In today’s world there are a lot of things that make you scratch your head – the latest one is the valuation attached to the Coinbase IPO, of US$90 billion on a fully diluted basis after the first couple of days of trading. For those of you that have not about heard about Coinbase, it is an exchange where users buy and sell different cryptocurrencies and they charge a fee for facilitating the transaction. For reference, Intercontinental Exchange who own the New York Stock Exchange (NYSE) among others, has an enterprise value of ~US$84 billion and Nasdaq Inc that owns that the Nasdaq Stock Exchange and which Coinbase is listed on has an enterprise value of ~US$30 billion.
The reason that investors are willing to attribute such a high valuation to Coinbase is that, unlike many other highly valued tech companies, it is profitable and appears to be trading on a reasonable earnings multiple. According to the Coinbase website they generated Net Income of between $730 million and $800 million for the quarter and clearly investors are buying the stock on the basis of recent earnings. Some investors also seem to believe that “crypto has the potential to be as revolutionary and widely adopted as the internet” (according to Coinbase anyway!). We believe that these currencies have no intrinsic worth and that the value sits in blockchain technology, but that is an argument for another day.
Coinbase is able to earn so much money because fees charged on every transaction are almost ~0.50%, an extraordinarily high number compared to other exchanges. Our two comparators for this article i.e., the NYSE and the Nasdaq, charge a per transaction fee of around 0.01%.
Another example closer to home is the ASX which charges a clearing fee of 0.00225% on equity trades. For Coinbase to justify its valuation it will have to ensure that it can continue to charge these high fees, but as we have recently seen, there is immense pressure on trading fees in many corners of the market. The most well-known trading platform is Robinhood which allows for zero brokerage trading in the US and has a suite of competitors. In Australia we have Superhero that has a fixed cost of $5 per trade on ASX stocks and zero brokerage for ETF trading. Coinbase also has several competitors such as Binance, Global, Huobi Global andKuCoin to name a few. Based on data from CoinMarketCap we find 366 cryptocurrency exchanges who are all vying for a slice of the fee pie.
It seems to us that the fees that Coinbase earn will in time head toward the same level as stock exchanges or perhaps even lower since they do not have a monopoly on trading like most national exchanges do. If this is so, the current valuation does not look reasonable at all, and the volume that will have to be traded on the Coinbase platform to make the valuation seem reasonable would have to be extraordinarily high. Strangely, the Coinbase founders and management seem to agree with us. Via the IPO, director Fred Wilson sold more than half his stake, CEO Brian Armstrong sold 71% of his stake, President Emilie Choi sold 63% of her stake, CFO Alesia Haas sold 100% of her stake, Chief Product Office Surojit Chatterjee sold 97% of his stake, Chief Accounting Office Jennifer Jones sold 86% of her stake and early backer Union Square have sold out completely.
Buying into a company that is overearning, where insiders are selling and where comparisons with competitors make prices look silly, seems to us to be a recipe for disaster. Our value investing philosophy is to seek companies with the exact opposite traits. Fortunately, the ASX is now presenting several such opportunities. Over the long run value investing has generated outperformance for discerning long term investors.