Coinbase released some impressive Q1 2021 numbers recently. Before deciding whether or not to invest, let's do some due diligence, diving into some of the risks and make a case for why and why not.
What are the risks?
- There is some uncertainty about how the company plans on using the cash they are generating in a meaningful way. As an investor, this has implications on how we expect the stock to perform. Should we be expecting to receive cash from dividends, high appreciation from growth, or perhaps both?
- Another risk to consider is regarding how long their current high growth rate can be maintained. What might future growth look like for their main business as market makers providing liquidity?
- The last risk we'll consider here is about that the future of Coinbase is dependent on the future of crypto because their revenue is tied to the transaction volume of cryptocurrencies.
- This will be difficult for investors to manage this risk; however there could be some interesting options strategies that might help.
The bull case
After considering the risks, what are some of the reasons to believe we should buy the stock:
- Coinbase just reported very strong profitability measures. While high revenue numbers are important, strong EBITDA margins and Net Income margins address the profitability of the company. The higher these margins, the more cash is being generated that can be given back to investors as dividends or reinvested in the company to increase growth. Revenue and EBITDA multiples are used to measure how well a company is doing and compare them to other companies.
- Not only are they showing profitability, but they are also experiencing very high growth with Q1 2021 revenue being higher than all of 2020
- The high cash flows puts them in a good position to reinvest cash into lots of opportunities for growth through developments of additional products and services in the crypto space.
- Coinbase is much more profitable than other comparable marketplace companies like Airbnb.
- The initial valuations were before the Q1 numbers were released so investors will be trying to determine whether or not these numbers will continue to grow. The strong Q1 numbers make the initial $100-$120billion valuations seem reasonable.
- Coinbase diversifies the concentration risk from Bitcoin because other major cryptocurrencies, like Ethereum, don't have the same halving schedule so their prices are likely to be less correlated.
The bear case
After considering the risks, what are some of the reasons to believe we should not buy the stock:
- There is an expectation of high volatility. Crypto investors tend to be willing to invest in companies with even higher multiples, sometimes to triple digits.
- Currently Coinbase has a relatively high take rate of 5%; however, that will likely drop as more competitors enter the market and in order to attract more institutional investors. This makes what they plan to do with that cash flow even more important to maintain their strong growth.
- Investing in Coinbase is indirectly investing in the trading volumes of crypto which is still dominated by bitcoin. Based on historical 4 year halving periods, we can expect trading volumes to be good in 2021 but start seeing declines in 2022 and drying up in 2023.
To get a better understanding of crypto and what is being traded on Coinbase, here is an introduction to crypto from our experts.