Personally, I find it difficult to assign value to 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 goes public through an IPO, it is interesting because I can gain exposure to cryptocurrencies and also assess whether the stock is undervalued or overvalued. In this analysis, I will share my opinion and provide 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 begin the analysis, I should mention that I do not currently own any shares in Coinbase. However, I am a satisfied customer of the company. I find the interface of Coinbase to be very simple compared to other cryptocurrency exchanges. Since I have only made a small investment in cryptocurrencies and I plan to hold onto them, I don't mind paying slightly higher fees in exchange for the convenience it provides. Furthermore, I believe that Coinbase's "learning rewards" feature, which allows users to earn free tokens by watching videos, is a compelling reason to sign up for the platform, regardless of whether or not you are interested in purchasing cryptocurrencies. I mean, who says no to free money, even if it is only a little? Only the downside is that, being in Denmark, I am unable to stake all of my tokens.However, it is easy and fast to transfer them to Nexo, where you can earn daily compound interest. Nevertheless, my positive personal experience with the company will not influence this analysis, as I will maintain objectivity throughout. If you want to buy shares or fractional shares in Coinbase, you can do so through eToro. eToro is very user-friendly and easy to get started with. You can start with as little as $50. Click on the picture below to get started.
Coinbase is an American company that was founded in 2012 and operates as a cryptocurrency exchange platform. They serve both retail and institutional customers. They generate almost all of their income by charging fees when customers deposit funds or engage in buying or selling cryptocurrencies. In 2022, transactions contributed with 74,81% of the total revenue. Coinbase generates transaction revenues from both consumers and institutions, but consumers contribute to the majority of the revenue. In fact, approximately 95% of the transaction revenues in 2022 came from consumers. Even though Coinbase is a trusted company that has never lost any funds due to a security breach, and has more than 100 million verified customers in over 100 countries worldwide, I don't believe that Coinbase currently has a moat. However, in their prosperous, they did mention several things that set 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 over time, but as of now, 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 appreciate, as founders are typically committed to growing the business. He holds a dual bachelor's degree in Economics and Computer Science, as well as a master's degree in Computer Science from Rice University. Prior to founding Coinbase, he worked as a developer at IBM, a consultant at Deloitte, and a software engineer at Airbnb. When he was at Airbnb, he experienced firsthand how difficult it was to send money to South America, which led him towards the crypto space. As a CEO, he would like to cultivate a specific culture throughout the company. I found it quite intriguing to read "The Coinbase Culture Doc," which provides insights into his thought process. The culture doc focuses on six tenets of their culture, which are as follows: top talent in every seat, playing as a championship team, being candid and kind, focusing on the customer, fostering repeatable innovation, and acting like the owner. While he elaborated on the tenets in the actual document, I believe these headlines explain very well the direction he would like to take Coinbase. While some of them are more obvious than others, I personally like that focusing on the customers gets such a high priority, while he also encourages innovation and responsibility. Personally, I believe that having a well-defined company culture will not only contribute to the growth of the company but also lead to employee satisfaction. Looking at the score on Comparably, Brian Armstrong and his management team receive a high rating. In fact, the CEO score places him in the top 5% among companies of similar size.
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.
Below, we see key financial metrics from the past three years. Coinbase delivered impressive financial results in both 2020 and 2021, with significant revenue growth. Coinbase also managed to increase their operating margin, EBITDA margin, and EBIT margin from 2020 to 2021. Thus, they managed to deliver impressive growth, as seen in the EPS (earnings per share) which increased from 1,4 in 2020 to 14,50 in 2021. However, 2022 was hard on Coinbase, as it was affected by the 65% drop in Bitcoin prices. Revenue dropped by approximately 60%, and although Coinbase maintained a 100% gross profit margin, its operating income, EBITDA, and EBIT all turned negative, resulting in Coinbase no longer being profitable. In an effort to improve operating income in 2023, Coinbase has implemented significant headcount reductions. It remains to be seen whether Coinbase will be able to regain profitability in 2023.
Before we proceed with the discounted cash flow model, I would like to examine the risks and potential of Coinbase. One significant risk is that their revenue is dependent on the price of cryptocurrency assets. The best example of this can beseen in 2022, as indicated by the numbers above. Coinbase still makes most of its revenue from transaction fees, and transactions are highly correlated with the price of cryptocurrencies. Thus, if we experience another challenging year for Bitcoin and other cryptocurrencies, it will have a negative impact on Coinbase. One positive aspect is that Coinbase performs better than the overall cryptocurrency market. One example is Q4 2022, where general trading volumes declined by 21%, while the trading volume at Coinbase declined by 12%. Hence, it is indicating that Coinbase is winning market shares. Another risk is the potential for cyberattacks and security breaches on their platform. Luckily, it hasn't happened yet. However, if they were to experience cyber-attacks or security breaches, it would have a significant impact on their brand. Additionally, if their platform were to become unavailable for any period of time, it would negatively affect their revenue since trading would be impossible. They operate in a highly competitive market. Coinbase expects that competition will further intensify moving forward, and if they don't build a moat in the long run, they could lose customers to current or new competitors. Finally, regulations in the crypto industry could hurt their business. Cryptocurrencies are still new, and it is expected that we will see more regulations moving forward in most countries. It is too early to say how these regulations will unfoldand how they will affect not only crypto assets but also exchanges. However, if more countries adopt the same stance as China, it could have a detrimental impact on the entire sector.
There is also a lot of potential for Coinbase moving forward. The cryptocurrency market is still in its early phase. The crypto market is growing rapidly. In August 2020, the total market cap was $800 billion, and by August 2023 the market cap is 1,2 trillion, which is after a rough 2022. However, as mentioned earlier, the trading patterns are highly correlated with the price of cryptocurrency assets. If we experience another crypto bull market, the total market capitalization of cryptocurrencies will likely reach new record highs. Furthermore, cryptocurrency adoption is still growing. In the first half of 2021, the global number of crypto users was 200 million, and it is expected to grow to 420 million by the end of 2023. Coinbase will diversify its revenue. Coinbase aims to diversify its revenue to reduce its correlation with the price of cryptocurrency assets. Coinbase aims to diversify its revenue through three different areas. One is staking rewards, which were 3% of net revenue in Q4 2022. Another aspect is the inclusion of subscription fees, available through Coinbase Pro, which is already operational. Additionally, Coinbase is launching Coinbase Bundle, which will enable users to access a carefully selected portfolio of cryptocurrencies at a set price. And finally, through institutional services, Coinbase will provide various solutions for institutions, including 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 enhancing the customer experience. The way they have reduced the complexity of crypto and emphasized intuitive product design has made them the primary crypto exchange where customers start buying cryptocurrencies. They are going to further enhance the customer experience by providing 24/7 customer support. In the following paragraphs, I will outline my calculations to determine the intrinsic value of Coinbase.
I have now investigated the financials, risks, and potential of Coinbase. I will now examine the price by utilizing a discounted cash flow model. To do so, I will need some numbers that you can see below. The numbers are the 2022 figures, which I found on Finbox. However, I have determined the perpetuity growth rate and the discount rate myself. The reason I chose a 3% perpetuity growth rate is that it typically falls between the historical inflation rate of 2-3% and the historical GDP growth rate of 4-5%. I decided to go with a 3% as it is in the middle. The chosen discount rate of 12% is because it falls within the typical range of 9-12%. I decided to go with the higher discount rate because of the sector in which Coinbase operates.Remember that all the numbers used 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 its operating costs. Thus, I have decided to use the EBIT of 545 from 2020. I have calculated that EBIT will grow by an average of 85% per year, which aligns with the growth forecast at Finbox. I decided to use the Depreciation and Amortization figures from 2022 and expect them to follow the trend of EBIT, growing by 85% per year. Historically, it has grown more each year. Finally, I decided to use the Net Working Capital from 2022, which was much higher than in previous years, and I expect it to drop by 10% per year over the next five years. Unfortunately, I cannot find a convenient way to share the entire spred sheet here. However, I have provided the numbers so that you can perform the calculations yourself. However, once I completed my calculations, I found that the intrinsic value of a Coinbase share is $59.
Having investigated Coinbase, I find the company to be an interesting way to gain exposure to the cryptocurrency market. Unlike cryptocurrencies, Coinbase provides some numerical data that can be used for calculations. I don't think that Coinbase currently has a moat, which puts me off a bit from investing in the company. However, I really do like the management, and I'm very confident in Brian Armstrong's ability to grow Coinbase moving forward. There is a lot of potential for Coinbase, as I'm quite confident that more people will use cryptocurrencies moving forward, and many will start their journey at Coinbase. To keep customers engaged, I believe Coinbase is employing the right strategy by prioritizing the customer experience over offering 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 effect 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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