Coinbase (COIN): Take Advantage Of The Pessimism And Accumulate

Bitcoin (BTC-USD) fell around 65% in 2022, marking its worst year since 2018 when it lost approx. 74% of its value. The main reason for the cryptocurrency’s fall in 2022 was the increase in interest rates in the US and other countries that mirror the Fed’s policy actions.

When interest rates increase, asset prices for riskier assets like bitcoin and other cryptocurrencies usually decline as investors shy away from them in favor of high returns on risk-free investments.

The plunge in the value of bitcoin and other tokens has led to an investor exodus in the broader cryptocurrency space. Coinbase Global (NASDAQ:COIN) has not been spared. The crypto exchange lost more than 85% of its value on the stock market in 2022. COIN currently sports a market cap of $7.89 billion, a far cry from the lofty $65 billion market cap it commanded when it debuted as a publicly traded company in April 2021.

Bearish sentiment

Even after COIN’s dramatic crash in 2022, investors are still not convinced that the stock has upside potential. COIN has a notably high short interest of 23.89%, indicating that bearish sentiment is still high. This pessimism is, in my opinion, unjustifiably high and the stock is worth watching for buy opportunities over the next two to three quarters.

The reason investors are bearish on COIN is that its revenues (primarily derived from trading fees) and margins have declined amid a drop in the volume and value of transactions in the cryptocurrency space. For Q3 2022, COIN’s trading volume was $159B vs. $217B in Q2 and $327B in Q3 of 2021.

As long as trading volumes in cryptocurrencies remain subdued in relation to historical levels, which is the expectation based on current interest rates, I believe COIN is unlikely to stage a strong recovery in its financial performance.

Analysts expect revenue of $3.18 billion in 2022 and $3.36 billion in 2023 vs revenues of $7.35 billion in 2021 and $1.14 billion in 2020. EBITDA for the trailing twelve months is $100.80 million vs $4.53 billion in 2021 and $582.3 million in 2020.

Building scale and investing in competitiveness

COIN’s compressed margins are not just a function of the decline in its revenue, but also the result of it spending more on its operations in order to maintain a competitive edge in an increasingly crowded industry.

There are more than 100 active crypto exchanges today, each offering more or less the same products and services. COIN is currently the second largest exchange after Binance, according to CoinMarketCap, which ranks and scores exchanges based on traffic, liquidity, trading volumes and confidence in the legitimacy of trading volumes reported.

To maintain this market-leading position, COIN has inevitably had to increase its investments in operations and research and development. The table below, which utilizes figures drawn from the company’s income statement, illustrates this.

	2020	2021	TTM
Selling, general and administrative expenses	$335.6 million	$1.56 billion	$2.17 billion
R&D expenses	$271.7 million	$1.29 billion	$2.19 billion

Click to enlarge

I believe it is a bullish sign for a company to invest in building scale and competitiveness when it is operating in a crowded and competitive industry like crypto. This is a point that bears are missing. There are also a few more positives worth discussing.

For example, COIN has been able to offset the weakness in its underlying business by increasing its exposure to interest-earning assets at a time of higher rates. Its interest income in Q3 2022 was $101.78M compared with just $8.39M a year ago. Increased interest income is a positive development that has not received as much attention from investors.

COIN has also been able to retain the majority of its users in the past few years, even though they are understandably trading less than they did during the crypto bull market of 2021. Monthly transacting users (MTUs) were 8.5 million in Q3 2021, down from 9.0 million in Q2 but up from 7.3 million in Q3 2021. For 2022, the company expects to see MTUs at the top end of its outlook of 7 – 9 million users.

An engaged user base and increased investments in operations and R&D are critical ingredients for success that COIN already possesses. When interest rates peak and trading in cryptocurrencies start growing again, COIN will be well-positioned to resume a solid growth trajectory.

While it’s impossible to predict when interest rates will peak, and how long the Fed will take before it eases financial conditions again, most economists expect rate hikes to stop in 2023. This makes COIN a potentially good buy amid the pessimism that has weighed on the share price, thus presenting a potential discount.

Key risks to watch

COIN is not a set-and-forget investment and bulls need to beware of the risks. The main one is the fact that the company is investing in operations and R&D at a time of depressed revenue. This could lead to an imminent capital raise, which in the short term tends to hurt the share price because of dilution or increased leverage.

Similarly, the cryptocurrency space has been riddled with scandals, the most notorious one being the FTX (FTT-USD) fiasco. COIN has so far maintained a clean track record but this has not shielded the stock from the negative sentiment that has permeated the crypto space. This is another risk investors need to be mindful of.

Valuation is another risk as there are not many comparable publicly traded companies that one can use to determine whether COIN is overvalued, fairly valued or undervalued. Moreover, the fact that it has slipped into losses in 2022 also means that price/sales is the best valuation metric to use at the moment. I personally do not trust price/sales when used in isolation, so COIN’s price/sales of 2.47x doesn’t tell me much about the stock’s valuation and potential upside or downside.

Bigger picture

In conclusion, investors need to look at the bigger picture, which is the fact that crypto is now an established asset class. Many institutional players are now involved and the risk of regulatory crackdown is overstated given the current downturn and scandals have not posed any systemic risks worthy of intervention.

The current negative cycle will come to an end. Taking advantage of the bearish sentiment to build a stake in well-positioned players like COIN could be a smart move. The stock could surprise to the upside once rates peak.