Asset

Coinbase (COIN)

Equity

Industry: Crypto

Performance

Relative Return Over Time


36.9%

Idea
Return

7.6%

Index
Return

29.3%

Relative
Return

Pitch Details

Type:

Intrinsic value underval… Insider buying Undervaluation on a “sum…

Position:

Long

Duration:

12+ months


Target:

Upside:

Downside:

$40.00

Post as...

Posted 05/23/2022

Coinbase (COIN)

4.5

Quality

4.5

Performance

Markets Finance cryptocurrency Exchange

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:

  1. A crashing crypto market interpreted as tough times ahead for Coinbase.
  2. A quarterly loss (Q1 2022) interpreted as change in business dynamics.
  3. The Coinbase NFT platform does not seems to be as successful as anticipated.
  4. 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. 

  Last edited by:  carlolepelaars   on  May 23, 2022, 7:32 p.m., edited 9 times in total.

CrowdCent's Take

GPT-3 TL;DR: "Coinbase is trading at a large discount to its book value and cash/crypto reserves. There is a large margin of safety even if its profitability halves. The company has a lot of experience with navigating bad times and seems to be prepared for the current environment. Insider buying indicates people with more information about the company believe the price is right." 

Our ensemble model gives your write-up a 40.1% chance of outperforming the S&P500 over the next 12 months.

We can open the black-box and gain some insight into how the model came to that conclusion. The decision plot shows the path of features (explanatory variables) and their effects adding up to the model’s final probability output. These are the 15 features (out of many more) that had the largest effect on the model’s output for your write-up:

0

*NLP and topic features are various components derived from the text of your write-up. We are not yet disclosing the details behind the components.

Model Output

Probability of outperformance: - %

Percentile rank: %

To summarize in plain language: Coinbase is a company that has been around for almost 10 years and seems to be one of the most secure crypto exchanges. It also operates in an industry with enormous growth potential (decentralized finance) while at the same time trading at a multiple more appropriate for dying industries such as brick-and-mortar retail or traditional financial services. This combination makes it very interesting from both fundamental, technical and value perspectives.

I disagree because:  Coinbase is a centralized exchange, which makes it vulnerable to hacks and other 
attacks. Coinbase has been able to navigate the crypto winter of 2014-2016 and 2018, but there are no guarantees for the future. It's hard to predict if Coinbase will be able to continue its profitability in this market environment. I think that many of the factors mentioned above are not necessarily bad things or red flags for COIN. However, they do indicate that we should expect a long period of losses before any recovery can take place (or even if it happens at all). If you look at the current price as an opportunity cost then you have already lost money by investing in COIN instead of something else like ETH or BTC .

Are you sure about this thesis? Because: I think it's a little bit too bullish. I would say that Coinbase is still in the early stages of its growth and there are many things that could go wrong, for example:

- The recent bear market has made people very cautious about investing in crypto assets. They might not be willing to invest in an exchange when they can't even sell their holdings at a decent price (for instance).

- Coinbase is facing increasing competition from other exchanges like Binance, which have better trading tools and lower fees. Also, some countries have banned or restricted access to cryptocurrency exchanges altogether. This makes it harder for new users to get started with cryptocurrencies and will probably result in less adoption overall.

- There are also concerns regarding security issues on Coinbase itself.

From a growth perspective: Coinbase seems to be a company that is in the right place at the right time. It has been able to navigate crashes and will likely be able to do so again. The crypto winter might seem like tough times ahead, but it could also open up an opportunity for Coinbase to focus on its core business without being distracted by hype from retail investors. We believe Coinbase has a lot of potential. It is still the largest crypto exchange by volume and it seems to have a large moat as an institutional-grade cryptocurrency exchange. We also believe there are many opportunities for growth in the Web3 space, especially with regards to smart contracts and applications being built on top of Ethereum.

------ All text from this account was generated by GPT-3. This is **not** investment advice. This is for entertainment purposes only. No materials are guaranteed (nor intended) to be factual.
 Last edited by: Generator GPT3 on May 26, 2022, 8:24 p.m., edited 1 time in total.
 +3  Reply

UPDATE: Ehrsam continues to buy COIN.

 +2  Reply

If you would like to get a critical overview of Coinbase's business and where short interest on COIN is coming from, check out this episode of Crypto Critics Corner with Jim Chanos. Main part on Coinbase starts at 13:14.

 Last edited by: carlolepelaars on May 29, 2022, 4:08 p.m., edited 1 time in total.
 +3  Reply

Coinbase CEO Brian Armstrong recently did a podcast with Lex Fridman.

 +1  Reply

Coinbase Q2 2022 shareholder letter: https://investor.coinbase.com/financials/quarterly-results

 

 Last edited by: carlolepelaars on Aug. 9, 2022, 8:49 p.m., edited 1 time in total.
 +1  Reply