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Note: This is a long analysis. You can read this write-up with images and better formatting here.
Introduction
Coinbase’s revenues are transparent: in their most recent quarterly report, Coinbase stated that over 81% of their revenues came from trading fees (the other 19% comes from “Subscription and services”). I will use Coinbase’s historical trading volumes, which are public information, to come up with a reasonable estimate of what their revenue will be.
I manually compiled the trading volumes of every day from January 1st, 2022 to September 30th, 2022. This period of nine months covers three quarterly reports: Q1 covers January to March, Q2 covers April to June, and Q3 covers July to September. Note that the Q3 earnings report is due to be released on November 3rd—just a couple weeks from this write-up.
Coinbase trading volumes, in addition to overall cryp*o trading volumes, have been on a steady decline. While there are many contributing factors, none of them are particularly important to this analysis.
Using the Data
What is important is figuring out how trading volume correlates with the revenue Coinbase earns from users trading on its platform. It’s obvious that they are positively correlated, but the extent to which they are correlated will affect COIN’s earnings, which in turn will affect our analysis and estimate. I have displayed the pertinent information below. *images not allowed in r/stocks
As shown, the volume-to-revenue (V:R) ratio of Q1 was 0.003275571507 and the V:R of Q2 was 0.003090481727. The ratios are within 6% of each other. I interpret this to mean that Coinbase’s V:R is relatively constant—there will be variations and small differences, but it is reasonable to use this ratio as a tool to find an estimated revenue. Since it is unclear exactly how these ratios are affected, I defined Q2’s 0.003090481727 to be a conservative estimate ratio and Q1’s 0.003275571507 to a liberal estimate ratio. I will use these values to create an estimate range, which I have displayed below. *images not allowed in r/stocks
The lower bound estimate is $477,707,813.421 and the upper bound estimate is $506,317,862.566. But remember: this is only revenue from trading fees. I still need to factor in the revenue from subscriptions and services (S&S). Coinbase’s S&S revenue in Q1 was $151,855,000 and $147,390,000 in Q2. I think it is very reasonable to assume that their S&S revenue will decline further than Q2’s: declining trading volumes are indicative of declining quantities of Coinbase users, which is indicative of fewer users who want Coinbase’s S&S. However, I want to be generally conservative in my estimate, so I will just stick with their Q2 S&S revenue. *images not allowed in r/stocks
My revenue estimate for Coinbase’s Q3 report is $625,097,813.4 to $653,707,862.6. This is approximately a $30 million, or 5%, range.
Expenses and Other Stuff
There are three main categories of Coinbase’s expenses that are pertinent to this analysis: Operating Expenses, Interest Expenses, and Other Expenses.
As listed on their income statement, operating expenses consist of the following categories: transaction expense, technology and development, sales and marketing, general and administrative, and other operating expenses. While operating expenses as a whole increased from Q1 to Q2, the categories within operating expenses increased and decreased differently. I have listed the operating expenses below. *images not allowed in r/stocks
Note that restructuring expenses are a category on the Q2 report, but are not listed on the Q1 report. In their Q2 report, Coinbase states that the cost comes entirely from when they laid off 18% of their employees in mid-June. The cost breakdown was as follows: $39,259,000 of separation pay and $3,194,000 of post-employment benefits.
Also note that while Coinbase breaks down the factors that increase or decrease various operating expenses, they only reference these monetary adjustments when comparing them to the quarterly period a year prior to the report. This means I am unable to directly compare the increases and decreases of the factors of the different operating expenses from Q1 to Q2.
Ideally, I can formulate a reasonable estimate on what Coinbase’s operation expenses will be in Q3. The first element of operating expenses that can be concretely determined are their restructuring expenses: they haven’t announced any layoffs since June, so they will not be incurring costs related to layoffs in Q3 (except for “COBRA health insurance in the US, and 4 months of mental health support globally”). Thus, I find it reasonable to conclude that they will not have any substantial restructuring expenses in their Q3 report.
Transaction Expenses
Here is Coinbase’s explanation of what “transaction expense” encompasses:
“…costs incurred to operate our platform, process cryp*o asset trades, and perform wallet services. These costs include account verification fees, miner fees to process transactions on blockchain networks, fees paid to payment processors and other financial institutions for customer transaction activity, and cryp*o asset losses due to transaction reversals. Transaction expense also includes rewards paid to users for blockchain activities conducted by us, such as staking. Fixed-fee costs are expensed over the term of the contract and transaction-level costs are expensed as incurred.”
This means that transaction expenses will be positively correlated with trading revenue: as more users trade on their platform, they earn more revenue and must spend more on operating their platform. Since trading volume on Coinbase’s platform is declining, it is reasonable to assume that their transaction expenses will also decline. *images not allowed in r/stocks
As shown, there is roughly a difference of 8% between the rate in which Coinbase Trading Volumes and the rate in which Transaction Expenses fell. This proves that they are not perfectly correlated; instead, as Coinbase improves its operations, fixed costs are reduced and overall efficiency is improved. Thus, it is reasonable to expect that transaction expenses, when ignoring trading volumes, will decline over time. With Q3 trading revenue of $154.5739 billion, the Q2:Q3 trading revenue ratio is 0.72908781326. Discounting it by the ratio of the Q1:Q2 Coinbase trading volume ratio to the Q1:Q2 transaction expenses ratio, 0.60176873294 / 0.68551747663 * 0.72908781326=0.64001614042. Thus, I believe a reasonable estimate of Coinbase’s Q3 transaction expenses is $107,002,378.
General and Administrative Expenses
General and Administrative (G&A) expense is a very broad category: it encompasses business/legal/finance, HR, customer support, depreciation, and more. Coinbase doesn’t delineate what percentage of the G&A expenses were constituted by which precise expenditures, but there was one set of information I thought would help me form a better estimate. *images not allowed in r/stocks
Above is a breakdown of stock-based compensation (SBC) in Q1 and Q2: Coinbase distributes SBC expense over three categories of operating expenses: Technology and Development (T&D), Sales and Marketing (S&M), and G&A. While there was an increase in SBC overall from quarter to quarter, the most dramatic increase (in terms of dollars) was the G&A category. The $30.207 million increase explains more than half of the $56.591 million increase in overall G&A expenses. The other $26 million? We may never know. I do, however, believe that as they navigate the current economic downturn, they will cut costs (including stock-based compensation). Their Q1 G&A expenses of $413,578,000 will likely turn out to be larger than their Q3 G&A expenses because demand in Q1 was so much higher. However, this analysis is, I repeat, an estimate: I will use $413,578,000 as a guess for their Q3 G&A expenses.
T&D, S&M, and Other Operating Expenses
T&D and S&M are positively correlated with Coinbase trading volumes, and Other Operating Expenses (OOE) is positively correlated with the performance of the broad cryp*o market. I expect Coinbase to reduce both T&D and S&M with the goal of reducing overall costs. OOE is mainly composed of gains and losses on cryp*o assets and derivatives. This conceptually explains the large jump in OOE from Q1 to Q2 of $258,627,000 to $422,762,000. Given that the cryp*o market traded largely sideways in Q3, I expect that their losses on cry*to will be reduced. My estimate of these three expenses is $928,445,458.
Other Expenses
A number on Coinbase’s Q2 report that surprised me was its Other Expenses (not Other Operating Expenses) of $172,524,000. This is a large number compared to Q1 Other Expenses of $32,844,000. There were two main reasons behind this difference: a $167.4 million loss on foreign exchange in Q2 compared to a $41.8 million loss on foreign exchange in Q1, and an impairment expense of $69 (nice) million on “strategic equity investments”. These “strategic equity investments” refer to the portfolio of Coinbase Ventures, Coinbase’s venture capital division. Impairment expenses in Q1 only totaled to $100k—an increase in impairment expenses of 69000% in the span of roughly three months. What will Coinbase’s loss on their VC investments look like in Q3? Hard to say. I do, however, believe that as we continue to work through the current recession, most startups will experience declining revenues in addition to capital becoming more expensive and restrictive. Thus, I find it reasonable to presume that Coinbase’s impairment expenses will be at least greater than Q1’s. I will use Q1’s Other Expenses, $32,844,000, as the benchmark for this estimate, allowing up to $69,840,000 (mid-point between Q1 and Q2) of uncertainty.
Interest Expense and Income Tax
Coinbase’s Interest Expense (IE) has modestly stayed the same. It increased from $22.138 million in Q1 to $23.656 million in Q2: a 6.86% increase. Given that interest rates have steadily risen since the beginning of this year, and Q3 has undergone a similar increase in rates as Q2 (about 1%), I believe it is reasonable to guess that Coinbase’s Q3 IE will increase at a similar rate as Q2’s. My estimate is that Q3 IE will be $25,278,801.6.
Coinbase’s income tax rate is 11.8%. Using the numbers I have assembled so far, their income tax benefit will range from $104,081,997 to $105,071,539. *images not allowed in r/stocks
My conclusion is that Coinbase EPS will be between $-3.00 and $-2.97. I also believe that, since I was generally conservative in my estimate, Coinbase EPS has a high chance of being lower than the bound of $-3.00. The current average analyst expectation for Coinbase earnings is $665.47 million, and the current average analyst expectation for Coinbase EPS is $-2.38. This implies that the market has not priced in this write-up’s EPS range. Therefore, on the week of earnings, I will be purchasing 14-DTE OTM puts to capitalize on volatility, and sell the options once earnings are announced. I am excited to see how my analysis compares to their Q3 report, and will likely post a follow-up to compare the results.
Disclaimer: I am not a financial advisor and this article is not financial advice. Do your own research. Consult a professional investment advisor before making any investment decisions.
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