News of the Week (April 1 - 5)

News of the Week (April 1 - 5)

24 min read

Table of Contents

1. Nu Holdings (NU) – New Piece of the Portfolio

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Nu Holdings Ltd. Reports Fourth Quarter and Full Year 2021 Financial Results - Building Nubank

Over the last month or so, I’ve spent a large chunk of time researching Nu Holdings and Latin America. I’ll have a detailed investment case sent to you all this month, but I’ve started a new position in the firm and wanted to briefly explain why right now. I didn’t want to make you wait. This will serve as a very brief, 30,000 ft. view summary of the investment case… much more to come.

Banking is a commodity. Within commodities, the best way to differentiate is with an input, capital or operating cost edge.

That’s what Nu delivers with its branch-less business model and a cost-to-serve that is lower than any incumbent. Its customer acquisition cost is lower, its cost of risk is lower as its underwriting is better (across cycles) and it generates more revenue per user than alternatives too. This leaves us with a firm that is naturally more profitable than the competition, with a higher margin ceiling and greater cross-selling potential than anyone else in the Latin American space. These advantages are passed on as savings to clients via better account yields and lower loan interest rates.

That’s how you stand out in banking, and that’s what Nu provides in Brazil. It’s now quickly following that same playbook in Mexico with a 15% savings yield. That’s a steep price to pay for deposits, but leadership still thinks the 15% can coincide with a convincingly positive NIM. While it has 50%+ market share in  Brazil today, I see no reason why it won’t own a large chunk of the Mexican TAM as well. Its value proposition is perhaps even clearer there as its 15% savings yield compares to incumbents that charge clients for permission to park their funds. Customer growth in Mexico is already explosive and has accelerated since this yield was implemented. And? It already is the market share leader for new credit card issuance in Mexico (and now Colombia too). It is dominating Brazil, it is beginning to dominate in Mexico and should dominate in Colombia. 

The Nu balance sheet is pristine, with capital ratios at double the regulatory minimum for Nu Bank. This doesn’t include a larger cash buffer from the holding company that would make its ratios triple the regulatory minimum. It has successfully expanded into new credit demographics as well as secured and unsecured lending products while expanding its risk-adjusted net interest margin. That recipe shows proper risk underwriting, which will only improve with time. All of these items yield the following trends seen below:

From a macro perspective, Brazil and Mexico are both highly appealing (Colombia too). The populations are young and growing, with both governments driving Nu-friendly financial reform. Both countries combine very high interest rates with very low inflation. This leaves significant room to cut and accelerate Nu’s lending and interchange businesses. Brazil’s Financial Minister just told us that more cuts are coming. 

That will weigh on currency a bit and should be a net interest income headwind. But? The tailwind to origination volume and velocity of money should more than offset that pain, while easier policy diminishes risk of economic turmoil. Expected U.S. rate cuts should diminish the relative currency devaluation risk too. It’s a decent part of the cycle to be adding Latin American exposure, in my view. 

That’s as detailed as we need to get for now. It’s currently at 2% of my portfolio. Again, the investment case article coming this month will intricately expand on all of these ideas, more deeply cover Latin American economics, foreign exchange, and geopolitics, while introducing several new ideas as well. I can’t wait to share. Long Nu… hopefully for a long time.

2. SoFi (SOFI) & Robinhood (HOOD) – Credit Card & Bullish SoFi Analyst Notes

a. Credit Card Commentary

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Please note that I own SoFi and do not own Robinhood. That’s important context as we work through this section.

SoFi raised its cash back rewards card from 2.0% to 2.2% this week, for all categories. Many assume the timing is no coincidence, with this move being a direct response to Robinhood’s 3.0% cash back card for paying Gold members.

Robinhood's New Gold Card Goes Head-to ...

That could be the case, but I don’t really care. SoFi and Robinhood don’t compete like Twitter pundits seem to think. SoFi’s customer is a young, ultra-prime credit professional who isn’t passionate about single stock investing. Robinhood’s customer is the young, passionate retail investor. Different customers.

The Robinhood card will likely do well, and its success will have zero material impact on SoFi’s success. While these two firms do compete, they only compete in two of the smallest products that SoFi offers – credit cards and investing. Neither of those products are large lead generators for SoFi. And Robinhood even uses SoFi’s tech stack to power its own checking business.

The concern for both of these cards is how profitable they’ll actually be. The cash-back credit card has been a large, yet shrinking margin drag for SoFi to date. SoFi is basically giving users its entire interchange fee cut while Robinhood is giving them more than that cut (it would have already had to share some of the 3% interchange fee with ecosystem partners). So how are they going to make money? Via the anticipated direct deposit halo effect that coincides with lower churn and higher engagement from these high-value offerings.  That, and the Robinhood Gold subscriptions, which the card requires.

Candidly, I think SoFi has a better chance of making that work than Robinhood; that opinion isn’t solely powered by the lower rewards vs. Hood’s. SoFi’s primary banking and lending cores (you need to directly deposit your paycheck weekly to get the 4.6%) make its deposit base stickier and less cyclical. Still cyclical, but less so than Robinhood’s absurdly cyclical retail brokerage niche.

The deposit halo effect will likely work well for Robinhood when times are fun. The added net interest income from these deposits should be able to cover the hefty rewards. But don’t be surprised if we see material cuts to these rewards or Robinhood Gold price hikes when crypto isn’t rocking and retail volumes aren’t immensely strong.

This is a fragile game to play for both of them, but especially for Robinhood. Deposit churn amid potential tougher times in the future, paired with brand new credit risk, could turn sour. That will not happen now, but the next tough part of the cycle will be a real test. This is also a newer world for Robinhood than for SoFi, and credit card underwriting is not easy. Just ask Apple or Capital One or Discover… or yes… SoFi. SoFi doesn’t need to share fees from interchange take rates with as many 3rd parties as Robinhood does, thanks to its charter. Needham called that out explicitly in a SoFi note from this week. That also makes this more durably feasible for SoFi.

This seems like I’m picking on Robinhood, but I’m not. Their user interface is best in class by a large margin, and they’ve done very well with driving subtle brokerage innovation. I just see all of this excitement surrounding card rewards and think a bit of cold water should be poured on it. And regardless, congratulations to Hood shareholders on their excellent recent returns. My opinion here does not change the fact that you’ve made a lot of money. Take a bow.

In other SoFi news, Galileo offered post-purchase buy now, pay later financing options for its customers.

b. 2 Bullish Notes

Needham initiated SoFi coverage this week with a buy rating and a $10 price target. The initiation covered the business model, which I discuss frequently. Rather than repeating that, I wanted to highlight what’s new in this note as well as how estimates compare to consensus and SoFi’s own guidance.

Needham values SoFi’s lending business at $8 per share based on a 2.5x tangible book value (TBV) multiple. It talked up the same cost of funding edges with the charter vs. disruptors that we always do. It talked up the same diminished reliance on volatile capital markets too. It sees net interest margin (NIM) contracting slightly for the next two years due to the student loan mix shift and expected rate cuts. It still sees net interest income growth being quite positive as its asset base grows to offset subtle NIM deterioration. It sees NIM bottoming over 5%, with it around 6% currently.

It also dove into SoFi’s fair value accounting practices. To that, I say thank you. It mentioned SoFi’s good standing with all regulators, clean audits from a Big 4 Firm, and skepticism that it would be possible for SoFi to use overly aggressive marks without expedient regulator objection. I agree. It also spoke on SoFi’s default rate assumptions in 2024 providing a nice credit buffer to leave room for more deterioration than it expects.

Needham values the other two segments (tech platform & financial services) at $2 per share combined and sees them as “crown jewels.” It sees the tech platform compounding at a 22%+ clip for the next two years via new clients ramping and new products like post-purchase BNPL. It’s encouraged by these two segments continuing to grow as a piece of the pie, considering the more asset-light nature of the offerings vs. lending.

Despite the optimism, Needham still sees revenue growing at a 16% compounded clip for the next two years. 16% is essentially in line with SoFi’s guide for this year, but not at a two year compounded clip. SoFi sees 22.5% revenue compounding for the next 3 years, which would require material acceleration in 2025 and 2026. Needham doesn’t seem to expect that at this stage, yet the analyst is still optimistic. SoFi management has consistently shown you that its targets are always realistic or overly conservative. Noto’s interview 90% of the way through calendar Q1 made it seem like SoFi was gearing up to do more of the same.

I will say that sell side earnings estimates have been materially falling for SoFi since February. Sell siders now see $0.04 in EPS for 2024 vs. $0.14 just two months ago. Revenue estimates have fallen by more than 6% since November 2023. EBITDA estimates are basically flat, which shows the EPS reduction is related to expected dilution from the convertible note offering this year. The team explicitly told you the offerings will be NEUTRAL for EPS, yet analysts don’t think they’re close to right. This will set up a pretty fascinating Q1 earnings report. If SoFi’s team is right, I truly think the stock will be handsomely rewarded. If not, it will likely continue to be punished. I remain optimistic. We shall see what happens later this month. It will be yet another highly important report for this company.

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3. Disney (DIS) – Proxy Fight, Password Sharing & 2026

a. Proxy Fight

Disney won its proxy fight against Nelson Peltz and Trian. Trian will not get its desired board members. For now, this is pretty irrelevant to me. As I’ve said many times before, Iger is steering this turnaround in a surgical manner. This was a stamp of approval for the job he’s doing, while Trian’s pressure also surely placed a larger shareholder microscope over all of Disney’s actions. Works for me. Iger knows he has shareholder support; Iger knows he is being closely watched. Some say this spells concern for succession considering the board boggled the last leadership change. I’m speculating, but I truly don’t think Iger would have come back if he wasn't guaranteed more control over the process this time. And I also think recent board additions like James Gorman were quite positive. STILL, it’s very likely that I will exit Disney before his retirement if the company and stock perform well enough to avoid the risk of another botched succession.  Disney is not a 20% compound grower for the next 10 years, it is a recovery play.

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Separately, Iger was asked about Musk’s harsh words towards him in an interview this week. His response could not have been more perfect: