What’s going on here?
Hot on the heels of announcing soaring revenue last quarter, Coinbase – the largest cryptocurrency exchange in the US by trading volume – is set to begin offering shares publicly next Wednesday via a direct listing.
Some think Coinbase could be the hottest new stock of 2021: it’s a fast-growing and already highly profitable company exposed to an enormous market in a disruptive industry. But with a $100 billion valuation implying the firm is already worth as much as major investment bank Goldman Sachs, I thought it’d be worth assessing whether Coinbase shares really look like such a good buy.
What does this mean?
Coinbase offers its cryptocurrency exchange platform and wallet services to three main types of customer: individual retail investors, big institutional traders such as hedge funds, and “ecosystem partners” including merchants accepting crypto payments and issuers of crypto assets.
Coinbase earns about 85% of its revenue – which rose over 800% in the first quarter of 2021 compared to a year before – from charging commission fees on trading, mainly among retail customers. The rest comes primarily from subscription and services fees.
This means that Coinbase’s fortunes are closely linked to cryptocurrency price action – and particularly that of bitcoin, which continues to account for the majority of the market. Higher prices attract fresh investment, while even rapidly falling prices will drive higher trading volume. Just like at an investment bank’s trading department, this volatility leads to more fees and higher revenue.
But Coinbase’s reliance on crypto price movements makes it hard to forecast future revenue for the firm – and even harder to put a price on its own shares. To evaluate the potential of Coinbase, you probably need to think more like an early-stage venture capital investor rather than a traditional stock market analyst.
Coinbase provides many services, but investing is a big bet on bitcoin prices (Source: Coinbase)
Why should I care?
Coinbase’s shares will be freely available for you to buy and sell from next Wednesday Given the mixed performance of recent stock listings, it’s important to weigh up the risks and rewards of investing ahead of then.
The case for buying in
1️⃣ Big market opportunity
Coinbase’s addressable market is enormous. Its exchange is currently available in around 40 countries worldwide, with plenty of scope to expand beyond its current 56 million-strong user base – already up from 32 million a year ago and 43 million in December. The total market capitalization of all cryptocurrencies, meanwhile, is now around $2 trillion. With customer acquisition costs as low as $5.15, Coinbase could capture a growing slice of a growing pie.
2️⃣ Enormous profit margins
Coinbase boasts an adjusted EBITDA margin of 60%, up from 40% last year: higher than at payment firms Square (5%) and Paypal (30%), and almost as much as major exchange CME’s 65%. Coinbase’s costs – half of which are salaries – are largely fixed and unaffected by rising revenue. The company’s high-quality infrastructure and reputation for security also mean it’s able to charge retail traders higher fees than competitors – and attract business clients like Tesla.
3️⃣ Steadier revenue options
Coinbase wants to expand into new locations, new products and services, and new crypto assets (at present, only 1% of the world’s 9,000 cryptocurrencies are tradable). Many of these opportunities involve less volatile operating models – charging crypto custody fees, for example – that could bring greater stability to the firm's revenue.
4️⃣ Strong narrative
Coinbase is one of the first major crypto companies to go public. Investors looking to ride the rise of cryptocurrencies themselves – many of whom are barred from investing directly – may therefore view its shares as a proxy play. And that’s before you account for the support of an army of crypto-friendly retail investors.
The case for keeping out
1️⃣ Valuation
Coinbase’s market value has doubled this year to reach almost $100 billion – but that was before it reported monster first-quarter revenue of $1.8 billion a few days ago. Fast-growing fintech peers trade at around 15-20x the value of their revenue over the next twelve months – which implies existing private investors expect Coinbase to rake in revenue of around $6 billion across the whole of 2021.
That doesn’t seem so unreasonable anymore, but it still relies on cryptocurrency prices making further big moves. Check the table below once Coinbase shares close next Wednesday to see what revenue public investors are impliedly expecting. My view is that the number of unknown factors – many of them beyond the company’s control, such as the price of bitcoin – mean it’s almost impossible to assess whether the firm’s valuation is justified or not.
Implied revenues ($000s) and revenue multiples for Coinbase valuations of around $100 billion (blue)
2️⃣ Crypto winter risks
A lasting fall in cryptocurrency (and particularly bitcoin) prices would obviously be a major blow to Coinbase’s revenue. Somewhat counterbalancing this risk are the company’s long-term plans to scale up investment in new products when crypto prices are low. So as long as a crypto winter doesn’t turn into a crypto ice age, a fall in prices could therefore provide an interesting buying opportunity for potential Coinbase investors.
3️⃣ Limited short-term outlook for retail revenue growth
There are two main drivers of Coinbase’s all-important retail transaction revenue: monthly transaction users (MTUs) and average revenue per user. Coinbase’s first-quarter figures showed 6.1 million MTUs and average per-user revenue above $45. But the company’s own forecasts expect 5 million MTUs by the end of 2021, with average revenue falling to between $34 and $45. Unless crypto markets continue their meteoric rise, next quarter’s earnings could exhibit some shrinkage.
4️⃣ Increasing competition
The crypto space is filled with threats coming not only from other exchanges (such as Binance and Kraken) but also fintech firms, challenger banks, and payment apps like the aforementioned Paypal and Square. Battling for customers in such an environment could negatively impact Coinbase’s revenue growth and its profit margin.
5️⃣ Regulation & security
Regulatory risk ranks pretty high for Coinbase. If a country with lots of users changed the company’s regulatory status – based, perhaps, on a perceived danger posed to retail investors by crypto assets – it would have to scramble to scale back or alter the way it ran some of its most profitable segments. The ever-present threat of a cyber attack, meanwhile, could have a devastating impact given Coinbase’s trust-centric line of work.
So what’s my conclusion? Coinbase shares are a high-risk but potentially high-reward investment. The company’s stock price could easily drop 50% if one of more of the major worries outlined above materialized. But the stock’s upside may be greater than your 100% maximum downside. In my view, Coinbase displays many attributes that could see it become the next hypergrowth market success story. At the very least, it’s worth adding the shares to your watchlist and waiting for a buying opportunity that might just be too good to pass up.
