Coinbase: Deep value opportunity in crypto?
"The way to make money is to buy when blood is running in the streets" - John D. Rockefeller Sr.
Coinbase Global, Inc. (COIN) arguably had one of the most grueling public listings in recent financial history. Since its direct listing the share price has fallen over 80%. VCs and insiders cashed out, while retail investors (and ARKK investors) were left holding the bag. Now Coinbase is trading at an interesting price compared to its profitability and cash/crypto reserves. We are left to wonder: is this a classic value trap or deep value?
Crypto winter is coming?
The public and media have been pretty cynical about Coinbase over the past weeks for several reasons:
- A crashing crypto market interpreted as tough times ahead for Coinbase.
- A quarterly loss (Q1 2022) interpreted as change in business dynamics.
- The Coinbase NFT platform does not seems to be as successful as anticipated.
- Brian Armstrong's tweet about an additional risk disclosure interpreted as a red flag for Coinbase business stability.
These are things we of course take into consideration, but we also have to realize that most of these factors rely on public perception and not necessarily have anything to do with reality.
Let's do the math
To get a perspective on the current market cap of Coinbase let's look at the latest 10-Q. COIN market cap is ~15B, while Total assets - customer custodial funds = ~20.9B - ~10B = 10.9B. To be conservative, let's assume its 1.3B worth of crypto assets will half and its goodwill (1B) is worthless. Then total assets = 10.9B - 0.6B - 1B = 9.3B. Total liabilities - custodial funds = ~14.4B - ~9.7B = 4.7B. We arrive at around 9.3B - 4.7B = 4.6B of solid equity. Coinbase has been able to run ~51% ROE with a profit margin of ~33.6% and operating margin of ~41.3%. Even if we assume its profitability halves and it is able to earn only 1B a year, it will take 10 years where market cap = earnings + equity. Looking at PE, Coinbase's current PE is 6 and is still low even if its earnings half (12). Note that the current PE ratio of the S&P 500 is still around 20. It seems there is a large margin of safety for COIN at this price. It only seems justified if the market expects a long period of losses or if there are many hidden risks that Coinbase is not disclosing.
From its 10-Q we can see Coinbase has ~6.1B in cash and ~4.1B in total debt, leaving 2B of runway if it would not be able to make a profit from this point on.
Furthermore, despite competition from platforms like Binance, FTX and Crypto.com, I would argue Coinbase still has a large moat as a cryptocurrency exchange. It has been one of the longest running crypto exchanges, succesfully navigating crashes in 2014 and 2018. With its focus on security it seems to be basically the only exchange that large institutional investors can feel comfortable working with. The company has a lot of experience with navigating bad times and seems to be prepared for navigating the current environment.
Business shifts
Looking again at the 10-Q, we can see that, year over year, the assets held on Coinbase shifted away from Bitcoin into other assets:
Q1 2021: 62% Bitcoin, 14% Ethereum, 21% Others and 3% Fiat.
Q1 2022: 42% Bitcoin, 24% Ethereum, 31% Others and 4% Fiat.
Unfortunately it leaves us guessing if the 31% others are put into solid projects or mostly in meme coins like Dogecoin and SHIB. However, it does not seem unreasonable to view the increasing emphasis on ETH and other assets indicating a shift towards Web3. Hopefully we will see an increasing focus on smart contracts, applications and assets being put to productive use. This would open up a large opportunity for things like Coinbase staking products.
There is also an increase in institutional trading volume, which will be a huge market opportunity for a secure and relatively mature exchange such as Coinbase. Many large institutions are just discovering cryptocurrencies and cannot afford to work with small and/or shaky exchanges.
Q1 2021 volume: 120B Retail, 215B Institutional.
Q1 2022 volume: 74B Retail, 235B Institutional.
Insider buying
Let's look at a famous quote by Peter Lynch: "Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise."
If Lynch is right, Coinbase co-founder + board director and Paradigm co-founder Fred Ehrsam definitely thinks the price will rise. He has been buying 75M worth of Coinbase shares over the last week at ~$65 per share. Most insiders, including Ehrsam, have been selling since Coinbase's direct listing at inflated prices ($170+). We also wouldn't consider buying at these prices from a value perspective. However, at ~$65 a share, we can see this insider buying as an additional indication that people with more information about the company than we have also believe the price is right, even if the company has to crawl through a tough crypto winter.
Conclusion
We could go on and on about all the things Coinbase has going for it, like Coinbase Cloud, Coinbase Wallet, exciting acquisitions regarding derivatives trading and cybersecurity, etc. However, the main goal of this piece is to give an indication that Coinbase seems to have a large margin of safety while at the same time operating in an industry with enormous growth potential (decentralized finance and digital assets). At the same time it is trading at a multiple more appropriate for a dying industry. If this peaked your interest, take a look at the recent 10-Q, 8-K, Statistics and Dataroma overview.
Disclaimer: I personally took a position in COIN a few weeks back. However, this write-up is not advice that you should buy Coinbase stock too. Always consider your own investment goals and what risks you can afford to take. My opinion also does not necessarily reflect the opinion of CrowdCent.
