Coinbase: An alternative way to invest in cryptocurrencies.
Opdateret: 30. apr.
Personally, I find it difficult to value cryptocurrencies. While I do hold some different cryptocurrencies, I must admit that it is mostly for the fun of it, and I have no idea if I bought them cheap or expensive. Hence, when a company such as Coinbase IPO, it is interesting, as I can get some exposure to cryptocurrencies and still have an idea if the stock is cheap or expensive. In this analysis, I will share my opinion and make some calculations on Coinbase.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
This analysis will be a bit different from what you are used to read in my blog. Coinbase is a growth company, and because of that, I believe it is better to do a discounted cash flow analysis. So instead of using the principles I have learned from my Phil Town workshop, I use the principles I have learned from the GOAT academy. I should also mention that most of the numbers I use in this analysis is from Finbox, which I believe is a great tool to get different numbers from various companies.
Before I start with the analysis, I should mention that I do not currently own shares in Coinbase. However, I'm a happy customer of the company. I find the interface of Coinbase very simply compared to other cryptocurrency exchanges, and as I have only invested a little in cryptocurrencies, and it is a buy and hold position for me, I don't mind paying a little extra fees to make it easier for myself. Furthermore, I think their "learning rewards" feature, where you can earn free tokens by watching some videos, is reason enough to sign up for Coinbase, regardless if you want to buy cryptocurrencies or not. I mean, who says no to free money, even if it is only a little. Only bad thing is that being in Denmark, I do not get all my tokens staked. However, it is easy and fast to transfer them to Nexo, where you get daily interest that compounds. Nevertheless, my own positive experience with the company will not affect this analysis, as I will stay objective throughout the analysis.
Coinbase is an American company that was founded in 2012 and operates a cryptocurrency exchange platform. They serve both retail and institutional customers. They generate almost all their income by charging fees when their customers deposit funds or either buy or sell cryptocurrencies. In 2022 transaction contributed with 74,81 % of the total revenue. Coinbase generate transaction revenues from both consumers and institutions, but consumers are contributing to most of the revenue by far, as approximately 95 % of the transaction revenues were from consumers in 2022. Even though Coinbase is a trusted company that has never lost any funds due to a security breach, and that they have more than 100 million verified customers in more than 100 countries all over the world, I don't think that Coinbase in the current state has a moat. However, in their prosperous, they did mention several things that sets them apart from their competitors such as being the market leading brand, having a trusted platform, having an easy-to-use platform, and having significant scale. These things might develop into a moat with time but so far, I don't believe they have a moat.
Their CEO is Brian Armstrong. He is also the co-founder of Coinbase, which is something I like, as founders are usually determined in growing the business. He has a dual bachelor's degree in economics and computer science and a master's in computer science from Rice University. Prior to founding Coinbase, he has worked as a developer at IBM, a consultant at Deloitte and as a software engineer at Airbnb. When he was at Airbnb, he experienced firsthand how difficult it was to send money to South America, which lead him towards the crypto space. As a CEO, he would like to build a certain culture throughout the company, and I found it quite interesting to read "The Coinbase Culture Doc", which gives some insights in his way of thinking. The culture doc focusses on six tenets of their culture and are as following: Top talent in every seat, play as a championship team, be candid and kind, focus on the customer, foster repeatable innovation, and act like the owner. While he put much more words on the tenets in the actual doc, I think these headlines explains very well in which direction he would like to take Coinbase. While some of them are more obvious than others, I personally like that focusing on the costumers get such a high priority, while he also encourages innovation and responsibility. Personally, I believe that having a very clear-cut company culture will help not only growing the company but also result in happy employees. Looking at the score at Comparably, Brian Armstrong and his management team receive a high score, and the CEO score is in top 5 % if similar sized companies.
I believe that Coinbase doesn't have a moat yet, but they might build one in the future. I do feel very confident about management though. Later I will do a discounted cash flow model to calculate a price for Coinbase but before I do so, let us just have a look at some key financial metrics.
Down below we see some key financial metrics from the last three years. Coinbase delivered some great numbers in both 2020 and 2021, as they managed to grow revenue tremendously. Coinbase also managed to grow their operating margin, EBITDA margin, and EBIT margin from 2020 to 2021. Thus, managed to deliver an impressing growth, which is seen in EPS that went from 1,4 in 2020 to 14,50 in 2021. However, 2022 was hard on Coinbase that was affected by the 65 % drop in Bitcoin in 2022. Revenue dropped by approximately 60 %, and while Coinbase continued to deliver a 100 % gross profit margin, operating income, EBITDA, and EBIT all turned negative, and Coinbase was no longer profitable. Coinbase has done some things to improve operating income in 2023 as they have significantly reduced headcounts, and it will be curious to see if Coinbase manages to be profitable again in 2023.
Before we continue to the discounted cashflow model, I would like to investigate the risks and potential of Coinbase. One large risk that their revenue is dependent on the price of crypto assets. The best example of this is seen in 2022 as you can see in the numbers above. Coinbase still make most of their revenue from transaction fees, and transactions are very correlated to the price of cryptocurrencies. Thus, if we see another bad year for Bitcoin and other crypto assets, it will hurt Coinbase. One thing that is positive though is that Coinbase do better than the overall crypto market. One example is Q4 2022, where general trading volumes declined by 21 %, while the trading volume at Coinbase declined by 12 %. Hence, it it is indicating that Coinbase win market shares. Another risk is possible cyberattacks and security breaches on their platform. Luckily, it hasn't happened yet but if we are to see cyber-attacks or security breaches, it would significantly damage their brand, and if their platform is unavailable for some time, it would hurt their revenue as no trading can be done. They operate in a highly competitively market. Coinbase expects that competition will further intensify moving forward, and if they don't build a moat within long, they could lose customers to current or new competitors. Finally, regulations in the crypto industry could be hurt their business. Cryptocurrencies are still new, and it must be expected that we will see more regulations moving forward in most countries. It is too early to say how these regulations will be, and how it will affect not only crypto assets but also exchanges, but if more countries take the same stance as China, it could hurt the whole sector.
There are also lots of potential for Coinbase moving forward. The crypto market is still in an early phase. In the third quarter of 2021 the total crypto market capitalization was $2 trillion compared to $800 billion in the third quarter of 2020. However, as written previously, the trading patterns are very much correlated with the price of crypto assets. Thus, the crypto market capitalization is $1,2 trillion in April 2023. If we see another crypto bull market, the total crypto market capitalization will probably reach new highs. Furthermore, cryptocurrency adaption is still growing. In the first half of 2021 the number of crypto users globally was 200 million, and it is expected that it will grow to 420 million by the end of 2023. Coinbase will diversify revenue. Coinbase wants to diversify revenue to not be so correlated to the price of crypto assets. Coinbase wants to diversify revenue through three different areas. One is staking rewards, which was 3 % of net revenue in Q4 2022. Another is subscription fees, through Coinbase Pro, which is already up and running, and through launching Coinbase Bundle, which allow users to access a curated portfolio of cryptocurrencies at a fixed price. And finally, through institutional services, where Coinbase will provide various solutions for institutions such as custody, execution, data and lending. Coinbase is building a moat. While I believe Coinbase doesn't have a moat as it is, they are slowly building a brand moat. They are not going to compete on lower fees but have decided to focus on customer experience. The way they have reduced the complexity of crypto and emphasized intuitive product design has resulted in them to be the primary crypto exchange where customers start buying crypto currencies. They are going to further increase the customers experience by proving 24/7 customers' support. In the next paragraphs I will go through my calculations to find the intrinsic value of Coinbase.
I have now investigated the financials, risks, and potential of Coinbase. I will now look at the price by doing a discounted cash flow model. To do so I will need some numbers that you can see below. The numbers are the 2022 numbers, which I could find at Finbox. However, the perpetuity growth rate and the discount rate are numbers I have come up with myself. The reason I chose 3 % as perpetuity growth rate is that it is usually a between the historical inflation rate of 2-3% and historical GDP growth of 4-5%. I decided to go with a 3 % as it is right in the middle. The chosen discount rate of 12% is because it is usually between 9-12%. I decided to go with the higher discount rate due to the sector that Coinbase operates in. Remember that all the numbers made in these calculations are in millions.
I also need to determine how much EBIT, Depreciation & Amortization and Net Working Capital will evolve over the next couple of years. As we saw previously, EBIT was negative in 2022. However, Bitcoin and other cryptocurrencies have rallied so far in 2023, and Coinbase has reduced operating costs. Thus, I have decided to use the EBIT from 2020 at 545. I have calculated that EBIT will grow by an average 85 % a year, which is the growth forecast at Finbox. I decided to use the Depreciation and Amortization from 2022 and expects that it follows the line of EBIT and grows by 85 % a year. Historically, it has grown more per year. Finally, I decided to use the Net Working Capital from 2022, which was much higher than previous years, and I expect it drop by 10 % a year in the next five years. Unfortunately, I cannot find a smart way to share the whole sheet in here, but you get the numbers, so you can do it yourself. However, once I my calculations, I found that the intrinsic value of a Coinbase share to be $59.
Having investigated Coinbase, I find the company to be interesting way to get exposure to the cryptocurrency market, as compared to cryptocurrencies, you have some numbers to base some calculations on. I don't think that Coinbase currently has a moat, which puts me a bit off from investing in the company. However, I really do like the management, and I'm very confident in Brian Armstrong being able to grow Coinbase moving forward. There are lots of potential for Coinbase, as I'm quite confident that more people will use crypto currencies moving forward, and many will start their journey at Coinbase. To keep them there, I think Coinbase is having the right strategy by focusing on the customer experience rather than the lowest fees. However, I also think there are some risks moving forward, as it is hard to believe that we won't see any regulations at some point, and it is difficult to know what affect they will have on a company like Coinbase. Personally, I don't know enough about cryptocurrencies to invest in Coinbase in my copytrading portfolio, but I may buy a small speculative position outside of my copytrading portfolio below $40.
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