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Coinbase COIN S
October 05, 2023 - 2:48pm EST by
ElmSt14
2023 2024
Price: 72.00 EPS Negative Negative
Shares Out. (in M): 257 P/E NM NM
Market Cap (in $M): 18,532 P/FCF NM NM
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 16,803 TEV/EBIT NM NM
Borrow Cost: General Collateral

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Description

Short:                    COIN equity

Current Price:    $72.00

Target Price:      $35.00 at 2x tangible book which we think is generous; unlikely to be real EBITDA positive in our view

 

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Our thesis is that Coinbase is a timely short because it has rebounded strongly this year due to a combination of 1) Bitcoin being up +60% on the year and a large rally in low-quality stocks YTD but

  1. We believe that Coinbase’s core US franchise is at risk with the introduction of one or multiple Bitcoin spot ETFs, perhaps as soon as later this year, which should pressure both volumes and take-rate. 
  2. We believe that a positive (but faulty) legal decision that we think will get reversed soon
  3. We think the company should be valued closer to tangible book, as it largely makes money from interest income (which has benefitted from higher interest rates) and is unprofitable on its core crypto exchange operations.  We think the stock has more than 50% downside.

 

Background/Introduction

Pridwen pitched COIN as a short about a year and a half ago (https://www.valueinvestorsclub.com/idea/COINBASE_GLOBAL_INC/2183715169) with a good thesis that outlined the fact that the company was over-earning, losing market share and had very high customer acquisition costs.  We refer readers to that write-up and comment section for an overview of the business model and drivers.   

 

While many parts of that thesis were accurate, two notable developments were that:

  1. Coinbase has actually increased its fees as a short-term plug for revenues – with 2Q23 take-rates for consumer transactions being an egregious 2.2% compared to 1.2% at the time of the write-up
  2. Short term interest rates have increased substantially, so Coinbase has made up a lot of its operational shortfall with higher interest income, through no talent of their own

 

We think that the first part (consumer take rates) is imminently at risk and the second (interest rates) may be closer to its peak relatively soon.

 

Coinbase retail consumer segment

We believe that the imminent introduction of a spot-bitcoin ETF is going to be a distinct negative for Coinbase, both on volumes and on take-rate.  A quick timeline:

 

As shown below, retail consumer trading is the bread-and-butter of Coinbase’s business, accounting for nearly half of its revenues:

 

 

As you can also see, consumer trading is where Coinbase really rips off customers, with take-rates that are 100x higher than institutional clients – and that have almost doubled year/year to make up for lower volumes:

 

 

We believe that the introduction of multiple spot Bitcoin ETFs, with much lower fees and the ease of trading in an existing brokerage account (as opposed to a separate Coinbase app), will steal significant market share and pressure take rates.  This may happen as soon as later this month:

 

https://www.wsj.com/livecoverage/stock-market-today-jobs-report-09-01-2023/card/bitcoin-price-drops-back-after-sec-delays-fund-decisions-keamOjCdAYLIKZR9iaaP?mod=article_inline

 

With all of the major spot bitcoin ETF applications now delayed, the next date to watch is Oct. 16, the SEC's next deadline to respond to an application. The SEC can delay a decision again at that date if it chooses.

 

While Coinbase will likely pick up substantial institutional volumes as a results, as shown above, those volumes come with 0.02% take rates, compared to the 2.2% consumer take rates.  Even with $1 trillion of additional institutional volume, the incremental revenues pickup would be $200 million compared to the loss of potentially $600 million - $1 billion of consumer volume

 

 

SEC vs. Ripple and SEC vs. Coinbase

  • On June 6, the SEC filed its long awaited lawsuit against Coinbase and the stock went down to $52
  • On July 13, a judge named Analisa Torres in the Southern District of NY ruled in SEC vs. Ripple in a decision that, to put it mildly, has been heavily criticized by legal scholars and a higher-ranking judge in the same court à Coinbase increases 25% to $107 per share
  • On July 31, Judge Jed Rakoff issued a ruling in SEC vs. Terraform Labs that explicitly criticized the reasoning in Ripple – this ruling got far less attention and COIN stock remained in the high $90s

 

SEC vs. Coinbase                               https://www.sec.gov/files/litigation/complaints/2023/comp-pr2023-102.pdf

Torres USDC Ripple                         https://www.nysd.uscourts.gov/sites/default/files/2023-07/SEC%20vs%20Ripple%207-13-23.pdf

Rakoff USDC Terraform:               https://fingfx.thomsonreuters.com/gfx/legaldocs/gdvzwygzmpw/frankel-secvterra--MTDopinion.pdf

 

For the purposes of this write-up, we will not do a detailed analysis of all of the legal issues but touch on the crux of the matter:  Judge Torres’ ruling turns securities law on its head with a bizarre ruling that issuances to institutional investors in the primary markets (similar to IPOs) are securities and under the purview of securities regulations, but secondary market transactions among retail investors are not.  There is enormous volume of legal analysis that has pointed out the obvious flaws in this ruling, including Judge Rakoff’s ruling, and we think that this decision gets overturned and Coinbase’s stock goes back to the $50 level it had at the time of the SEC lawsuit.

 

In the appendix we have included the key excerpts and critiques of the ruling.

 

Valuation

Even ignoring the legal analysis and even granting the company full credit for its exorbitant current-take rates, Coin is still not profitable.  The company touts its adjusted EBITDA but it is a mockery of a metric made up entirely of stock-based comp and depreciation.  Consensus estimates call for $700 million of adjusted EBITDA but we think this is a phantom figure and will be adjusted downward as the ETF competition heats up next year. 

 

Given that literally the only line item that is a brightspot for Coinbase is interest income, we believe that a book value approach is the right valuation methodology.  Should the Fed decide to lower interest rates next year or the year after, we think Coinbase’s true losses will increase.  We think 2x tangible book or $34 per share is a generous price for this business.

 

Valuation:

 

Other Factors

  • Interest expense:  Coinbase is a beneficiary of the low interest rate world with 3 large debt issues with less than 4% coupons, all yielding more than 10%.  Granted, they are long-dated maturities, but if we are in a higher-for-longer world, the company’s interest expense will balloon to close to $400 million from its current $77 million interest expense

 

Short interest: There are 22 million shares short, or 14% of the float, but the borrow is readily available at general collateral rates and with 15 million shares average daily volume, we do not think short interest is an issue.

 

Risks

Bitcoin goes up

SEC / Ripple decision is upheld

Market Short Squeeze

Binance implosion – may be negative, may be positive but we do not believe so as Binance US market share has already gone to zero so Coinbase has already seen its benefits

https://www.wsj.com/finance/currencies/the-worlds-biggest-crypto-firm-is-melting-down-338b8e17

 

 

Ripple and Terraform Lab Cases

 

 

 

 

 

 

Legal reaction to Ripple ruling

 

Bloomberg/Matt Levine: https://www.bloomberg.com/opinion/articles/2023-07-14/ripple-is-a-security-and-it-isn-t?sref=ycYtR3EC

Yesterday the federal judge in the case, Judge Analisa Torres of the Southern District of New York, issued an important and rather strange ruling in the case.

 

Duke Blog: https://sites.duke.edu/thefinregblog/2023/07/17/reflections-on-the-ripple-decision/#:~:text=Judge%20Torres%20ruling%20is%20largely,accused%20of%20operating%20an%20unregistered

Conclusion

Until Congress acts, Judge Torres’ ruling opens the door for all kinds of creative methods for crypto developers to raise funds from the public without having to comply with ANY meaningful regulation (beyond general prohibitions against fraud and manipulation in commodity spot markets.) According to Judge Torres’ logic, if token purchasers do not know they are transacting with the token issuer, the securities laws do not apply (even if they do know, securities laws may still not apply provided the token issuer is not marketing the token as an investment opportunity). This is a recipe for investor abuse.

 

Ann Lipton: https://lawprofessors.typepad.com/business_law/2023/07/so-ripple.html?utm_source=securitiesdocket.beehiiv.com&utm_medium=newsletter&utm_campaign=doj-sec-cftc-and-ftc-line-up-to-charge-celsius-founder-with-fraud-and-much-more

The court held that the sales to institutional investors were sales of securities, but not the remaining sales.

I’ll start with: The holding makes no sense, but to understand where it’s coming from, you need to understand the arguments, which are similar to those made in other crypto cases.

 

Holland Knight: https://www.hklaw.com/en/insights/publications/2023/08/a-ripple-of-doubt

Perhaps chief among its bases for arguing why an appeal is needed now, the SEC points to a decision from another SDNY court expressly rejecting, in part, the finding in Ripple Labs – a possibility we predicted could occur following the original ruling.

 

https://www.pbwt.com/securities-enforcement-litigation-insider/sec-v-ripple-labs-analysis-of-summary-judgment-opinion

This outcome inverts first principles of securities law, including that disclosures should be encouraged so as to allow investors to better assess risk, and that less sophisticated investors need more protection than the more sophisticated.[21]  These odd results may encourage the SEC to file an interlocutory appeal and the Second Circuit to reverse.

 

Rare lawyer defending the Ripple ruling / Bill Morgan: https://www.cryptoglobe.com/latest/2023/08/xrp-crypto-lawyer-bill-morgan-defends-judge-torres-ruling-in-sec-v-ripple-case/

 

Disclaimer:  I, my firm, or my firm’s clients may have a position (long or short) in the securities discussed herein and may change such position without further notice.  This is not a recommendation to buy or sell any security.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1. Introduction of spot Bitcoin ETF

2. Reversal of Ripple decision

3. SEC lawsuit against Coinbase

4. Maybe interest rates going down

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