Shares of SoFi Technologies (NASDAQ:SOFI) plummeted 25% this week after the New York Stock Exchange announced it was delisting rival First Republic Bank from the exchange.
The stocks of PacWest (NYSE:PACW), Western Alliance Bancorporation (NYSE:WAL) and SoFi would shed a combined $2.5 billion within days.
Yet, as the Sesame Street song goes, one of these stocks does not belong.
SoFi is an online bank that generates fee income from customers, making it more like a fintech firm than an outright bank. By contrast, First Republic, PacWest and Western Alliance are pure deposit-taking banks that rely on net interest income.
Now that shares of SoFi have fallen below $5 again, investors finally have an entry price for this fast-growing stock.
SoFi Technologies: The Magic $5 Entry Price
SoFi Technologies is a San Francisco-based online bank founded in 2011 to process student loans. The firm has since expanded into related products covering mortgages, insurance, personal banking and credit cards. Many services are outsourced to third parties if SoFi can’t directly provide them.
Essentially, SoFi’s management realized that certain financial products are ideal loss leaders. Mortgages and home insurance, for instance, are commoditized industries; people will shop for the best rates and have little loyalty to any bank. Private student loans often operate the same way, and SoFi can offer lower prices to get people in the door.
Meanwhile, bank products like savings accounts and personal loans are far stickier. The same price-sensitive mortgage customers might go without changing bank accounts for decades, even if a neighboring credit union begins offering a higher savings rate. Investment accounts and IRA plans are equally hard to move once established.
SoFi thus uses competitive products to get new customers in the door, then cross-sells higher-margin products to these existing relationships. It’s the equivalent of a mortgage firm hawking high-yield time deposits and zero-interest credit cards. Not only are their customers already in their system. The mortgage broker will already have creditworthiness information and can price these products accordingly.
Investment banks have long used this practice to target high-net-worth clients. Many bulge-bracket banks have teams spanning wealth management, trading, equity analysis, and trusts to gain the maximum value from wealthy clients.
SoFi uses this concept to target younger, less wealthy clients on a far broader scale. It’s a business that relies heavily on fee income rather than interest spreads. In its first-quarter earnings call on May 1, SoFi’s management revealed that adjusted revenues had risen 52%, outpacing its 24% increase in loan growth by a wide margin. That shows the firm is successfully monetizing customers without increasing its balance sheet, and SoFi could become profitable by the end of this year.
The Difference With First Republic Bank
On the other hand, most regional banks like First Republic earn their keep through net interest income, the spread between the interest they earn from loans less the interest paid on deposits and other funding.
In other words, they’re forced to acquire “sticky” deposits head-on with enormous amounts of marketing.
Some go the route of building thousands of branches. The 4,000 branches of Bank of America (NYSE:BAC) outnumber the KFCs in the U.S. and cost the bank roughly $7 billion annually in upkeep. Meanwhile, firms like First Republic and Silicon Valley Bank courted business accounts that are more prone to causing bank runs.
Still, the outcome is the same. All traditional deposit-taking banks are highly leveraged entities that rely on risky debt to generate acceptable returns on equity. Not a business that you want to grow too quickly.
What’s SoFi Stock Worth?
My method of valuing SoFi involves 1) dividing the firm into traditional banking financial services components, 2) establishing the worth of each, and then 3) adding the two entities back together to determine total enterprise value.
Here, we can give SoFi’s online banking business a relatively balanced valuation. Wall Street estimates peg net interest income at $896 million annually through 2025, representing a relatively high 5.8% net interest margin. We’ll assume these margins are too optimistic and that these figures will only reach 5.5%. But we’ll also say that the potential growth rate is too low since SoFi has successfully converted existing loan customers into depositors at rapid rates. Assuming SoFi’s figures fall to 5.5%, we apply a 4.5X multiple typical of high-growth banks to bring us to a $3.8 billion valuation, or $4.09 per share
Then we have SoFi’s services business, the fintech portion that generates fee income.
Here, valuations bands are wider. SoFi is fast-growing, but its lack of profits provides greater uncertainty. Analysts believe the firm can increase this segment’s revenue from $992 million this year to $1.6 billion by 2025, a 27.5% compound growth rate, but SoFi currently loses around $2 for every $1 generated.
Here, a discounted cash flow model is helpful. Assuming operating profits eventually reach the 20% range, the justified value for the fintech side of the business comes to roughly $8.5 billion, or $9 per share. More aggressive assumptions can put its value as high as $15 billion, while conservative assumptions could drop its value to $3 billion.
In the most likely case, SoFi combined value is between $13-$20 today. And if growth rates reaccelerate, these figures will be far higher.
SoFi vs. First Republic: Why One Isn’t Like The Other
It’s always tempting to use shortcuts in investing. SoFi’s focus on affluent young tech workers seems much like the customers that First Republic and Silicon Valley Bank once courted. And SoFi’s growth in personal lending has put some investors on high alert. To these skittish traders, SoFi shares should trade at only a minor premium to tangible book value. The risks of paying more seem too great.
Yet, significant differences stand between SoFi and regional banks. SoFi has far “stickier” deposits, having avoided the temptation of courting corporations for business. The firm also has a different business model that focuses on the fee income generated from cross-selling products and services. In 2022, SoFi generated 63% of its revenues from these activities.
That makes SoFi at $5 a golden opportunity to buy a promising fintech stock for cheap. Though risks indeed remain, the expected share value provides a potential return that’s well worth the risk.
As of this writing, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.