1Q22 Earnings Show Coinbase’s Struggles
PIECE OF MONEY
Figure 1: COIN performance vs. S&P 500 from initial danger zone through 5/12/22
1Q22 weakness is a sign of things to come
As noted in the previous March 2022 update, the growth and profitability achieved by Coinbase in 2021 was not sustainable – 1Q22 proved it. In Coinbase’s neighborhood:
- Net operating income after tax (NOPAT) margin fell to -19% from 43% in 1Q21
- turnover of invested capital increased from 0.4 to 0.4, compared to 1.4 in 1Q21
- return on invested capital (ROIC) fell to -7% 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 also weak:
- trading volume hit its lowest level in five quarters
- monthly transacting users (MTU) fell 19% quarter over quarter
- average transaction revenue per user (ATRPU) was $35 in 1Q22, compared to $64 in 2021, $45 in 2020 and slightly above $34 in 2019.
Orientation is no better
Going forward, I expect Coinbase’s margin and revenue growth rates to decline as competition increasingly eats away at its business. Increased volatility, or another downward move, in the crypto market could also spook retail investors after big losses so far this year.
Management’s forecast for 2022 does little to allay concerns that the company is heading in the wrong direction. The guide shows:
- MTUs should be lower in 2T22 than in 1T22
- total trading volume expected to be lower in 2Q22 than in 1Q22
- predicted range for MTUs in 2022 between 5 and 15 million, not exactly an accurate estimate
- ATRPU in 2022 is expected to return to “pre-2021” levels, which certainly implies a decline
On the 1Q22 earnings call, management also noted that its goal “is to run the business roughly even, smoothed out over time for now.” In other words, the record profitability of 2021 is in the rear view mirror.
Don’t Ignore New Bankruptcy and Regulatory Risks
As noted in Coinbase’s latest 10-Q, the company faces the real risk of bankruptcy. The following statement was added this quarter:
“In the event of bankruptcy, the crypto assets we hold on behalf of our clients could be subject to bankruptcy proceedings and such clients could be treated as our general unsecured creditors.”
This public acknowledgment could instill fear among the company’s customers. Fear of bankruptcy proceedings could cause customers to cash out their investments as quickly as possible, further weakening Coinbase’s business and bringing the company even closer to bankruptcy.
As cryptocurrency grew in popularity among investors, regulations also increased. The Infrastructure Bill passed last year contains provisions increasing tax reporting requirements on cryptocurrencies, and I think this 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 biggest exchanges in the world
Although COIN has fallen 85% since the opening price on the date of its IPO, the stock is still significantly overvalued. Below, I use my inverse discounted cash flow (DCF) model to illustrate the high future cash flow expectations implied by Coinbase’s current valuation.
To justify its current price of ~$60/share, Coinbase needs to:
- achieve a 6% NOPAT margin (half Fidelity National Info Services’ TTM margin), long-term (2022-2031) despite the consensus for negative earnings in 2022 and management’s goal of achieving the balance of operations and
- increase revenue by 25% per year through 2031 (vs. consensus estimate of 4% CAGR from 2021 to 2024)
In this scenario, Coinbase would earn $73 billion in revenue by 2031, which is greater than the combined TTM revenue of the top 10 financial and commodities market operators. plus Charles Schwab (SCW) 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 of operating the business at “break-even” for “currently,” even a 6% NOPAT margin can be optimistic.
71% drop even if the consensus is correct
I examine an additional DCF scenario to highlight Coinbase’s downside risk even as the company grows at consensus rates and gradually improves its margins from minus 19% in 1Q22 to 6% long-term.
If I assume that Coinbase:
- NOPAT margin equals 1% in 2022 (just above break-even) and improves to 6% by 2027,
- revenues grow at consensus rates in 2022, 2023 and 2024 (-37%, 54% and 14%), and
- revenues increase by 10% per year from 2025 to 2031, then
COIN is only worth $17/share today, down 71%.
A 6% margin over the long term can be optimistic for several reasons. First, Coinbase plans to increase hiring, expand internationally, and significantly increase its technology and general and administrative expenses in the near term.
Second, as I’ve noted in the past, competition looms large and can eat away at any opportunity for outsized margins (i.e. the zero-fee race) given that Coinbase is dependent on transaction fees to most of his income. Traditional exchange operators, brokers and payment companies such as PayPal
Third, it is unlikely that Coinbase can simply stop spending to achieve its high 2021 profitability again, at least in the long term. Coinbase must continually spend on marketing and advertising, not only to promote its product, but also to convince new users of the underlying utility of crypto.
Stock traders don’t have this problem (or expense), because despite criticism, the stock market and its derivatives are widely accepted forms of financial value and offer tangible uses such as managing risk, raising capital, etc share faces criticism and questions about its use at every turn, which Coinbase must dispel, at no cost.
Figure 2 compares Coinbase’s implied future revenue in the above scenarios to its historical revenue as well as Charles Schwab’s 2021 revenue and the combined 2021 revenue of Intercontinental Exchange and Nasdaq.
Figure 2: Historical and Implied Coinbase Revenue: DCF Valuation Scenarios
Each of the above scenarios also assumes that Coinbase’s invested capital equals 10% of revenue each year. This growth in invested capital is less than half of the change in invested capital as a percentage of revenue in 2020 and 2021. If I assume that Coinbase’s invested capital grows at a similar rate to 2020 and 2021, the downside risk is still most important.
Selling for cash on hand might be the best case scenario
As Coinbase continues to spend heavily to expand its platform and keep up with the latest crypto market developments, investors may view sustainable profits as a distant dream rather than a mid-term reality. In such a scenario, the best case scenario (rather than spending money on a loss-making business) might be to sell the business for its cash value net of liabilities, or $1.0 billion. However, even this scenario is a bit of a moving target, given that Coinbase burned through $1.4 billion in cash in 1Q22 alone. That said, Coinbase’s net cash value in 1Q22 is $5/share.
Worse still, if investors or potential suitors consider the company’s ability to sustain an “ongoing concern” to be tenuous, which would be likely in such a scenario, they could push for a lower price or even be scared off. by concerns about legal action.
Look beyond the current rating
Coinbase’s record profitability in 2021 makes my Robo-Analyst rating on the stock attractive. However, 1Q22 results and management guidance reveal that the company’s financial performance in 2021 is not sustainable and earnings are going to be much lower in the medium to long term. The view of human analysts at my company is that the stock presents a worse risk/return than its current Robo-Analyst rating suggests. Going forward, I expect the company’s profitability to decline as expenses increase and growth slows, crypto adoption loses momentum and regulation increases. If the company’s performance is in line with my expectations, its Robo-Analyst stock rating will be downgraded as soon as its record 2021 results slip further and further into the past.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation for writing about a specific stock, industry, style, or topic.
 Companies in this group include Cboe Global Markets (CBOE), CME Group
 Consensus estimates based on seven analyst estimates in 2022, 24 in 2023 and 14 analyst estimates in 2024.