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Wednesday, May 18, 2022

Why Coinbase Will Be a Multibagger Stock

The stock market didn’t like what it saw from Coinbase (COIN 8.90%) in the first quarter of 2022. Revenue was down, the company reported a loss, and the collapse of cryptocurrency valuations over the past few weeks has been a huge cause for concern. If you thought Coinbase’s crypto-trading platform was going to be a money-printing machine, like it was in 2021, the quarter looks like a disaster. 

But here is where a long-term mindset is needed for Coinbase, and CEO Brian Armstrong laid out the case well in the company’s conference call. Coinbase has been through turbulent markets in its decade of existence, it has a vision of a future where cryptocurrency empowers the world to be financially independent, and it has a fortress-like balance sheet to invest during this downturn and attract the best talent in the world. If cryptocurrency plays a big role in the future, this should be a massive winner for investors. 

Image source: Getty Images.

What the quarter said about Coinbase and crypto

There are a few notable metrics from Coinbase’s quarter. One is that monthly transacting users were up 3.1 million from a year ago to 9.2 million, but that was down 2.2 million users from the fourth quarter. Assets on the platform were also up from $223 billion a year ago to $256 billion, although that was also down from $278 billion last quarter. 

Revenue fell 53% sequentially to $1.17 billion and net loss was $430 million, but adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) was a positive $20 million. 

How should we process these numbers? Here’s how I think about the trends: 

  • The user base is growing overall, but it’s volatile. 
  • Revenue is volatile and declined because of a reduction in crypto trading in the quarter. 
  • Subscription and service revenue (i.e., nontrading revenue) jumped 169% from a year ago but fell 29% sequentially to $151.9 million. This shows long-term improvement in the nontrading business. 
  • Profits became losses because Coinbase continues to invest in future growth and new products, despite short-term headwinds. 

How Coinbase is responding

Business activity is down, and cash flow has gone from high levels to effectively zero. So, how is management responding? Here’s what Armstrong said during the conference call. The quote is long, but I think it’s important for long-term investors to read it in full and even listen to the entire call: 

So the good news is that as a crypto company, we’ve lived through many different cycles in crypto, including major drawdowns, which I think make us well suited to operate through these environments. And I have to tell you, kind of going back over the last 10 years in crypto, the up periods, we tend to focus mostly on scaling. There’s so many customers beating a path to our door that we have to have all hands on deck just to keep everything running.

And so the down periods are often sometimes kind of a welcome change from that, in the sense that we get to focus on building the next layer of innovation that will benefit us in the next cycle. We also tend to see the down period as a big opportunity because we’re greedy when others are fearful. We tend to be able to acquire great talent during those periods and others pivot, they get distracted, they get discouraged. And so we tend to do our best work in a down period.

If you believe in the future of cryptocurrency and its impact on the economy, this is a great mindset. The company has laid out its plans to make it easier to buy crypto, acquire non-fungible tokens (NFTs), launch an NFT, and even build an NFT-gated website using Coinbase’s tools. These plans are just now starting to reach the market. 

And Coinbase is putting its money where Armstrong’s mouth is, increasing headcount by 188% from a year ago and 33% sequentially to 4,948 people. How long can Coinbase invest in a down market? 

Coinbase’s cash pile

The reality is that Coinbase can invest in a down market because it’s flush with cash. At the end of the first quarter, it had $6.14 billion in cash and equivalents, $180 million in USDC tokens, and $1.33 billion in crypto assets. This was offset by $486 million in crypto-asset borrowing and $3.39 billion in long-term debt. 

Add all of those numbers up and Coinbase has $3.8 billion in net cash on the balance sheet. This compares with a market cap hovering around $10 billion to $12 billion, depending on the hour. 

COIN Market Cap Chart

COIN Market Cap data by YCharts

Remember that Coinbase is generating positive adjusted EBITDA even in a down market, so the company is well-positioned to invest and acquire for long-term growth in today’s market. 

The future of Coinbase is the future of crypto

The cryptocurrency market looks dire at the moment, and we’re seeing that with Coinbase stock. But I see too much investment, too many smart people moving into the industry, and too many opportunities for growth and disruption to think that the future of cryptocurrency isn’t extremely bright. The business will change and mature, but that’s a good thing. 

If crypto does come back in a big way, I think Coinbase will be a multibagger for long-term investors. The stock is trading as if Coinbase will simply burn through billions of dollars in cash with no upside. But I think we will see management invest in the future and come out of this downturn stronger. Armstrong and the team have made it through a downturn before and have the balance sheet to do it again. 

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