Coinbase: Squeezing The Lime With Coinbase Prime

Summary Coinbase is positioned for growth as institutional investors show increasing interest in cryptocurrency. I expect Coinbase Prime to be a significant revenue driver, focusing on institutional clients. Stablecoins play a big role in this growth phase too. Coinbase’s valuation indicates potential upside, with expected revenue growth and strong EBITDA margins, indicating expansion in valuation multiples. Investment thesis “When life gives you lemons, you make lemonade.” This metaphor aptly describes the second generational opportunity that Coinbase ( COIN ) sits on today as institutional investors have joined retail investors on the bullish bandwagon for seeing enough appeal in cryptocurrency as an alternative asset that justifies capital allocation towards this emerging asset class. While many bitcoin ETFs began trading on exchanges this year, Ethereum ETFs are close to being approved as they reach the final stages of SEC approval . So far, this has drawn record interest in alternative assets , as Bitcoin led the charge in the rally seen in the crypto markets this year. Interest in capital allocation towards alternative assets and digital currency among institutions remains elevated, with data pointing to continued momentum throughout the year . At Morgan Stanley’s recent FPC Conference last week, Coinbase’s head of institutional product, Greg Tusar, went deep into detailing how Coinbase’s institutional product serves as a solid base for the company’s strategy for the next leg of growth. In my personal opinion, I strongly suggest investors read the transcript, where management has some astute views on how Coinbase plans to grow the institutional side of the business. I believe Coinbase is positioned yet again at an inflection point where it has built and is continuing to build the required products and infrastructure that will allow it to reap the benefits down the centralized crypto market road. Despite the massive run-up in shares, I still recommend a Buy on Coinbase. The growing significance of Coinbase Prime Coinbase has historically recognized the bulk of its revenues from its trading products on the consumer side as well as on the business side. Revenues collected from trading products are generally trading fees based on take rates collected from participants trading cryptocurrency on Coinbase’s platform. Coinbase also later added subscription services, such as Coinbase One, that gave traders additional benefits. During bull markets, an expansion of trading activity meant Coinbase stood to immensely benefit from their fee collection, as noted below in the bull markets during the pandemic years, as noted in Exhibit A. Exhibit A: Coinbase’s revenue growth returns to re-acceleration mode in the last two sequential quarters (Coinbase filings via Statista) However, in bear markets, such as the one that followed in 2022, it became clear to management that depending solely on trading revenue, especially for a crypto market that still did not have a wider adoption curve, posed headwinds for Coinbase. The company started doubling down, deploying internal company resources on developing and shipping products for its customers, and getting into ancillary markets that eventually proved to be accretive for the company. In the Q4 earnings call , management continued to talk about the three organizational priorities that they were leaning on to build a solid foundation for their business. First , capitalizing on the current tailwinds that Coinbase was benefiting from due to bullish momentum will always be a mainstay of their business, as Coinbase collects rent at the gateway of trading transactions on its platform. Growing their international markets as well as other trading products, such as spot trading and derivatives, were pivotal. Management also shared how the company maintains a 70% market share in the crypto futures market. Second , it is management’s priority to drive utility around crypto to foster the applications of crypto assets and digital currency. In my view, this is going to be a pivotal area for growth as the adoption of crypto assets expands beyond the realms of trading activity as crypto gets more accepted as a medium of payment, store of value, etc. Coinbase Wallet and Base are some of the products and platforms that Coinbase currently offers to its users. While Wallet can be used as more than just a store of value while also being used as a way to facilitate payments for transactions, Base is an on-chain scaling solution built on the Ethereum network meant to build Layer 2 applications, another way to facilitate end-user transactions. But most importantly, the culmination of these two priorities has also led to the Coinbase Prime product, allowing management to scale the volume of transactions and services onto the institutional side as well. Coinbase Prime. This can be seen in Exhibit B below, which illustrates how the Subscription & Services segment has added some stability to the volatile revenue volume of Coinbase, which changes based on market volatility. Exhibit B: Subscription and services becoming an increasingly relevant segment to Coinbase (Company sources) The biggest revenue driver in the Subscription & Services segment is the revenue that the company generated from stablecoins, which was not as meaningful earlier but has almost tripled in 2023 and now accounts for almost half of the Subscription & Services revenue segment, as seen in Exhibit C below. Exhibit C: Coinbase’s Subscription & Services revenue segment by sub segments (Company sources) This is important because most traders, especially institutional participants, use stablecoins such as USDC ( USDC-USD ) for moving digital assets or for other trading purposes, solidifying the management’s three priorities that I talked about earlier, where utility was the second priority. Here is an excerpt from the FPC conference held last week: Stablecoins are one of the most interesting use cases outside of crypto as an investment. And what we see are a lot of funds, professional traders, others that want to need the ability to move crypto 24/7 around the clock from Exchange A to Exchange B preferring to use USDC rather than trying to move through bank wires and those sorts of things. And so, it’s for institutions probably the single most important utility use case aside from investing that we see. In the same conference, management also mentioned that of the ~$330 billion in assets held by Coinbase, around $170 billion was due to institutional clients. ETF issuers were also an example of those institutional clients that moved their assets into Coinbase and used Coinbase’s various products, such as its custodial services. According to its Q1 shareholder , Coinbase was the custodian for 8 of 11 Bitcoin ETFs. The crypto asset management market, where Coinbase offers its Prime product, is estimated to grow at ~22% CAGR . This is much faster than the midteens compounded growth rates that its crypto exchange market is expected to grow at. I believe Coinbase Prime looks poised to propel Coinbase into its next phase of growth. Coinbase’s valuation indicates upside potential Coinbase management pointed to Q2 revenues being in the range of $525-600 million. With the ~1.6 billion worth of revenues already recorded in Q1, the company is on track to report H1 2024 revenues in the range of $2.1-2.2 billion, implying a 60% surge in revenue compared to the same period last year. I expect the SEC to approve the spot Ethereum ETFs within the next 1-2 months, which should point to the general availability of spot Ethereum ETFs on the markets in Q3 of this year. This should again give a significant boost to Coinbase’s trading volume, especially from its institutional clients. Based on these assumptions, I expect Coinbase to report revenue growth of ~60% in 2024 over the previous year. Over time, I expect Coinbase to grow its revenues at ~27% CAGR growth rates. This is based on the growth rates I noted in Coinbase’s two end markets I alluded to earlier. In terms of EBITDA margins, Coinbase demonstrated strong growth through last year on an adjusted basis, with the company reporting adjusted margins of ~33%. I expect these margins to dip this year as management sees more expenses in product development, client support, and regulatory requirements. But over time, I expect the company to scale margins higher on the back of an expected deployment of its institutional product portfolio. I will take a ~2.5% share dilution rate, while the WACC rate will be ~11.5%. This includes its current beta and other estimates that can be viewed here to calculate WACC. Coinbase has a favorable capital structure, with ~$6.6 billion in cash and ~$4.2 billion in debt. Exhibit H: Valuation model for Coinbase (Author) Based on the earnings growth rates and after comparing this to the S&P 500’s long-term growth rates , I estimate ~15% upside to Coinbase’s stock. Risks and other factors to consider I had earlier talked about management’s three core priorities, where I mentioned how trading revenue and utility were the top two priorities for the year. The third priority that management has been and will continue to focus on is its regulation. Coinbase is one of the primary participants within the crypto regulatory framework, and the SEC has a history of litigation against Coinbase and other crypto participants on a broad range of policies in this space. Management has and continues to emphasize regulation as a priority to work with the SEC over policy work to bring more structure to the industry, which should aid its earlier two priorities. Takeaway Coinbase now sits at another inflection point as it turns its attention to acquiring institutional clients as part of its Prime portfolio and delivers progress along its three core priorities that I mentioned earlier. The company has already invested in building out its institutional capabilities, and 2024 was a promising head start that the company demonstrated in taking advantage of the momentum due to general bullishness in the crypto markets as well as optimism due to bitcoin ETFs. This again shows the ramp in revenue Coinbase has due to the opportunity that it has already taken advantage of. Keeping these perspectives in mind, I recommend a Buy rating on Coinbase.

Source: Seeking Alpha