Why Coinbase Remains Attractive from a Long-Term Perspective

Coinbase Global (COIN) stock has witnessed a sharp correction in the last six-months. During this period, the stock has declined by around 68% and trades just above $100.

This correction does not come as a surprise. Bitcoin (BTC) has also corrected sharply from all-time highs and the cryptocurrency has struggled to breach $40,000 levels.

A commonly used investment strategy is to buy a fundamentally strong stock when fear is the dominant market sentiment. When greed is the dominant sentiment, the stock is already overvalued.

This holds true for COIN stock after its deep correction. The stock trades at a price-to-earnings-ratio of 7.0 and seems oversold. I am bullish on Coinbase for the next few years and this coverage elaborates on the positive catalysts.

Reasons for Bitcoin Correction

The price action on COIN has high positive correlation with Bitcoin. It’s therefore important to talk about the reasons for the cryptocurrency trending lower.

It seems that liquidity tightening is the biggest factor for the correction. The Federal Reserve recently increased rates by 50 basis points. With inflation remaining stubbornly high, further rate hikes are in the cards.

Although, it’s just not Bitcoin, as most equities have corrected with relative liquidity tightening. A decline in liquidity in the financial system would translate into lower speculative activity. For Coinbase, this would imply relatively lower income from trading activity.

While this risk is likely to persist, investors need to note two important points.

First, even with multiple rate hikes, real interest rates will remain negative. Beyond the knee-jerk reaction for risky asset classes, funds will continue to flow into equities and cryptocurrencies, as investors seek returns that can comfortably beat inflation.

Furthermore, cryptocurrencies have not faced any significant regulatory headwinds. On the contrary, the Biden administration is looking at responsible innovation from the crypto-world. Once the macro-economic headwinds wane, wider adoption of cryptocurrencies will translate into higher Bitcoin prices.

Positive Catalysts for Coinbase

For 2021, Coinbase reported revenue of $7.4 billion and an adjusted EBITDA of $4.1 billion. This implies a healthy EBITDA margin of 55.6%. A key positive is that the company’s business has high cash flow potential.

Like 2021, it would be unrealistic to expect multi-fold growth in revenue and EBITDA. However, Coinbase is positioned for sustained growth in the next few years.

One reason to be bullish is wider cryptocurrency adoption. At the end of 2021, there were nearly 300 million crypto holders globally. Estimates indicate the crypto holders can swell to one billion by the end of 2022. These estimates are an optimistic case scenario considering the ongoing bear market. However, crypto adoption will continue to increase in the next few years. This will benefit Coinbase.

Coinbase increased institutional investors by 50% on a year-over-year basis in 2021. The company also launched Coinbase Prime, which is an integrated solution for institutional crypto needs. Beyond retail users, the company is positioned for healthy growth as the number of institutional investors swell.

Coinbase is also positioned to benefit as the number of assets increase on the company’s platform. In 2021, the company added trading and custody support for 95 and 72 new crypto assets, respectively. It’s worth noting that the trading volume (% of total) of assets other than Bitcoin and Ethereum (ETH) was 44% in 2020. This increased to 55% in 2021. Clearly, the addition of new assets has translated into diversification and revenue growth.

In terms of revenue diversification, Coinbase also generated $500 million in revenue in 2021 from subscription and services. This includes revenue from staking, earn, and custody.

It’s also worth mentioning here that Coinbase ended 2021 with cash and equivalents of $7.1 billion. Recently, it was reported that Coinbase ended talks to acquire a Brazilian crypto firm, 2TM. Given the cash buffer, the company will continue to seek inorganic growth opportunities.

Risk Factors

In terms of risks, cryptocurrencies are a high-beta asset. There is also an expectation of a potential recession in the U.S. in 2023. Downside in crypto or lower trading volumes can impact growth significantly.

Coinbase is also facing intensifying competition as the number of cryptocurrency trading platforms swell. There might be a case for impact on EBITDA margins. However, Coinbase is strong financially and can negate competition by acquiring peers and boosting market share.

Coinbase also expects lower EBITDA in 2022 with aggressive investments and a slowdown in trading activity. This factor is largely discounted in the stock. Beyond the near-term headwinds, the adjusted EBITDA outlook is likely to be robust.

Wall Street’s Take

Turning to Wall Street, Coinbase has a Moderate Buy consensus rating, based on 14 Buys, two Hold, and two Sell ratings assigned in the past three months. The average Coinbase price target of $274.88 implies almost a 165% upside potential.

Concluding Views

The markets typically over react to good or bad news. Sharp reactions provide an attractive entry point. Growth stocks have been struggling as the markets discount liquidity tightening. This is a good opportunity to accumulate some quality businesses.

Coinbase stock has declined to attractive levels. The downside risk seems capped from here. However, once Bitcoin has another rally, the upside potential is significant.

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