Investors in Coinbase Global (COIN -0.11%) have had a volatile ride lately. The crypto exchange went public through a direct listing in April last year after pricing its shares at $250. The price rose to $429 on the first day of trading before closing at about $328 that day. Since then, the stock fell to a low of around $220, and recovered to $360 before resuming its downward spiral.
As of this writing, the stock is below $200, down more than 50% from its peak. Frustrated and confused, investors are seeking reasons for such huge swings. While we cannot be certain of the drivers, we can certainly make some educated guesses. Here is mine.
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Investors are concerned about the sustainability of Coinbase's performance
Coinbase has had a great ride over the last two years. While most companies faced enormous challenges amid the pandemic, the crypto company delivered some amazing performance. For perspective, Coinbase's net revenue for the second quarter of 2020 was $178 million. In the following quarters, it rose more than 10-fold to a high of $2 billion in the second quarter of 2021 thanks to the growth in crypto assets and the increase in transactions among users.
In the third quarter of 2021, Coinbase continued to deliver strong numbers as net revenue and net income came in at $1.2 billion and $406 million, respectively. Still, investors were not impressed because the results were weaker than the prior two quarters. The decline in crypto asset prices led to a decline in trading volume, hurting Coinbase's trading revenue and net income.
While you can't complain too much about the latest results (Coinbase still made hundreds of millions in net profit), it is clear that the company is too dependent on transaction-related fees. Out of the $1.2 billion in net revenue in the third quarter, 88% came from transaction-related income. Hence, it is highly exposed to the volatility of the crypto market. To put it bluntly, more than 80% of Coinbase's income is beyond its control!
On a slightly positive note, Coinbase has been growing its subscription and services revenue in each of the last four quarters. Revenue from this was up more than 10-fold from $11 million in the third quarter of 2020 to $145 million in the latest quarter. Still, there is a long way to go before this can compensate for the volatility in trading-related revenue. Investors will still have to bear with this volatility for a while.
The tech stock sell-off
It was a great time to be a tech investor in the last few years. For example, popular tech stocks like Tesla (TSLA 3.97%) rose close to 1,600% in the last five years alone.
Lately, the rise has reversed. Just as the ascent took the high-growth tech stocks to the sky, the descent brought them back down to earth. For example, Shopify (SHOP -2.21%) saw its stock decline by almost 50% from its peak while Tesla shed more than 25% of its market capitalization. The sell-off spared few companies, including Coinbase.
The main driver of the recent tech sell-off is the fear of rising interest rates. Higher rates hurt the intrinsic value of almost all companies, especially those high-growth tech stocks. Because these companies typically make the bulk of their cash flows many years in the future, higher rates will materially reduce the present value of those anticipated cash flows.
Besides, it did not help that Coinbase was trading at a high valuation during the tech sell-off. For perspective, it currently has a market capitalization of about $50 billion. Divide that by the annualized third-quarter net income of $1.2 billion and it gives a price-to-earnings (P/E) ratio of more than 30. And that is after the steep decline from its peak!
What is next for Coinbase?
Coinbase is riding a gigantic trend as the crypto economy becomes mainstream. As one of the leading players in this industry, it is well positioned to benefit from the tailwind.
Still, investors shouldn't expect a smooth ride. The crypto industry is still nascent and will undergo plenty of tests in the coming years before becoming a part of our daily lives. Regulation, competition, and obsolete technologies are a few key risks to watch.
On top of that, investors should prepare themselves for more volatility in stock prices as financial institutions adjust to higher interest rates. There is no guarantee that the recent tech sell-off is over. And if it is not, there is a good chance that Coinbase's stock price may fall further when the sell-off resumes.
In short, investors should expect a bumpy ride for a while.
