Coinbase Global: Still Woefully Risky Despite A Well-Deserved Upgrade (NASDAQ:COIN)

On November 2nd, the management team at Coinbase Global (NASDAQ:COIN) announced financial results covering the third quarter of the company’s 2023 fiscal year. In addition to seeing revenue increase year over year, the company exceeded analysts’ forecasts on both the top and bottom lines. Naturally, investors are viewing this optimistically. In particular, there’s the fact that the company has succeeded in cutting costs materially and it is now consistently generating positive cash flows. While this in and of itself is a positive thing, I do still believe that investors in the enterprise are playing a dangerous game of speculation.

Those who follow my work know that I have not been a fan of this enterprise. But it is also true that fundamentals have been improving. This fundamental improvement has now led me to upgrade the company from a ‘strong sell’ to a ‘sell’ because cash flow at the end of the day is still valuable. But this is not to say that the company is in good shape. For now, cash flows are positive. However, the company is still dealing with a faux asset of negligible intrinsic value and it is also seeing some rather painful declines on the user and asset side. Ultimately, I believe that these issues, if not addressed, will cause shareholders a great deal of pain. And because of that, I would urge caution for those who find recent developments bullish enough to justify an investment.

Good news first

Before we get into some of my concerns, let us first appreciate how well recent performance achieved by Coinbase Global has been. Starting with the most recent quarter, which is the third quarter of the company’s 2023 fiscal year, we see that revenue came in strong at $674.1 million. That represents an increase of 14.2% over the $590.3 million generated the same time last year. It was also $20.6 million higher than what analysts anticipated. There were a couple of drivers behind this growth. The most obvious when looking at the income statement is the ‘other revenue’ category. Revenue skyrocketed from only $14 million last year to $51.1 million this year. This part of the company generates revenue that’s primarily earned on the corporate cash and cash equivalents on the company’s books. Basically, the company allocates capital on its balance sheet toward other investments that earn it interest income. Though some of the revenue also comes from the sale of crypto assets that it is the principal owner of. Given the higher interest rates that the economy is dealing with, it’s not surprising to see a surge in income when it comes to this category.

What requires a little deeper digging is the net revenue associated with its core operations. In the image below, you can see the many working parts of this. While overall revenue increased from $576.4 million last year to $623 million this year, there were some areas of weakness for the company. Total transaction revenue, for instance, plunged from $365.9 million to $288.6 million. I would get into this a bit more shortly. There were other ways in which revenue increased though.

The biggest rise actually came from revenue associated with stablecoins. Sales there skyrocketed 124.3% from $76.9 million to $172.4 million. Since 2018, the firm has generated income on funds under an arrangement with the issuer of USDC that falls under its stablecoin offerings. But that picture has changed since then because, effective August 18th of this year, it has started earning a pro rata portion of income earned on USDC reserves That is based on the amount of USDC held on its platform, as well as from other related activities. Most of the money made by Circle, the issuer of USDC, is from assets that back the stablecoin, such as dollar deposits and short-term securities. The rise in interest rates has certainly been beneficial in this regard. And if stablecoin adoption grows materially, that could be a good catalyst for revenue and profitability for Coinbase Global.

In addition to outperforming on the top line, Coinbase Global outperformed on the bottom line. The firm generated a loss per share of $0.01, which was far better than the $2.43 loss per share generated one year earlier and it exceeded analysts’ forecasts by $0.52 per share. This took the company from generating a net loss of $544.6 million to generating a loss of only $2.3 million. The increase in revenue helped the company in this regard. But it was more than that that drove the improvement that the company experienced. For instance, technology and development costs plunged from 94% of sales to 48%, with some of that improvement driven by a more than 50% cut in stock-based compensation associated with those operations. Some of that cost cutting, as well as other costs cutting under the same category of expenses was driven by a 24% decline in headcount. Investments in website hosting and infrastructure also helped cut costs on that front from $96.3 million to $40.6 million. General and administrative costs also improved drastically, dropping from $339.2 million to $252.6 million as the company embraced greater automation of services and a reduction in customer support activities in a bid to stem significant cash outflows.

The improvement from a profitability perspective also helped when it came to cash flows in general. Operating cash flow went from negative $397.5 million to positive $313.9 million. If we adjust for changes in working capital, it went from negative $156.5 million to positive $126.2 million. And finally, EBITDA for the firm went from negative $115.9 million to positive $180.9 million. As you can see in the chart above, 2023 as a whole is looking up compared to 2022 as evidenced by results for the first nine months of the 2023 fiscal year relative to the same time last year.

Now for the bad news

To be perfectly honest with you, this improvement in both the top and bottom lines, particularly in the third quarter, is impressive. Investors have a right to be happy about recent developments. It stands to reason that additional cost cutting could help the company from a cash flow perspective. But this does not change the fact that the firm has some serious issues to contend with. The first of these I won’t delve into really. That’s because I have covered that issue before in separates here and here. The core of this particular argument is that many cryptocurrencies, particularly Bitcoin (BTC-USD), lack any significant intrinsic value and having a business that generates such a significant amount of revenue from a faux asset is awful from a long term operational and strategic perspective.

This does not mean that everything that the company does lacks value. That would be a mistake to say. For instance, while they have issues of their own, stablecoins could be considered a viable asset. And given how many countless thousands of other cryptocurrencies exist, I would imagine that there are others out there that do have some true value to them. More broadly speaking, blockchain technology itself is a massive innovation that has true staying power. So there are certain aspects of the company that could go on to generate value for investors. But when you have 48.7% of all customer crypto assets that the company holds in the form of Bitcoin and 37% of transaction revenue, up from 31% last year, coming from Bitcoin, that is truly worrisome.

Again, for more details on my thoughts regarding this particular matter, I would refer you to the aforementioned article. But even outside of this, there is another issue brewing. In the chart above, you can see both the value of crypto assets and the transaction volume that the company has seen over the past several quarters now. And in the chart below, you can see what management refers to as MTUs, or monthly transacting users. Because cryptocurrency prices can be extremely volatile, the data in the chart above is not all that significant. But it is interesting to see. The data on the chart below, however, paints a very disturbing picture. The fact of the matter is that, in almost every quarter from the first quarter of 2022 through the third quarter of this year, the company has experienced a decline in MTUs. The drop since the start of this window of time has been 2.5 million, or 27.2%. And what makes matters worse is that the percentage decline it seems to be worsening.

At the end of the day, Coinbase Global is a network of sorts. Or at least it has network effects. Seeing declines like this would be like seeing declines in the number of MAUs (monthly active users) of Facebook or any other social platform. It paints a picture that cryptocurrency adoption is not expanding but, perhaps, might even be contracting to some extent. At the very least, it doesn’t seem to be growing meaningfully. This is something that I wrote about in another article that you can read here. When I see this data though, it is worrisome because essentially all of the price in a faux asset like Bitcoin comes from the bigger fool theory. And when you have a situation like that, it is only the hype that keeps the ball rolling. When the music stops, the picture can change rather abruptly and painfully. And the music is definitely slowing.

Takeaway

In the near term, Coinbase Global is doing a really fantastic job compared to what it was able to achieve even last year. Revenue has started growing again and both profits and cash flows are looking up. There are parts of the company that could be viable in the long run if management can continue growing those particular operations. But this doesn’t change the fact that the company has some real issues to contend with. Its core business still centers around something that does not have any meaningful value to it. So if the company is to thrive, it must continue to diversify away from those core operations. But when you see data such as the MTUs, it paints a scary picture because it shows a rapid decline in activity on the network. And unless that picture changes for the better, the company could face issues down the road.