Despite the blowout Q1 financial results crypto exchange Coinbase released last week, its expected $100 billion valuation remains "ridiculous," according to a new report from stock research firm New Constructs first shared with Decrypt.
Coinbase recently announced Q1 profit between $730 million and $800 million on revenue of approximately $1.8 billion. Those figures dwarfed Coinbase’s performance for the entire previous year, adding to speculation that Coinbase may see a valuation of $100 billion or even higher once it goes public via direct listing on the Nasdaq on April 14.
But clearly, not everyone is convinced Coinbase can continue to deliver on the high bar it has now set for itself.
"Even though Coinbase’s revenue surged over the past 12 months, the company has little-to-no chance of meeting the future profit expectations that are baked into its ridiculously high expected valuation of $100 billion," the New Constructs note says.
Discussing Coinbase’s valuation with Decrypt one month ago, New Constructs CEO David Trainer said, "As long as Wall Street can get you going on the sentiment, as long as you stay focused on the drug high, you don’t have to worry about the drug down."
What kind of crypto market is Coinbase living in?
The report’s salient point is that the crypto market is still very young, despite Coinbase’s assertions in its S-1 filing, in which the company said, "crypto has the potential to be as revolutionary and widely adopted as the internet."
That kind of language can stoke lofty valuations, but according to data shared in the New Constructs report from analytics firm CivicScience, 66% of U.S. adults are "not interested" in crypto, and 18% have "never heard of it." What’s more, CivicScience found that—despite growth in the industry—the number of US adults investing in cryptocurrencies remains at just 9%.
Assuming the crypto market matures—and more companies come into direct competition with Coinbase—the market could "crush profitability" for Coinbase by as much as 98%.
Per the report, Coinbase collected ∼0.57% of every transaction in fees in 2020. This totaled $1.1 billion in trading revenue on $193 billion in trading volume—in turn making up 86% of revenue for 2020. "As the cryptocurrency market matures and more firms inevitably pursue Coinbase’s high margins, the firm’s competitive position will inevitably deteriorate," the report says.
Those competitors—exchanges like Gemini, Bitstamp, Kraken, and Binance—will likely offer lower or zero trading fees as a strategy to take a slice of the market share for themselves. The report suggests this would start the same "race to the bottom" seen with stock trading fees in 2019.
And if the crypto industry continues to grow and be as "widely accepted as the internet," to borrow Coinbase’s assessment, the company’s competitive position might also decrease if traditional brokerages begin offering the ability to trade cryptocurrencies. "They will most certainly cut down on the unnaturally wide spreads in the immature cryptocurrency market," the report says.
As an example, the report considers if Coinbase’s revenue share of trading volume fell to 0.01% (equal to traditional stock exchanges). If so, it’s estimated Q1 2021 transaction revenue would have just been $35 million.
What should Coinbase’s valuation be?
The New Constructs report suggests Coinbase’s valuation "should be closer to $18.9 billion." This would represent an 81% decrease from the company’s expected $100 billion valuation.
New Constructs uses a reverse discounted cash flow (DCF) model to make its claims. DCF analysis is a valuation method that involves estimating the value of an investment based on its expected future cash flows. Critics claim that DCF models are too reliant on uncertain future predictions—and New Constructs accepts this kind of analysis can be "extremely misleading," despite being "extremely helpful when used in the right way."
The firm also said it is not using a DCF model to predict the future. Rather, it is using the DCF model to "quantify the expectations for future cash flows that are baked into stock prices." Previously, New Constructs has applied this method to Netflix (NFLX).
Using this method, the report even suggests that to justify its expected $100 billion valuation, Coinbase must maintain a 25% net operating profit after tax, and grow revenue by 50% compounded annually for the next 7 years. This would equate to $21.3 billion in revenue by 2027, 1.5 times the combined 2020 revenue of the Intercontinental Exchange and Nasdaq.