Coinbase Global: A Buy Based On Growth And Valuation

Summary

• Coinbase likely benefited from market volatility in Q2'21.
• Coinbase should report strong user growth and revenues as Q2 market volatility boosted transaction revenues.
• Institutions are going to play a larger role for Coinbase's growth in the future.
• Coinbase’s profit growth is cheap given the high profitability of the marketplace.

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Shares of cryptocurrency exchange Coinbase Global (NASDAQ:COIN) disappointed after the firm’s direct listing in April, but the drop has made Coinbase’s profit growth cheap. While shares have trended down after the stock market debut, the marketplace is set to report strong revenues and earnings growth on August 10, 2021.

Why Coinbase is a buy before earnings

I believe Coinbase benefited from volatility in the crypto markets in Q2’21 and the marketplace will show continual growth in monthly transacting users/MTUs. Coinbase’s MTUs increased by the factor of 4.7 Y/Y to 6.1M in Q1’21 as cryptocurrencies exploded into the mainstream and the combined market capitalization of the crypto market exceeded $2T for the first time ever. Although enthusiasm faded in Q2’21 as Bitcoin and Ethereum’s market values dropped in half, Coinbase likely had a good financial quarter as it cashed in on high trading volumes.

I expect that growth in monthly transacting users slowed down a bit in Q2, chiefly because of falling cryptocurrency prices, but the cryptocurrency exchange should nevertheless report strong platform metrics in its earnings release on August 10, 2021. Supported by growing mainstream acceptance of digital currencies, Coinbase has seen its trading volume soar last year: The total transaction volume processed through the platform was $335B in Q1’21, representing an 11-fold increase Y/Y and a 3.8-fold increase Q/Q. Amid high levels of volatility in the market - and volatility is good for platforms that depend on transaction revenues - Coinbase could beat profit expectations set for the next quarter... the EPS for Q2'21 is $2.57.

(Source: Coinbase)

Since heavy trading likely occurred in Q2’21, Coinbase’s transaction revenues could be much better than expected. The marketplace earned $1.54B in transaction revenues, more than three times the amount it earned in the previous quarter ($476M) and nine times more than a year ago ($172M). Retail investors were responsible for 94% of transaction revenues indicating that Coinbase, despite growing institutional adoption, is largely dependent on a retail base that tends to trade a lot of short-term price movements. For Q2’21, I expect $1.2B to $1.3B in transaction revenues because I believe it is unlikely that Coinbase exceeded its impressive Q1’21 results. But even if transaction revenues dropped sequentially, Coinbase will likely have had a super profitable quarter.

(Source: Coinbase)

Coinbase is already highly profitable and had an operating margin of 55% in Q1'21. Many recent tech-IPOs and direct listing are far from being profitable which makes Coinbase really stand out: The platform’s operating income surged by a factor of twenty-five Y/Y to $988M in Q1’21, due to a lack of competition and buoyant cryptocurrency market conditions.

Institutional momentum

Coinbase has developed a reputation as a trusted and secure online trading platform for crypto assets which supports the platform's drive to launch new products and services. In January, Coinbase launched “Coinbase Asset Hub” which allows for the seamless integration of new digital assets. This feature is directed at Coinbase’s partners and will expand the number of tradable digital assets on the platform significantly… which could potentially draw in new institutional customers.

Institutional customers represent a big growth opportunity for the marketplace. Retail traders are responsible for most of Coinbase’s transaction revenues, but institutional uptake of digital assets is accelerating and it shows in the amount of assets that institutional investors now hold on Coinbase’s platform. Institutional assets totaled $122B in Q1’21 and exceeded the combined value of retail assets by $21B. Institutional assets on Coinbase also grew twice as fast as retail assets. Because of this, I expect that a larger share of profit growth will be driven by accelerating institution adoption of digital assets, and fees generated from those assets.

(Source: Coinbase)

Valuation

Coinbase is set to show strong profit growth in FY 2021. The platform is expected to have $8.91 in EPS this year which values the marketplace at 26.5 earnings. I expect Coinbase to have EPS of $11 this year because crypto market volatility will likely prove to be very positive for the transaction part of Coinbase’s platform model. An EPS of $11 lowers Coinbase's P-E ratio to 21.5. Since Coinbase is already super profitable, the marketplace’s earnings are cheap.

(Source: Seeking Alpha)

Balance sheet

Coinbase had no financial debt on its Q1’21 balance sheet but the firm has since issued $1.25B in Convertible Senior Notes due in 2026. Funds are meant to support the development of Coinbase’s crypto ecosystem and fuel the marketplace’s growth. Coinbase also had $2.0B in cash giving the firm enough cash to support new product development.

(Source: Coinbase)

Other considerations and risks

The cryptocurrency market is new and uncharted territory, even for Coinbase. China has started to crack down on the cryptocurrency market and miners are leaving the country as a result. But Coinbase generated 76% of its revenues from its US customers in 2020, so the crackdown in China does not affect Coinbase as much as Chinese trading platforms. The US, at least for the moment, does not appear to be interested in cracking down on cryptocurrency exchanges, but regulatory risk poses the biggest risk for Coinbase’s stock. Besides regulation, Coinbase’s earnings are heavily influenced by transaction revenues which are very volatile and make earnings projections unreliable. Slowing MTU and transaction revenue growth could indicate decreasing stock returns for Coinbase investors. Longer term, I expect Coinbase’s high trading fees to come under pressure as other trading platforms enter the market and offer more competitive fee structures.

Final thoughts

Coinbase’s earnings are cheap and the stock is a buy before earnings. A volatile crypto market is a positive for Coinbase, not a negative, because it encourages trading. Because of this, the marketplace is all but guaranteed to report strong user and earnings growth for Q2'21. Longer term, I expect institutional investors to become more important to the platform and drive a larger share of Coinbase’s profit growth.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of COIN either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.