Coinbase: A Crypto Sell-Off Only Adds To The Reasons To Avoid The Stock
2022.06.15 15:01
At the moment, there are over 700 stocks trading on US exchanges with a market capitalization over $10 billion. Not one of those stocks has had a worse 2022 than Coinbase Global (NASDAQ:COIN), which has declined a stunning 79.6%.
COIN Daily
Coinbase’s position at the top (or bottom, as it were) of the list perhaps isn’t that surprising. Cryptocurrencies have had a brutal 2022. Bitcoin (BTC/USD) and Ethereum (ETH/USD) have been more than halved year-to-date.
Terra (LUNA/USD) blew up. Celsius (CEL/USD) plunged this weekend after the Celsius Network halted withdrawals.
Meanwhile, growth stocks of all stripes have been hit hard as well. The next four worst-performing large-cap stocks of the year are Shopify (NYSE:SHOP), Unity Software (NYSE:U), Roblox (NYSE:RBLX), and Snap (NYSE:SNAP), each of which has fallen at least 74%.
At this point, some investors might be intrigued by Coinbase stock. They might see the sell-offs in both cryptos and in growth stocks as a short-term overreaction to interest rate hikes from the Federal Reserve.
They might see COIN as a value play: trailing 12-month earnings, in fact, is over $10 per share on a GAAP (Generally Accepted Accounting Principles) basis, putting the stock’s price-to-earnings multiple below 5x.
Indeed, only about 30 large-cap stocks have a lower P/E multiple. Many of them, such as homebuilder DR Horton (NYSE:DHI) and automaker Ford (NYSE:F), are intensely cyclical stocks whose earnings may be crushed in a recession. Hardly any seem to have the growth potential of Coinbase.
But the fact is that COIN doesn’t look attractive, even 86% off its highs, and in spite of such seemingly impressive fundamentals. There are enormous risks here beyond the suddenly ill health of the cryptocurrency industry.
This is not a case of the market selling off a quality stock because it’s panicked; it’s a case of the market being late in coming to the realization that Coinbase isn’t a quality stock at all.
COIN Stock Isn’t ‘Cheap’
Last month, I highlighted the concerns about both Coinbase’s low earnings multiple and its big decline. It’s worth summarizing both points again briefly.
The P/E multiple does look attractive—but those earnings are not sustainable. Coinbase itself admits as much. After the company’s first quarter report, Coinbase guided for an Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) loss of some $500 million.
It is an absolutely staggering reversal. In 2021, Coinbase earned over $4 billion on the same basis. A simple P/E multiple might make COIN look cheap now, but it will look far less so once Q2 numbers are reported in late July or early August; by Q4, if not Q3, COIN’s P/E will be negative.
That huge fundamental shift also explains much of the weakness in the stock over the past few months. Indeed, arguing that COIN is “cheap” because it’s dropped 86% from its November highs ignores the fact that the business looks astonishingly different. It also ignores the fact that COIN very likely was overvalued seven months ago, as so many growth stocks were.
Simply put, COIN should have sold off.
Looking Forward
What’s most important, broadly speaking, is that both the P/E multiple and the year-to-date decline are backward-looking metrics. Investors need to look forward. When it comes to Coinbase, the future doesn’t look all that promising.
Again, one need only listen to the company itself. It was only weeks ago that Coinbase was hiring aggressively. Part of the reason for the loss expected this year was that Coinbase planned to “continue to invest wisely to drive long-term growth.” It’s not investing anymore.
It was on May 10 that Coinbase wrote about those plans in its first quarter shareholder letter. Less than two weeks later, the company paused hiring. Two weeks after that, it started rescinding offers it had already made. On Tuesday, the company announced it was laying off 18% of its staff.
It bears repeating: five weeks after it was investing “wisely” behind its business, Coinbase is cutting nearly one-fifth of its workforce. As with the move from huge profits to big losses, it’s a stunning reversal.
The core explanation for the layoffs is that Coinbase’s business is falling off a cliff. In announcing the move, chief executive officer Brian Armstrong pointed to the risk of another “crypto winter,” noting that his company had survived four such events so far. The response each time was to manage costs in order to survive.
The fact that Coinbase is returning to those tactics—and doing so in such an aggressive fashion—suggests that near-term results are going to be ugly and that even the expectation of a $500 million loss this year was far too optimistic.
Owning The Business
Now, again, an investor could believe that what Coinbase is dealing with is a short-term blip. The company has survived “crypto winters” before. 2021 results at least show how much profit the company can make in the good times.
But there are concerns beyond the short term here as well. Coinbase revenue and profits aren’t coming down just because crypto prices are down. They’re coming down because the platform is losing market share.
Competition has been intense, with everyone from Block (NYSE:SQ) to PayPal (NASDAQ:PYPL) to Robinhood (NASDAQ:HOOD) targeting the space.
And to at least some degree, those competitors are winning. One Wall Street analyst in April estimated that Coinbase’s market share had dropped from 12% to 8% in a matter of months.
Bitcoin volume on privately held FTX has soared past the amount traded on Coinbase.
Competition doesn’t just hurt volumes. It hurts revenue. Coinbase’s revenues are based on its take rate: the percentage of a trade it keeps for itself. Competition erodes that take rate over time.
The same phenomenon occurred in equity brokerage: commissions, often above $35 in the 1980s, were slashed when online trading exploded in the late 1990s—and for most trades are zero today.
So, there’s more going on here than just a crypto bust. There are structural, long-term problems with the Coinbase business—problems that don’t get solved by cutting employees and costs.
In that context, looking forward, COIN hardly seems like a steal. The company still has a market capitalization over $12 billion, and an enterprise value just shy of $10 billion.
Yet, its debt is priced as low as 60, with a yield over 10%—a yield that suggests the bond market is pricing in a material chance that Coinbase actually goes bankrupt at some point over the next decade.
To be sure, that scenario seems unlikely. Coinbase will cut costs, crypto likely (though not definitely) will bounce back to some extent, and the company can get back toward profitability.
But a $12 billion market cap isn’t justified by avoiding bankruptcy. It’s justified by creating consistent, substantial, free cash flow. Coinbase isn’t going to do that any time soon. Until there’s clarity on when it will, COIN absolutely can keep falling.
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