Coinbase (COIN) has been down as much as 50% off its highs, since IPO. We know the crypto market is struggling right now, and has a lot of headwinds with tightening monetary policy. But, if you believe in crypto as a long-term play, an investment in COIN can pay huge dividends if you're willing to ride out the volatility.
Coinbase was founded in July 2011 by former Airbnb engineer Brian Armstrong. In 2012, co-founder Fred Ehrsam, a former Goldman Sachs trader, joined the company, after which Coinbase launched services to buy, sell, and store bitcoin. It is now the leading cryptocurrency exchange in the U.S., for its reputation, compliance, and track record as a custodian. Because of these things, Coinbase has been able to maintain transaction fees above many of its peers.
As you can imagine, or probably know, Coinbase has experienced phenomenal growth with the rise and fall and rise again of cryptocurrency. But, I think the jury on cryptocurrency – regardless of any upcoming volatility – is out... it's here to stay, and it's only going to grow in the long-term. Coinbase, as the leading on-ramp from crypto, is going to be a beneficiary to this trend.
As innovation in crypto continues, Coinbase has been able to diversify it's revenues from transaction fees to crypto-collateralized loans, crypto debit cards, and other blockchain-related support/services. Let's take a deeper look at its revenues...
As it stands, 85% of Coinbase's revenues come from transaction fees. This is revenue they generate from crypto assets being bought and sold on their platform. Right now, which you'll see in more detail in our valuation, they earn about ~0.35% on total transaction volume.
Transaction volume is mostly (~70%) driven by institutions; but it's important to note that the majority (~95%) of transaction revenue is driven by retail – which you can see below.
For this reason, it's very clear that the short-term success of Coinbase relies HUGELY on retail adoption and trading... or put more "bearishly" speculative behavior. We'll look at the risks later.
Subscription and Services Revenue
Subscription and Services Revenue growth is trending to be much higher in 2021... about twice the growth in transaction revenue. This is a good sign of crypto maturing (a bit) into the utility phase, where people are being involved in staking and other yield-generating activities.
But, again, its important to note that 20% of these revenues are coming from Coinbase Custody – its custodial service for institutional clients.
Other Revenue includes sale of and income generated from Coinbase's own crypto assets. Occasionally Coinbase will transact with these, and generate profits from doing so.
As always, our valuation spreadsheet is available to members of the email list. You can also ask any questions you may have, and engage in conversation in our Discord. I highly recommend you do.
Valuing Coinbase is a very difficult thing to do; and for that reason any valuation (whether it be mine, or anyone's) should be taken with a grain of salt because of the high level of uncertainty.
There are key assumptions that we'll need to make with regards to the crypto market, which obviously no one has a crystal ball to. For the purposes of my valuation, I assumed that the growth of Coinbase (and crypto) would be relatively flat until 2024. This is probably a fair "base case", imo. Of course, we'll have more volatility that I can build into this model; but assuming that margins are normalized at 25%, Coinbase should have EPS of $6.58 in 2024.
Coinbase, which you can see in our DCF model, is a cash flow generating machine! I estimated an average of $2.5B of free cash flows over the next four years, and they have no long-term debt. With that, I get a fair value per share of $500... which is 100% upside from where they're trading. However, there are other models to use, which give us more conservative results... like I said, the high level of uncertainty has to be considered here and ultimately you need to make the call when investing your money.
When I factor in normalized FCF, Sales, and Earnings multiples, I can feel comfortable in assigning a $300 price target... which if you can get this stock at $215, where it seems to consistently bottom, you're looking at a 30-40% upside.
But, let's understand the risks before making any moves...
- The most obvious risk here is in the crypto markets (and the macroeconomic environment) itself. It's been historically volatile, and we are likely at the end of one of the biggest bull runs. The correlation between the price of Bitcoin and Coinbase can be seen in the charts. But, with Coinbase you're getting more than just Bitcoin... you're getting a business with free cash flows. It's correlation to Bitcoin should diminish over time, as it diversifies its revenues.
- Revenue Diversification is another key risk that Coinbase needs to address over time. As you saw, its increasing revenues from Subscription is helping mitigate this risk. The total assets on the platform, which is shown below, is also moving away from Bitcoin dominance – but we don't know if this is just aligned with normal crypto cycles.
- Competition is probably Coinbase's most significant threat, given it doesn't really have an economic moat. There are many crypto exchanges popping up, which are doing a lot of volume. Binance, other Chinese exchanges and Singapore's Crypto.com are doing increasing volumes. However, Coinbase has an advantage of being the major U.S. player.
- Regulation is another key risk overhanging the entire crypto market. In the past, SEC did prevent Coinbase from launching Lend – its lending product due to regulatory concerns. But, I also think that Coinbase's compliance is a reason why its a trusted brand with investors globally.
CRO vs Robinhood Stocks
Other "competitors" I considered was Crypto.com (CRO) token and Robinhood (HOOD) stock. Very quickly, here's why I believe Coinbase is the superior investment.
First, CRO, is not a security. It's a utility token on Crypto.com's ecosystem. So, it's not a fair comparison to begin with. However, if you are bullish on Crypto.com as an exchange, CRO token can provide you with yields for holding by staking and mining other cryptocurrencies using their Supercharger. I actually think CRO is a great investment, which is more direct holdings of crypto. Crypto.com is being super aggressive with marketing and potentially taking some share from Coinbase. However, I think Crypto.com and any foreign exchange is going to face more regulatory scrutiny in the U.S. It is what it is. But, that stop me from investing in CRO... it's just a different animal, with an overlapping exposure.
Robinhood (HOOD) is a competitor because of its reliance on cryptocurrencies for revenues. It has nearly 20M monthly active users... which is almost 3x Coinbase. Robinhood's latest financial results show a clear slowdown in retail participation in the stock market, which is what prevented me from investing in. Because of this, it appears that Coinbase is already taking the heat for the slowdown it'll inevitably see in crypto trading. But, unlike Robinhood, Coinbase is actually profitable. HOOD is still losing money on a GAAP-basis. For that reason, I'd go with COIN any day.
Sometimes we get opportunities to get in investments where we have to double-check to see what we're missing... why is this deal so good... and that's the case with Coinbase. The deal is undeniably good, with a 24x P/E for a company growing +300% YoY. But, the market (for good reason) doesn't believe that growth to be sustainable. However, the key difference between Coinbase and any other speculative growth stock in the market that's getting hammered right now, is that Coinbase is profitable and cash-flow generating. Can they be generating the same FCF yields in the bear market? They are much more mature company, so there is a pretty good chance of that.
In my opinion, investing in Coinbase comes down to individual portfolios and how much crypto exposure you already have (or don't have). If there's no, or limited crypto exposure, at the moment, I think an investment in Coinbase here makes sense.
Coinbase is also launching an NFT marketplace, which I didn't want to give too much weight in my valuation, because I do believe that category to be in a serious bubble. But, for what it's worth, OpenSea, the largest NFT marketplace just got a $13.3B valuation – which is 25% of Coinbase's market cap. Coinbase probably has 5x the users as OpenSea and would be much easier and more liquid for NFTs.
Yes, there's a lot of hype... but I do believe in the technology. Coinbase is a very calculated gamble at these levels, imo. But, if I were to start a position, it would be very small or "nibble" into it, as they say... because, as early as we are in crypto, the average "investor" is still speculating, and this will slow down.
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