which at a premium valuation shifts us to a more cautious stance.”