Coinbase: IPO Analysis

Price Targets:

• 1 Month Target: $260 (with upside) -> We expect some short-term volatility near the IPO (as of posting the price was $330)

• 9 Month Target: $75 (as of posting the price was $330)

Intro:

Coinbase is now nearly a household name amongst investors. For many, it was the first time you were able to easily acquire a “bitcoin” or any other alt-coin and feel like you could hold this mythical cryptocurrency. Fast forward 9 years from its inception in 2012 and Coinbase is the powerhouse of crypto-exchanges.

Coinbase makes most of their revenue (86%) from cryptocurrency transaction fees and in 2020, overall trading volume skyrocketed 142%, during which Bitcoin’s price went from sub $10k in price to nearly $30k.

When you think about it, these are all directly related to each other. As Bitcoin’s price rises, more investors are interested in investing, so the trading volume will increase which means’ Coinbase will make more revenue.

With so many institutions beginning to adopt cryptocurrencies as an asset class and trusting Coinbase (11% of all cryptocurrency assets are on Coinbase), the upside potential seems high in the long run, but as the crypto market matures, the revenue risk the company faces will mean it will need to evolve in order to meet the $100B valuation expectations.

Remember, this is our long-term analysis. We expect the stock to see a nice early bump just like how most of these high-profile IPOs have been structured.

If you’d like to ride the roller coaster over the next month, make sure you know when to jump out.

Details:

1. COIN’s revenue from transactions may not be sustainable as the market matures. In 2020, Coinbase averaged a transaction fee of about 0.57% which amounted to $1.1 billion in revenue. This seems like an amazing position to be in, but history shows that as markets mature and more firms begin to nip at Coinbase’s high margins of 0.46%, its leading position will soon be challenged by upstarts just like stock exchanges were challenged by the likes of Robinhood’s zero stock trading fees. In fact, competitors like Gemini, Bitstamp, Kraken, Binance and others will likely get aggressive and begin to offer lower or zero trading fees as a strategy to take on market share, which will initiate a “race to the bottom” that we saw Robinhood kick off in late 2019. Put it this way, if Coinbase’s revenue share fell to where traditional stock exchanges are today, 0.01%, its revenue would fall down 97% to $35M in Q1 from an estimated $1.5B.

2. COIN recognizes that it needs to reinforce the castle walls against its competitors. In its Q1’21 update, the company called for a 300% in sales and marketing expenses when compared to the same time last year. This mean’s that you should be expecting to see a whole lot of billboards, Instagram ads, and maybe even Superbowl commercials amongst many other promotions for Coinbase. This may seem like Coinbase is doing extremely well and expanding its reach, but let’s not forget that this massive increase in expense would hurt overall margins while the firm’s $100B valuation implies that the margin will hold steady.

Currently profitable, but is it worth $100B?

One of the standout reasons investors are hot on COIN is because it’s generating a profit.

It’s impressive, but don’t be mistaken, the $100B valuation implies the following:

1. 25% margin on net operating profit after tax needs to be maintained

2. Revenue needs to grow 50% compounded annually, which is well above the benchmark on Nasdaq’s 2004-2011 of 30% compounding growth.

3. Coinbase is expected to be trading at 11-12x revenue when compared to it’s peer group of 7

To put this in perspective, Coinbase will need to be earning $21.3 billion in revenue by 2027 which would be 150% Nasdaq and Intercontinental Exchange’s combined 2020 revenue, 46% of the trailing 12-month revenue of the 11 top Financial and Commodity Market Operators, and nearly double Charles Schawb’s 2020 revenue. To further illustrate this point, if Coinbase maintained its fees at 0.46% of trading volume, it implies that the overall trading volume on Coinbase would be $4.6 trillion by 2027, which would equal 97% of all cryptocurrency trading volume in 2020.

So if the world isn’t so rosy and actually full of competitors… what is Coinbase worth?

If we take a more realistic world view of other crypto exchanges waging war, decreased margin due to sales and marketing spend, and look at how history has shown how exchanges normalize as the market matures, we estimate that Coinbase is worth $18.9B - 81% downside to the expected valuation.

This is based on us assuming that revenue will grow 21% compounded annually (basically taking Nasdaq’s best of the best 10-year growth period) and reducing the NOPAT margin down to 23% (NOPAT represents a company’s potential cash earnings as if it had no debt.

While are nuances like NOPAT not including one-time losses or charges, typically related to a merger or acquisition, as a standalone value it is a very good starting point to analyze a business’s operating efficiency).

Conclusion:

While the company itself is doing extremely well, the market is overvaluing the company at the projected $100B valuation. Our long-term price target is based on historicals in stock exchanges and their growth and margin erosion as competitors enter the foray and ignite a race to the bottom.

It’s without a doubt that cryptocurrencies are increasing in popularity and that as more institutions adopt crypto as an asset class, more trades will happen on the top exchanges. But when the valuation of $100B implies that COIN will become the largest exchange in the world and maintain its margin, we advise caution and keep a watchful eye on how COIN can meet seemingly unrealistic expectations despite the early bump that these stocks will typically see. 

Ticker: COIN

Rating: Underweight