Thesis for Coinbase (COIN) Investment in Q4 2023
Sharing my thesis for COIN late last year, and why there is room for a further run-up
2023 was a roller coaster year for me with lots of changes in my life, so I haven’t had much time to focus on individual stock investing. However, the single concentrated investment I made was in Coinbase (COIN) in Q4 of 2023, around October.
I recognize that posting this now in April when the stock has tripled to quadrupled already is unfair, and it’s fair to think that I only post about it because it has gone up. I don’t have much of an excuse except to say that I meant to post this analysis last year, but life got the better of me. At least I am getting to it now! It was the single new sizable position I put on in 2023, and I hope you find my thought process around it helpful in your own investing journey.
Thesis
Investing comes down to understanding the few key drivers that matter, because otherwise there is no end to the amount of data on a company.
Coinbase was beaten down because of the bear market, but also because of the narrative that Bitcoin ETF launches will have people using Coinbase less. However, Coinbase is the underlying custodian for most of the ETFs from which it will generate fees. I also believed that COIN’s trading volumes would increase dramatically from the coming bull market and the natural human desire to rotate into higher returning altcoins, that ETFs don’t allow for yet.
Almost half of Coinbase revenue is not from trading anymore; it generates massive revenue from USDC issuance, especially during high interest period where it earns 5% on the USD it stores to back USDC. Should interest rates fall, it is likely that trading revenue booms, so the company today is much more balanced business-model wise.
Coinbase is pretty much a monopoly in fiat to crypto transfers for US.
Robinhood doesn’t let you withdraw crypto more than $5K at a time so I stopped using it.
Binance US, the biggest competitor, has been wiped out by regulation.
Speaking of regulation, Coinbase has immense regulatory capture that helps it achieve monopoly status for US crypto. See this snippet from Bill Gurley:
Unknown upside from Base chain.
The intellectual capital at Coinbase that is required for a fast-moving space like crypto will be hard to beat.
Valuation
A big part of the thesis rested on the idea that the bull market in crypto would come. Having been in crypto for a long time now, I’ve seen multiple cycles and felt certain that the bull market was coming, especially with the approaching Bitcoin halvening.
If the bull market does come (as it did, no surprise), it is easy to value Coinbase relative to how it was valued in the last bull run, 2021, because it achieved a profit that year.
In 2021, Coinbase reached a peak of 21x earnings. In Q4 2023, Coinbase was trading at only 8x its 2021 earnings. I compare Coinbase’s valuation in Q4 2023 to its 2021 earnings, which is non-standard, because that was the one year Coinbase booked a profit, and it’s easy to conceptualize a valuation based on an earnings multiple. More importantly, I was strongly convinced Coinbase would book a profit again in the coming bull market, so using 2021 earnings to judge the current valuation seemed the right way. In fact, 2021 earnings may be conservative because I expect 2024 earnings to be higher. Finally, I felt that Coinbase would be re-rated and valued this way by the price-setting hedge funds in the coming bull market. What do I mean by this?
The market dynamics today are such that multimanager funds aka pods (like Citadel, Point72, Balyasny) are the incremental price setters given their increased AUM and trading volume. See https://x.com/FundamentEdge/status/1750540981219577981
I believe that multi-managers have become the incremental price setters in the market. (also...the incremental price setters for talent). This has important implications, whether you are at a pod or competing with pods. - Brett Caughran, former hedge fund manager and founder of Fundamental Edge training academy
This means that COIN will be re-rated when the bull market comes and it achieves profitability in 2024. Forget that a bear market will come again - COIN will trade as if its bull market profitability level is a constant, because this is how multi-managers trade. They will not factor in that revenue will eventually fall dramatically again (like a value investor might), so COIN will likely overshoot its fair valuation and trade at something like a 20x multiple to its projected higher-than-normal earnings for 2024.
Target Price
I bought around the $80 range, took some profit at $270, and I am holding the rest with a price target of $300-500 which is dependent largely on how long and how high the crypto bull market lasts this time. Something nobody can predict, hence the wide range. Why this price target?
Coinbase is in a much stronger position this cycle because big competitors are wiped out, it has cut a lot of costs, and each subsequent bull market is bigger. Coinbase did 3.6B in profit in 2021, before they had a monopoly nor high income from USDC. If they can do 5B in profit this year, and apply a 20x multiple, that results in a $420 price target.
Given the volatility and unpredictability of the crypto markets, nobody can say for certain what Coinbase’s exact earnings will be, but I think probabilistically it is reasonable to assume this level of profit and general price target. Hence, when Coinbase was trading at $80, it seemed like a heavy discount. But we can hold this viewpoint because we are familiar with the crypto markets. How might a traditional investor have viewed the situation? Let’s see below.
Opposing Thesis
Value Investors Club is a forum where professional investors post long and short ideas which are thoroughly vetted. Probably the single highest quality forum for investing on the internet. The most recent post on COIN was actually a short from Oct 2023, interestingly. See https://www.valueinvestorsclub.com/idea/Coinbase/4016106177
I recommend giving it a quick skim.
It is a well written piece, but I think this is a prime example of how understanding an industry deeply gives you an advantage even over professionals.
Its thesis was:
We believe that Coinbase’s core US franchise is at risk with the introduction of one or multiple Bitcoin spot ETFs, perhaps as soon as later this year, which should pressure both volumes and take-rate.
We believe that a positive (but faulty) legal decision that we think will get reversed soon.
We think the company should be valued closer to tangible book, as it largely makes money from interest income (which has benefitted from higher interest rates) and is unprofitable on its core crypto exchange operations. We think the stock has more than 50% downside.
Here are my counterpoints to this thesis:
Point 1 is interesting, but lots of people will want to trade altcoins which makes one go to Coinbase to buy Bitcoin too. Crypto is a lot bigger than just Bitcoin, and it will be hard for ETFs to catch up to the infrastructure Coinbase has. For one, you are not even storing your own crypto with ETFs and cannot interact with crypto applications.
Point 2 I strongly disagree - much of the judicial rulings have been firmly in favor of crypto firms vs the SEC, as it should be. There is clear evidence of the SEC under Gary Gensler being contradictory and punishing the industry regardless of its merits.
Point 3 fails to recognize that if interest rates fall, trading volume increases.
Finally, the analysis mostly fails to recognize the impending bull market, and how that would re-rate the stock, which anyone familiar with crypto was expecting.
Nonetheless, the post had good analysis and is worth reading.
Hope this was helpful, and feel free to share thoughts in the comments!