COIN

Coinbase Global, Inc.

62.71
USD
6.50%
62.71
USD
6.50%
40.83 368.90
52 weeks
52 weeks

Mkt Cap 9.74B

Shares Out 155.24M

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Q1 2022 Earnings Shows Coinbase's Struggles

With Coinbase (NASDAQ:COIN) down 77% year-to-date (YTD) and 85% since we first put the company in the Danger Zone in March 2021, investors might be thinking now is the time to get shares at a discount. Think again. Coinbase's 1Q22 results and guidance do not bode well for the future, and we think shares are worth as little as $17/SHARE even with optimistic assumptions for long-term margins and revenue growth. Figure 1: COIN Performance Vs. S&P 500 Since Initial Danger Zone Through 5/12/22 Weakness In 1Q22 A Sign Of Things To Come As noted in our prior update in March 2022, the growth and profitability achieved by Coinbase in 2021 was unsustainable - 1Q22 proved as much. In the quarter Coinbase's: net operating profit after-tax (NOPAT) margin fell to -19%, down from 43% in 1Q21 invested capital turns fell from to 0.4, down from 1.4 in 1Q21 return on invested capital (ROIC) fell to -7%, down from 58% in 1Q21 free cash flow (FCF) was -$1.4 billion, compared to $969 million in FCF in 2021. Coinbase's own preferred metrics were weak as well: trading volume reached its lowest level of the past five quarters monthly transacting users (MTUs) fell 19% quarter-over-quarter average transaction revenue per user (ATRPU) was $35 in 1Q22, down from $64 in 2021, $45 in 2020, and slightly above $34 in 2019. Guidance Is No Better Going forward, we expect Coinbase's margins and revenue growth rates to decline as competition increasingly eats into its business. Increased volatility, or further downward movement, in the crypto market could also spook retail investors after big losses so far this year. Management's 2022 guidance does little to assuage the concerns that the business is headed the wrong direction. Guidance shows: MTUs is expected to be lower in 2Q22 than 1Q22 total trading volume expected to be lower in 2Q22 than 1Q22 expected range for MTUs in 2022 anywhere from 5 to 15 million, not exactly a precise estimate ATRPU in 2022 is expected to return to "pre-2021" levels, which certainly implies a decline In the 1Q22 earnings call, management also noted that their goal "is to roughly operate the company as breakeven, smoothed out over time for the time being". In other words, the record profitability of 2021 is in the rearview. Don't Ignore New Bankruptcy & Regulatory Risk As noted in Coinbase's latest 10-Q, the company has to address the real risk of bankruptcy. The following statement was added this quarter: "in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors." This public acknowledgement could spark fear in the company's clients. The fear of bankruptcy proceedings could drive clients to cash out their investments as quickly as possible, further weakening Coinbase's business, and bringing the company even closer to bankruptcy. As cryptocurrency rose in popularity among investors, regulations have increased as well. The infrastructure bill passed last year contains provisions increasing the requirements for cryptocurrency tax reporting, and we expect that is just the beginning. Additional regulations could diminish the popularity of cryptocurrency as an asset class and negatively impact Coinbase's growth trajectory. Coinbase Is Priced To Be Bigger Than The Largest Exchanges In The World Despite COIN falling 85% since the opening price on its IPO date, the stock is still significantly overvalued. Below, we use our reverse discounted cash flow (DCF) model to illustrate the lofty expectations for future cash flows implied by Coinbase's current valuation. To justify its current price of ~$60/SHARE, Coinbase must: achieve a 6% NOPAT margin (half of Fidelity National Info Services TTM margin), over the long term (from 2022-2031) despite consensus for negative earnings in 2022 and management's goal of "breakeven" operations and grow revenue by 25% compounded annually through 2031 (compared to consensus estimates of 4% CAGR from 2021-2024) In this scenario, Coinbase would earn $73 billion in revenue by 2031, which is greater than the combined TTM revenue of the 10 largest Financial & Commodity Market Operators[1] plus Charles Schwab (SCHW) and Robinhood (HOOD). Coinbase would also earn $4.1 billion in NOPAT in 2031, which would rank second, behind only Charles Schwab, in the group of companies noted in the revenue comparison. Given management's goal to operate the business at "breakeven" for "the time being", even a 6% NOPAT margin may be optimistic. 71% Downside Even If Consensus Is Right We review an additional DCF scenario to highlight the downside risk in Coinbase even if the company grows at consensus rates and gradually improves its margins from negative 19% in 1Q22 to 6% long-term. If we assume Coinbase's: NOPAT margin equals 1% in 2022 (just above breakeven) and improves to 6% by 2027, revenue grows at consensus rates in 2022, 2023, and 2024 (-37%, 54%, and 14%[2]), and revenue grows by 10% compounded annually from 2025-2031, then A 6% margin over the long-term may prove optimistic for a few reasons. First, Coinbase plans to increase hiring, expand internationally, and greatly increase its technology and general and administrative expenses in the near-term. Second, as we've noted in the past, competition looms large, and can eat away at any opportunity for outsized margins (i.e. race to zero fees) given Coinbase's reliance upon transaction fees for the majority of its revenue. Traditional exchange operators, brokers, and payment companies such as PayPal (PYPL) or Block (SQ) could see Coinbase's weakness a chance to take market share and limit Coinbase's long-term profit potential. Third, it is unlikely Coinbase can simply stop spending to again achieve its high profitability of 2021, at least over the long-term. Coinbase must continually spend on marketing and advertising, not just to promote its product, but also to convince new users of crypto's underlying usefulness. Stock exchange operators don't have this problem (or expense), because despite criticisms, the stock market and its derivatives are widely accepted forms of financial value and provide tangible uses such as risk management, raising of capital, etc. Crypto on the other hand faces criticism and questions about its use at every turn, which Coinbase must dispel, at no small cost. Figure 2 compares Coinbase's implied future revenue in the scenarios above to its historical revenue as well as Charles Schwab's 2021 revenue and the combined 2021 revenues of Intercontinental Exchange and Nasdaq. Figure 2: Coinbase's Historical and Implied Revenue: DCF Valuation Scenarios Each of the above scenarios also assumes Coinbase's change in invested capital equals 10% of revenue in each year. This growth in invested capital is under half the change in invested capital as a percent of revenue in both 2020 and 2021. If we assume Coinbase's invested capital increases at a similar rate to 2020 and 2021, the downside risk is even larger. Selling For Cash On Hand Could Be Best Case Scenario As Coinbase continues to heavily spend on expanding its platform and keeping up with the latest developments in the crypto market, investors may see lasting profits as a faraway dream, rather than a medium-term reality. In such a scenario, the best-case scenario (rather than spending money on a money-losing business) could be to sell the business for the value of its cash net of liabilities, or $1.0 billion. However, even this scenario is a bit of a moving target, given that Coinbase burned $1.4 billion in cash in 1Q22 alone. With that said, the value of Coinbase's net cash as of 1Q22 is $5/SHARE. Worse yet, if potential investors or suitors see the company's ability to maintain as a "going-concern" as tenuous, which would be likely in such a scenario, they could push for a lower price or even be scared off by concerns about lawsuits. Looking Beyond The Current Rating Coinbase's record profitability in 2021 drives our Robo-Analyst rating on the stock to Attractive. However, 1Q22 results and management guidance reveal that the financial performance of the business in 2021 is not sustainable and that profits are going to be much lower in the medium and long term. Our human analysts' view is that the stock holds worse risk/reward than its current Robo-Analyst rating suggests. Looking forward, we expect the company's profitability to diminish as expenses rise and growth slows with crypto adoption losing momentum and regulations rising. Should the company's performance follow our expectation, its Robo-Analyst stock rating will be downgraded soon as its record 2021 results slide further and further into the past. Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, sector, style, or theme. [1] Companies in this group include Cboe Global Markets (CBOE), CME Group (CME), Deutsche Borse AG (OTCPK:DBOEF), Fidelity National Information Services (FIS), Interactive Brokers Group (IBKR), Intercontinental Exchange (ICE), MarketAxess Holdings (MKTX), Nasdaq Inc. (NDAQ), Tradeweb Markets (TW), and Virtu Financial (VIRT). [2] Consensus estimates based on seven analyst estimates in 2022, 24 in 2023 and 14 analyst estimates in 2024. Get our long and short/warning ideas. Access to top accounting and finance experts. Deliverables: 1. Daily – long & short idea updates as necessary, forensic accounting insights, chat features 2. Weekly - exclusive access to top-ranked long & short ideas 3. Monthly - 40 large, 40 small cap ideas from the Most Attractive & Most Dangerous Stocks Model Portfolios 4. Quarterly – Best & Worst ETFs and Mutual Funds in each Sector & Style This article was written by New Constructs is an independent research technology firm that provides unrivaled insights into the fundamentals and valuation of private & public businesses. Combining human expertise with machine learning and NLP, the firm shines light into the dark corners (e.g. footnotes) of millions of financial filings and provides superior investment research. The firm's Robo-Analyst technology is the first-ever vertically integrated investment research platform: performing data collection, financial modeling and assigning investment ratings to over 10,000 securities - automatically. This new technology is research automation at its best according to: 1. Harvard Business School & MIT Sloan prove our fundamental data is superior. 2. Ernst & Young proves the superiority of our financial analytics over Capital IQ & Bloomberg. 3. Indiana Kelly School of Business proves our stock ratings outperform human analysts. If these prestigious institutions trust us so much that they decided to publish official papers to prove the superiority of our research, then you can safely trust us, too. New Constructs' clients include investors of all types from quant funds like GSAM who subscribe to proprietary data feeds, advisors and individuals who subscribe to our investment research directly through our website. David is CEO of New Constructs (www.newconstructs.com). David is a distinguished investment strategist and corporate finance expert. He was a 5-yr member of FASB's Investors Advisory Committee. He is author of the Chapter “Modern Tools for Valuation” in The Valuation Handbook (Wiley Finance 2010). Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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