Summary Coinbase's revenue is highly volatile, and the company must stabilize its revenue streams and address regulatory barriers to improve its risk-return ratio. Despite recent growth, the uncertainties surrounding Coinbase's business model and the crypto market make it a risky investment with only a 25% chance of exceeding its current stock price. Favorable regulation and increased institutional adoption of cryptocurrencies are critical for Coinbase's long-term value, but these factors are already priced in. Given the high level of uncertainty and the need for more stable revenue, I recommend holding on to the stock rather than investing now. Overview Coinbase ( COIN ) is a blockchain company. As based on a nascent technology, it is uncertain but promising. After Election Day, bitcoin securities have risen wildly, foreseeing looser regulation from the Trump administration (Figure 1). Coinbase is one of the beneficiaries, and I estimate that the run-up will keep in the coming weeks. Figure 1: Seeking Alpha Despite this, I do not recommend investing in the company now due to the uncertainties surrounding it. In my base case, I estimate a value near its current stock price, but incorporating the risk, I estimate a 25% probability of having a value greater than its current stock price. Its revenue fluctuated from a low $590 million in 2022Q3 to a high $1,450 million in 2024Q1. From this high, it decreased to $1,129 million in the last quarter. Free cash flows fluctuated wilder and went from -3,059 million in 2022Q2 to $3,219 million a couple of quarters later (Figure 2). It is hard to value a company with such uncertainty. Either way, I will estimate its value, assigning probabilities to the most significant uncertainties. But first, I will identify what must happen to stabilize its business model: 1) The source of revenue must be more stable; 2) Bitcoin must eliminate its speculative nature and have an economic reality; it must be useful; and 3) regulatory barriers must be cleared away. Figure 2: Author Aiming for more stable revenue streams and economic reality for crypto Revenue is highly volatile due to crypto trading. Diversifying to a more stable revenue stream is critical for me to assign a better risk-return ratio for the company. The company is working on this diversification, but I think they are not at a comfortable point. Transaction revenue grew 98% year over year in the last quarter to $572 million, higher than subscription and service revenue, the more stable stream, which grew 66% to $556 million. So, those stable revenue streams were 49% of total revenue a year ago and now 46%. One of the revenue streams not linked to speculation is revenue from stablecoin. Its revenue has increased by 43% to $246 million. Stablecoin grows thanks to higher on-platform USDC balances, which is good news for the company. As more institutional entities trade USDC, they are using cryptocurrencies to make real-world transactions based on the real economy, which means the crypto utility is higher. Even with transaction revenue, I prefer that those transactions be from institutional players rather than consumers. Institutional entities mean two things to me. Firstly, they derive a more stable flow of transactions, and secondly, they provide credibility to cryptocurrency transactions since they are used by professionals. However, this trend—fees from stablecoin—gives more certainty to Coinbase's cash flow but makes monetizing more challenging. Coinbase charges 0.3% for cryptocurrency transactions but 0.15% for USDC conversion to USD . Besides, clients that hold $500 million assets or higher are exempt from any fee. So, institutional clients who have grown so much are paying less for the services. Sales and marketing costs have increased 110% to $165 million, from 12% of revenue to 14%, a clear sign that the company is making less for the same effort to acquire and retain customers. The Base service launched a year ago is another promising revenue stream that can create stable inflows for the company. Base is a software layer over the blockchain Ethereum network. Coinbase develops this layer and allows developers to code applications that can use Ethereum. Base is classified as Other Revenue that has grown from $51 million in 2023Q3 to $77 million in 2024Q3. It is just $26 million that doesn't move the needle yet. It is something that I will be watching closely, but it isn't meaningful now. Besides generating more stable revenue, with Base, the company tries to de-intermediate crypto networks to create proprietary networks, trying to capture the associated network effects. Regulation When investing in a company like Coinbase, it is critical that the regulations align with the industry's interests. Regulations must get looser. Crypto supporters demand that the industry not be regulated as a financial company. They claim that those strict regulations are contrary to innovation and will prevent the industry from growing and raising the needed funds. Under Trump, agencies like the SEC may reduce pressure to enforce actions against crypto firms. Regulation could shift from controlling crypto companies to protecting consumers from fraud. It may even promote self-regulation within the industry rather than heavy federal oversight. The House has passed the FIT 21 bill, a pro-crypto regulation bill supported by both parties. With the new Senate, the way is cleared. Figure 3: Seeking Alpha Even though Trump's Administration supports crypto regulation, as the market has demonstrated since election day, nothing is for granted. Coinbase allocated $25 million to Fairshake for pro-crypto advocacy ahead of the U.S. midterms. They will continue to support StandWithCrypto.org . I think the regulatory issue is one of the most certain of the three critical drivers of Coinbase's value. However, I think it is already priced in, as Figure 3 shows. Valuation Figure 4 shows the company's value drivers, considering a year as the last four quarters to capture the latest information. Regarding margins, I utilize a measure I call Cash Margin, which involves adjusting net income for non-cash items such as amortization and depreciation, stock-based compensation, and deferred income tax. Figure 4: Author As outlined throughout the article, there is too much uncertainty in the company and the industry. In this section, I will define a case based on what I estimate would be a plausible scenario. Later, in the risk section, I will quantify my uncertainties to grasp the probability of the value estimate being higher than the current stock price. My base case scenario is based on Figure 5. I expect revenue growth for the next year to be 45%. Later on, the growth rate will decrease to 17%. So, I believe the company will grow like a tech company in these ten years. The scenario is optimistic and assumes regulations will be favorable, the company will innovate, and it will be easier to get funding. The Cash Margin will be 30% during the period. This is the average for the last three years. It is quite uncertain because the company must expand its client base, and we don't know if it will be difficult. We have seen that the percentage over revenue has increased in the last 12 trailing months. On the contrary, a more favorable regulation will make it easier to gain customers. I am confident margins will be around 30%. Net working capital has fluctuated from -59% to 126%. I assume that it will converge to zero accumulated over the next ten years. Cash flows will be discounted at a 14.0% WACC because the beta is 3.34. The risk-free rate is 4.2%. The company's leverage is 34% of total capital. The perpetual growth rate is set at 3%. Figure 5: Author Figure 5 shows that my value estimate is $324 per share, a 9% premium over its current stock price. It is, in my opinion, a value close to the current stock price with no margin of safety. The implied multiple Price to Free Cash Flow is 51, in line with the current multiple (Figure 6). Figure 6 Risks In this section, I am trying to model the uncertainty in the revenue growth rate and cash margin. It is based on the valuation section scenario, and I will use a triangular probability function. I don't want to define a precise probability function because I have no evidence to support it. In reality, it is like considering multiple scenarios. Revenue growth's likeliest value is 29%, the average base case over the ten years. I believe that the revenue growth rate can be as low as -10%. That is the case where competition from Binance or other network operators leads the market and gets market share from Coinbase. I consider 50% to be the highest revenue growth rate. In this scenario, Coinbase grows at a formidable rate, the industry grows fast, and Coinbase gains market share. The cash margin varies from 20% to 45% and is around 30% of the base case. In the model, this variable has less impact than the revenue growth rate. The revenue growth rate explains 84% of the variation of value, the independent variable, and the cash margin is 16%. The result of the model is shown in Figure 7. It reflects the cumulative probability of the stock value, a sensitivity graph showing the different ranges of stock value based on each of the other growth rates, and a cash margin with the variables I have just described. The conclusion is that the probability of getting a value greater than the current stock price of $296 per share is 25% (the blue area), so the risks I have described will give a lower chance of getting that value. Figure 7: Author My base case has little margin of safety, and when I incorporate the uncertainties, there is only a 25% chance of achieving a value higher than the current stock price. Conclusion There is too much uncertainty in Coinbase and, in general, in any crypto security. I seek to clear this uncertainty by three things: The revenue stream must be more stable. Bitcoin must eliminate its speculative nature and have an economic reality; it must be useful. And third, regulatory barriers must be cleared away. My conclusion is that the company has room to advance on those three fronts. Risks are weighted in my valuation, with just a 25% probability of having a long-term value greater than its current stock price. I recommend holding on to the stock.
