A quick response to the Compass Point Sell rating
Ok, I've been through the Compass Point SoFi sell report. There is nothing new in here, but it is a well-written analysis of the bear case. Here are what the key arguments are:
1) Fair value accounting is boosting numbers and is a risk
2) It should be valued as a bank
3) The debt ceiling bump went too far so now it's overvalued
4) They cannot keep growing the balance sheet forever due to restrictions on capital ratios and therefore growth will slow once the balance sheet is full.
He also talks the possibility SoFi could be forced to move from fair value accounting to held-for-investement at-cost accounting, although he does not take this into account in his valuation. Management has said extremely clearly this isn’t even possible. Whether or not the rest of his analysis is right depends, in my opinion, on these key factors:
1) Will SoFi be able to sell their loans?
2) Will the market continue to see it as a bank and price it as a bank without growth?
He is completely right that SoFi cannot continue to grow its loan book forever. If they do not sell loans, they will hit a wall around 3Q23 or 4Q23 when they are forced by their capital ratios to either pull back on originations or sell loans from the books.
However, none of these bearish analyses take into account that noninterest income has taken a hit as a result of growing the balance sheet. Since they haven't been selling the loans, non-interest income has stayed flat in spite of increasing originations.
SoFi will not be able to keep growing the interest income (blue bars) at the same rate once they hit their capital ratios. Interest revenue should still increase, but at a more gradual pace. However, noninterest revenue ought to accelerate as long as they can sell the loans at the fair values they claim. This is where you need to make a judgement call. SoFi management has said that there is still demand for their loans, and that the reason they are not selling them is because they make more money by holding them. If they can maintain and grow originations and they are able to sell loans and maintain their historical gain-on-sale margins, the noninterest revenue (the green bars) will accelerate and growth will continue.
The risk here is that if they are unable to sell the loans, the interest revenue will top out once the balance sheet can no longer expand and the noninterest revenue will stay flat. In this case, growth would materially slow, ruining the SoFi growth story. This is a legitimate risk that all investors should take into account. I believe that the loans are such high quality that they will be able to find buyers. I could be wrong about that.
Compass Point completely ignores the tech platform
Out of the 22-page report, he only spent about one page talking about Galileo, and about half of that is just a description. He does not give the tech platform any credit in his valuation. The $5 price target is completely based on a 1.5x multiple to tangible book value. He does talk about how the tech platform could help this multiple and how it might be adjusted if you gave credit for the tech platform. However, that is not included in his actual price target.
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This is another analyst who sees SoFi as a bank and thinks it should be valued as just a bank. He is not giving them credit for their growth because he believes that growth will slow materially once the balance sheet can no longer be expanded. He does not give them any credit for their other businesses and bases the price target completely on a 1.5x multiple to their 2024 tangible book value. The tech platform is an afterthought that will only affect the price insomuch as it adds to tangible book value.
I think valuing SoFi as a bank that has no growth is a foolish way to view the company. I think SoFi will continue to compound growth at a 30%+ CAGR for at 2-3 more years. As such, I think this analysis is flawed. I do not believe he understands the business trajectory. I could be completely wrong, and growth could stall and it might then be reasonable for SoFi to be valued at the same level as its peers. I think I’ve put forth very compelling reasons why this is not going to be the case in prior articles and I won’t rehash those arguments here. All in all, this was not a hit piece at all. It is a well-reasoned presentation of the bear case. That bear case ignores growth that I think is fairly obvious.
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Disclosure: I have a beneficial long position in the shares of SOFI either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I have no business relationship with any company whose stock is mentioned in this article.
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