Coinbase ($COIN) #3 - Answering previous questions
Going back to answer open questions from prior research
03-03-2022
I set out today to answer the questions that were left over from the other research days. I would have been able to do more, had I not done “catch up“ posting of the last 3 days this morning. But this is now done and hopefully this will add value to some people in the community.
OPEN QUESTIONS
Regulations
Confirm the regulatory environment and stance in the US, Europe, and open market Asia.The US and Europe’s stance have been answered in previous discussions. In order to answer the Asian regulatory framework, we're going to focus on South Korea, Singapore and Japan.
https://www.globallegalinsights.com/practice-areas/blockchain-laws-and-regulations/singapore
The democratic / open market economy countries in Asia seem to have begun to develop a descent regulatory framework. There is a feeling of corporation and working together. This is something that Munger has stated many times in his various interviews: He's a big fan of Singapore. International competition to COIN may be the biggest concern, because if Binance or somebody else has a much easier way navigating the regulatory landscape it may conquer Asia. Not that that it is a problem really, US and Europe alone is a big market. It's too early to tell and unknowable right now. I have decided to focus the research on US and European competitors, base the worst case on those two continents and then anything that happens in Asia would be the cherry on the cake.
What are the SEC's concerns?
https://www.coindesk.com/markets/2022/02/07/ny-fed-stablecoins-are-not-the-future-of-payments/
This is a great take on stable coins and how tokenized deposits could do the trick. Again, this emphasizes our original hypothesis that we should disregard all possible revenue streams from stable coins. Now that I think about it, this is one of the reasons the SEC won't allow the lending project to begin. So we basically answered that question already. I am wondering though how a stable coin ties up assets?
When I have a USD in my hand I can go and spend it or lend it out at current interest rates. If I now place this USD into an account where it just sits (and possible produces interest income for COIN) and I receive a coin in return, representing this USD and I then lend it out for 4% (the proposed rate on COIN) wouldn't I in effect have the exact same amount of $ circulating / tied up as before? The physical USD sit's while the coin does the productive work. Same thing as the USD doing the productive work, right? Allthough technically the coin is worth more than the USD, because if I lend the USD to the bank and get 1%, but I can receive a coin that is worth the same but gives me 4%, I have in effect bought a $1 for a specific number of cents. This in turn would of create a value difference between the USD and coin it backs and there is the arbitrage. So yes, this is a heavy subject, and I will classify this as unknowable right now. It may also force interest rates on $ deposits up, but who knows. Too difficult. NO MORE TALK ABOUT STABLECOIN. Interesting though, that this is where the biggest focus lies for regulators.
ecb.europa.eu/pub/financial-stability/fsr/focus/2021/html/ecb.fsrbox202111_04~45293c08fc.en.html
Simply another regulatory piece which points towards a blockchain world were stable coins exist, but must be backed by cash equivalent assets in order to be approved.
Culture
Find videos etc. of Brian A. talking about Amazon, role models etc.Let me start out by saying that I don't believe Brian's haircut is a coincidence, but I digress.
https://decrypt.co/62627/coinbase-ceo-vows-better-customer-support-likens-company-to-amazon
I will go through the entire Reddit AMA below (VIDEO). According to the articles he makes a comparison to Amazon in the early days, liking his company with Jeff's. I think in the least he has taken a lot of inspiration from Bezos and that can never be a bad thing when it comes to capital allocation, testing, customer experience obsession and simply trying a lot of small things. The Forbes article focuses more on the AWS comparison, which lead me to adding Alchemy to the competition analysis list. Right now, our worst-case focus excludes cloud as a potential revenue source and assumes COIN will lose that market completely. If we can proof that out and make a descent purchase, we have a big margin of safety. On to the AMA:
Biggest Threat:
Regulation (I knew it! No, I didn't cheat). Brian says educating is the main thing they need to do. If they can effectively educate the public and the government they will win in the end.Cyber Security. Getting hacked would be quite bad to the reputation.
Continued Innovation. They need to remain nimble and continue to innovate(Bezos).
They do not focus on the competition, just on the customer. That was noticeable in hearing him answer this. He never even considered his competition anywhere. The tools to destroy themselves are all in their own control and by focusing on what the customer wants, they automatically do the best thing for shareholders in the long run.
DEX (Decentralized Exchange vs. COIN)
They will make it easy for their customers to access all products regardless of if it is their own. If the customer gets a better price on a DEX than Coinbase will route the trades so that the customer has the best price. They would also provide a direct access to any DEX or apps. Brian thinks about it like Amazon allowing third party sellers on the platform. Coinbase wants to give the customer what they want.Wherever the customers want to go Coinbase will make that easy to use, legal and thereby trusted. Brian says he wants to take buying an NFT from 25 clicks to maybe 5 clicks, thereby hitting on the customer simplicity and experience factors. In FinTech people need to have access to a real human being as part of their philosophy, thereby opening the door to great customer support.
The VISA card at 4% is a great product. My Chase card gives me 1%, so it is an easy choice. Currently what is holding me back personally is the ability to use... wait for it... stable coins. The volatility of Crypto is too great right now and if I want to buy a pizza on Thursday, I don't want to have to worry about the Bitcoin 20% drop on Tuesday. So I think that for this to gain traction we’re again needing more adoption throughout, but COIN as the regulatory first company will position itself to be among the first to stably offer this without glitches.
Competition
Many of them are not focused. The ones who are focused are not following all the regulations. COIN does not want to have ANY regulatory issues ever. I will check all that in the company deep dive.Coinbase seeks to give customers the best price when they are acting as an exchange and the broker at the same time. They move trades of platform if it is cheaper and thereby there is no conflict of interest.
Verify how the trades are always cheapest
Capital Allocation
Find failed investments
Study acquisitions and investments of the company to show that they are NOT like Amazonhttps://www.fool.com/investing/2022/01/27/why-coinbases-latest-acquisition-is-a-game-changer/
FairX is a 2022 acquisition to enter the crypto futures trading market. The purchase price is currently unknow. The addressable market is rather big however. A competitor did a similar acquisition for $216 million (lost the link…), but I am sure COIN paid more, because FairX has all US approvals.
2021
Bison Trails (future AWS style cloud) - $457,268 million (10K)
5 other acquisitions - $211,004 million (10K)2020
Tagomi - $41,792 (10K)There is not enough information to calculate a ROI now. The services will need to begin generating revenue to prove themselves. However, the total cost of these acquisitions could have easily been paid with NI. They chose to do a combination of cash and equity. Considering their growth potential this may have been a prudent move. If one considers the stock price to be undervalued equity financing can be good capital allocation, especially if the cash can be invested back into the business.
It is too soon to say if investments failed or how they played out. What we do know is that the total cost of these acquisitions is relatively small compared to the ability to pay them in cash. They just chose to use some equity. This opens the next questions:
1. How is the competition financing their acquisitions?
2. How are the latest funding rounds priced?
3. a16z is invested, who will they hold past the IPO?
Summary
I was able to answer the questions from the previous few days. This led to new questions, which is a good thing. Overall I got the most out of the Reddit AMA in combination with the Cultural document. The customer first, simplicity / UX first and all legal approach is defining everything they do, at least they say so. Amazon was able to proof that early by lowering prices. Coinbase has already said they will not compete on price, so I don’t expect that happening anytime soon.The big points for me are the focus on the customer and giving them what they want even if it means sacrificing short term revenue. The fact that all the acquisitions since 2020 could have been paid with NI of 2021. Both of these have Amazon DNA similarities. Of course with Amazon we have hindsight. When they did their thing in the early days they did similar investments, is all we know for sure.
Another point to make is that COIN currently trades alongside Bitcoin. Not 1 to 1, but pretty closely. This correlation as well as the current Market Cap continue to suggest that Mr. Market currently does not price any of the growth potential into the business. With a market cap of $40 billion today and $3.1 billion in Net Income we’re slightly above the no growth Pabrai valuation technique.
The competition deep dive is next. Since I am following Li Lu’s principle on knowing the worst case scenario well we’re going to focus on the US & European market share. If Coinbase never receives Asian customers at all, trading will be the only continued source of revenue what does the future look like if the competition catches up and the market share of COIN is shared relatively evenly. Right now (and I know my biases are ready to jump me) it seems to me more and more than COIN is undervalued. However, we need to build a case where COIN has a good margin of safety even if non of their investments work out.