Why Coinbase Could Be the Google of Cryptocurrencies

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Coinbase

might be the Google of cryptocurrencies. If that’s the case, its stock could be a bargain.

Barron’s Avi Salzman made the case for owning Coinbase stock in the April 19 issue of the magazine, arguing that it’s “a novel company with competitive advantages that have enabled it to increase market share despite fierce rivals.” The article also compared Coinbase to

Shopify

(SHOP), Square (SQ),

Charles Schwab

(SCHW), and Nasdaq (NDAQ).

But Coinbase also looks a lot like

Alphabet

(GOOGL) did at the time of its IPO. Google, as the company was known then, was worth roughly $23 billion when it made its public debut. That was 2004, when the

S&P 500

was around 1,100. Today, Coinbase is worth about $87 billion—based on the roughly 260 million fully diluted shares count—and the S&P 500 is at almost 4,200.

Back then, Google’s valuation raised some eyebrows. But Google was also generating earnings and free cash flow. Fast forward to today and Alphabet has generated about $240 billion in free cash flow over the course of its existence. That has made investors, who bought shares at $85 in its IPO very happy.

Coinbase, like Google, is already making money—a lot of money. The company generated about $320 million in cash from operations during 2020 from $1.2 billion in sales. In the first quarter of 2021, Coinbase revenue came in at $1.8 billion. Earnings were roughly $750 million. Coinbase’s net margin in the first quarter works out to roughly 42%. That’s high, but not all that high for an exchange. The average net profit margin for the big four publicly traded exchanges is about 35%.

Yes, Coinbase is already one of the world’s most valuable exchanges. The

Intercontinental Exchange

(ICE) has a market value—including debt—of roughly $84 billion.

CME Group

(CME), Nasdaq, and

Cboe Global Markets

(CBOE) are valued at $76 billion, $29 billion, and $12 billion, respectively.

The pace of value creation is breathtaking and will bring claims of “bubble” with it. The Intercontinental Exchange, after all, owns the 200-year-old New York Stock Exchange. Coinbase was founded in 2012 to trade Bitcoin, which was introduced in 2008. And despite its lack of pedigree, Coinbase doesn’t look all that expensive compared with the four traditional exchanges. It trades at 15 times enterprise value to sales, compared with an average of 11 times enterprise value to sales for the traditional exchanges. What’s more, the exchange stocks traded at 15 to 18 times EV to sales when they were faster-growing companies.

At 15 times annualized first-quarter sales, Coinbase would be worth $108 billion, or roughly $415 a share, 21% higher than Friday’s close of $342.

The trade is not without risk. Coinbase is inextricably linked to the success of Bitcoin. When it rises, trading volume does too. When it falls, so will trading activity. Another risk is competition. More exchanges will pop up, attempting to stake out ground in the new crypto land rush. But, like the search business before it, crypto might end up supporting very few players, and Coinbase could turn out to be Bing and not Google.

Fee compression, too, could be a problem. Coinbase can charge around 4%, in a day when stocks can be bought and sold for free. Fees will likely fall, which will pressure sales growth. But Coinbase is diversifying away from just transaction fees, notes MKM Partners analyst Rohit Kulkarni, just like Google became more than search. Kulkarni points out that more than 20% of retail users also “engage in at least one non-investing product,” writes Kulkarni. What’s more, he points out that Coinbase could, eventually, offer its own cryptocurrency, like Binance—another exchange that issued a crypto token.

Ultimately, though, there is one question potential Coinbase investors need to ask themselves: Do they believe cryptocurrencies have staying power? If they’re not a fad, then Coinbase is a must-own stock—just like Alphabet was.

Write to Al Root at allen.root@dowjones.com