SoFi’s (SOFI) shares are down 50% over the last one year but the stock may not have bottomed out yet. Latest data reveals that short interest in the name rose by 12.6% in the latest reporting cycle. This development is indicative of intensifying selling pressure from short-side market participants, and it suggests that the stock may have room to fall further over the coming weeks and months. Let’s take a closer look to gain a better understanding of it all.
The Shorting Intensifies
Let me start by saying that short interest is basically the aggregate number of short positions that are open and are yet to be covered. A sharp rise in the metric generally indicates that market participants are actively stacking short bets against a stock, in the hopes that it corrects in the subsequent weeks. Conversely, a dramatic drop in the metric points to an active market-wide short unwinding as, perhaps, the Street perceives the stock to have limited downside potential. So, the short interest metric is a handy tool to gauge the ever-evolving market sentiment pertaining to any given stock.
Coming back to SoFi Technologies, its short interest at the end of the latest cycle stood at 71.28 million, which marks a 12.6% increase sequentially and a 199% increase over the last 8 months. It’s worth noting that the credit services firm has about 564 million shares in public float which means that roughly about 12.6% of its tradeable shares had been shorted at the end of the latest short cycle. This is a significant increase of shorting in the name. I personally consider short interest to be significant once it accounts for over 10% of the company’s total public float, and SoFi has crossed that threshold.
Next, I wanted to see if short-side market participants were targeting SoFi in particular or if the entire industry group was witnessing heightened shorting activity of late. So, I pulled up the short interest data for about 45 other US stocks that also belong to the credit services industry. The results were rather interesting. As it turns out, most of the stocks (62.2% to be specific) in our study group saw a reduction in their short interest figures at the end of the last cycle. This suggests that market participants were not bearish on the credit services industry in general, but were growing bearish on SoFi of late.
We’re now presented with an interesting insight. We know that SoFi’s shares are down almost 30% over the last 6 months. If market participants felt the stock was bottoming out, they would’ve actively wound up their positions and moved their capital to more lucrative opportunities instead. Yet, short interest in SoFi continues to climb rapidly. This indicates that market participants are expecting the stock to further decline in value over the coming weeks and months. This development begs the question – why are market participants so keen on shorting SoFi Technologies’ shares in the first place?
Reasons for Caution
It’s worth noting that SoFi received its national bank charter about three weeks ago. This was not a surprise as the company has mentioned its intent to get the license, in its prior SEC filings (like here). As far as the long-term picture is concerned, the national bank charter expands SoFi’s total addressable market, stands to lower its cost of borrowing funds and also opens up upselling / cross-selling opportunities for the company. Overall, this development is positive for its continued growth.
However, in the near-term, the banking charter also means that SoFi Technologies is likely to see heightened compliance costs since it’s now going to operate as a bank. From the company’s recent 10Q filing:
If we are successful in securing a national bank charter through the proposed acquisition, we expect to incur additional costs in our operation of the bank primarily associated with headcount, technology infrastructure, governance, compliance and risk management, marketing, and other general and administrative expenses .
As a reminder, SoFi had $ 533.5 million in cash and equivalents on its books as of September 30, 2021. It, then, raised $ 1.2 billion by issuing convertible notes during October 2021. So, I do not see a dire need to raise capital immediately in order to survive. But if the bank intends to grow this new business vertically rapidly, nationwide, then it’ll have to raise more capital. It can:
- Dilute its existing shareholders in order to raise capital, and / or;
- Issue more interest bearing debt.
Neither of the above-mentioned scenarios look good on paper, at least not for the growth-seeking investors who have a short to medium term time horizon. We also do not know about the extent to which SoFi’s management will tap the above-mentioned avenues of capital funding. This very uncertainty, in my opinion, is one of the reasons that’s hurting investors’ sentiment of late.
Besides, banking stocks in the US are generally trading at significantly lower price-to-book multiples. Now that SoFi is venturing into the banking space, its overall multiple is likely to be valued closer to bank stocks and its shares could fall further.
Lastly, with inflation running rampant, the Street is expecting 4 interest rate hikes during 2022. This means that SoFi’s interest expenses and its cost of borrowing funds, could both variably increase during 2022, depending on the quantum of interest rate hikes.
There’s no denying that SoFi is a rapidly growing company. Its revenue has almost doubled between FY18 and FY20, which is a commendable feat. With its new bank charter, the company can now expand its ecosystem of financial products, offer competitive interest rates to draw users and keep growing its revenue over the coming quarters.
Having said that, it’s also worth remembering that good businesses do not always translate into good stocks. The company is currently surrounded by a few uncertainties – such as rising interest rate risk, risk of shareholders dilution, risk of being rerated like a traditional bank – which present near-term headwinds for the stock.
This, in my opinion, is why SoFi’s shares have been correcting of late. The buildup of short interest corroborates the narrative and suggests that the stock may see further downside in the weeks to come. So, risk-averse investors who do not have the appetite for significant portfolio drawdowns, may want to avoid the stock for the time being at least. Good Luck!