Coinbase: Stock Price Has Surged But Where To From Here?

Summary Coinbase's stock price has more than doubled since my previous article, and its market capitalization is now $33 billion. Decentralized finance is becoming recentralized as investors value creditworthiness and trust regulated intermediaries like Coinbase. Coinbase's market share has not significantly changed, and its profitability is still far from exchanges like CME. Even if it achieved 40% net profit margins, P/E would still be 30+. Considering the above, I would not rate this stock as a buy until its market share and/or profit margins see sustained and large improvements. In my October 2022 piece on Coinbase ( COIN) , I argued that (i) Coinbase would benefit from potential consolidation in the crypto industry (ii) Coinbase might perform better than crypto assets. Since then (as can be seen in the chart below), Coinbase's stock price has more than doubled, and its market capitalization is now $33 billion. Given much has happened over the past year, where will Coinbase go from here? Coinbase stock pricce (stockcharts) Decentralized finance becomes recentralized As I previously argued, while one of the reasons crypto became popular was its vision of decentralized finance, it was likely that "recentralizing" would happen because investors would value the creditworthiness of crypto exchanges: Investors need a trusted, well-regulated intermediary/exchange (e.g. Coinbase). Unfortunately without the regulations and checks and balances of traditional finance, to put it mildly, some of the other crypto exchanges did not perform so well (e.g. FTX ), which by contrast enhances the creditworthiness and value of Coinbase. After the initial novelty of crypto wore off, crypto turned out to be just another asset class and keeping assets safe become a more prominent consideration. Even if Coinbase charges a small fee per trade and a smaller platform charges zero commissions for crypto trading, given all that has happened with smaller platforms, investors may rather pay Coinbase for the ease of mind than fret over what might happen with a smaller platform. To some extent, Bitcoin ETFs have reflected this need: Investors are investing in Bitcoin as an asset but as a product traded on a traditional exchange. Against this background, I believe Coinbase has carved out a niche that it can potentially monetize. But is it worth the $33bn market cap? Is Coinbase worth it? I previously benchmarked Coinbase against other exchanges such as CME due to the similarities in the business model. When you strip away the crypto factor, Coinbase is just another exchange with network externalities and captive customers (e.g. switching costs prevent customers from leaving) that it can monetize, so essentially it is not that different from other exchanges. I will continue to use the same approach in this article, based on (1) Coinbase's revenues and (2) potential profitability based on other exchanges. (1) Establish a baseline for estimating Coinbase's revenues: Trading volumes Previously, I surmised that the 2021/22 trading volumes would revert to lower levels in the long run. This has played out as shown below ( source ), by one measure total USD value of crypto traded on exchange has fallen from a peak of $4 trillion/month in May-21 to about $400 bn/month in mid-2023 (before a slight pick-up in Q4-2023 as market interest was piqued from the impending approval of Bitcoin ETFs). Crypto monthly volumes (The Block) In its Management presentation , Coinbase notes that its results are dependent on volatility in crypto prices. This makes sense as volatility attracts interest - however it is unlikely an asset class is volatile forever and at some point volatility narrows (after all, how often will people trade the same baseball cards back and forth?) and long-run revenues and profits for Coinbase are probably better estimated under "normal" trading levels rather than boom year levels. Coinbase's market share Coinbase's market share of trading volumes has not changed significantly according to CoinGecko which estimates Coinbase at 6.3% of all exchanges in 2023, which is largely similar to 2022 and lower than 2021. (As an extra source to corroborate this figure) It is somewhat disappointing that Coinbase has not been able to make significant headways in its market share despite the legal troubles of its competitors such as Binance (which has lost significant market share since Jan-23). Based on the above, I believe using TTM revenues (roughly $2.6bn) is a good way to conservatively estimate baseline revenues for Coinbase given (i) the muted trading activity in crypto could indicate what Coinbase might earn in a "normalized" cycle average level and (ii) Coinbase's market share has not materially increased. (2) Potential profitability Coinbase can achieve Coinbase has improved its profitability over the past few quarters by cutting costs: while revenues have been largely flat since Sep-22, quarterly operating income has gone from -$500mm (Q3-22) to around -$100mm in Q2 and Q3 of 2023. While achieving near breakeven can help Coinbase survive, it is still far from achieving high net profit margins. Coinbase quarterly income statement (Seeking Alpha) Exchanges such as CME and ICE are quite profitable with net profit margins of 40% and 25% respectively, which Coinbase is not near attaining. Amounts in $bn Market cap TTM revenue TTM normalized net income CME 74 5.3 2.5 ICE 77 8.0 1.9 Coinbase 33 2.6 -0.9 Source: Seeking Alpha In my opinion, a big risk to achieving higher profitability is Coinbase's lack of visible improvement in its market share. If Coinbase is unable to achieve a dominant market share, then it might not be able to realize net profit margins similar to CME, ICE, etc. Even were Coinbase able to achieve a level of profitability comparable to CME, assuming Coinbase's "normal" revenue is similar to current levels, $2.6bn of revenues a year at a 40% net profit margin corresponds to $1bn in annual profits which translates to a P/E of 33 (which is relatively high unless Coinbase can demonstrate massive growth potential on top of achieving $1bn in annual profits). Bitcoin ETFs: impact is unclear I do not think the recent uptick in trading volumes due to interest surrounding Bitcoin ETFs is an important factor for Coinbase, as one or two quarters of strong trading volumes does not justify (or disprove) Coinbase's $33bn valuation. It remains to be seen whether Bitcoin ETFs have a net positive or negative impact on Coinbase, i.e. do the ETFs divert trading volume or do the ETFs create more overall trading volume that Coinbase benefits from on a net basis. Balance sheet considerations less prominent This was a more prominent factor in Oct-22, when the market cap was $13 bn and net cash of $2bn (comprised of $5bn in cash equivalents and $3bn in debt) was significant compared to market cap. With a current market cap of $33 bn this is less of a positive, though it should allow Coinbase to have more staying power and resources than its less well-capitalized competitors. Overall conclusion Compared to when I published my previous article on Coinbase, the Company is definitely in a better competitive position relative to its competitors and the stock price has immensely increased. However, whether Coinbase can justify and expand its current valuation is worth careful consideration: Even were Coinbase able to achieve net profit margins similar to CME, it would still have a P/E of 30+, and Coinbase is a long way from achieving those margins (currently it has only managed to achieve near breakeven). Its lack of significant increase in market share in 2023 despite competitors stumbling left and right is worrying, and I would like to see some definitive proof that it is able to consistently win market share from its competitors (and increase profitability through market power, new product offerings etc.) before I feel confident in its current valuation (or see any upside). Based on the performance of the business in the past year, I would not consider buying at current prices which I believe have priced in a lot of potential improvements and upside in future operations, and it remains to be seen whether or not the Company can deliver. If the Company cannot significantly increase revenues/profits, I don't see the current stock price as sustainable.