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Both Coinbase and Robinhood have suffered amid weakness in trading volume.
Chris Delmas/AFP/Getty Images
As if investors in
Coinbase
Global and
Robinhood
Markets didn’t have enough to worry about, there is an additional factor that could reduce the value of each company to existing shareholders by almost one-third over the next five years.
Already in 2022, shares in the cryptocurrency exchange (ticker: COIN) and retail-focused trading platform (HOOD) have all but collapsed. Coinbase stock has tumbled 73%, and Robinhood has lost 52% of its value.
Mainly to blame are a market environment that has punished high-growth companies in the tech sector, coupled with weakness in crypto and stock trading volumes that is weighing on revenue. Now, the stock-price declines themselves are growing into a new risk for investors, according to Kenneth B. Worthington, an analyst at
The problem is one of share dilution, Worthington wrote in a note Sunday. it occurs when companies issue additional stock, reducing the value of shares held by existing holders. J.P. Morgan estimates that the expected pace of issuance, and resulting share dilution, at both Coinbase and Robinhood will reduce the value of each company to existing investors significantly by 2027.
Coinbase didn’t respond to a request for comment from Barron’s. Robinhood declined to comment because the company is in a quiet period before it releases its earnings next week. Coinbase also reports earnings in the coming weeks.
Share dilution is an issue for Coinbase and Robinhood because both companies put significant emphasis on stock-based compensation for employees. Stock-reward programs can be tricky in an environment of lower share prices because to maintain employees’ expected compensation levels in dollar terms, companies need to issue more stock than they would have at higher prices.
“Coinbase and Robinhood like their tech-company peers issue substantial equity to company employees allowing companies to both attract and incentivize employees while keeping cash compensation lower,” Worthington wrote. “This approach becomes more complex when the price of the public equity declines substantially—~70% from [initial public offering] in the case of Coinbase and ~75% for Robinhood.”
While Coinbase doesn’t disclose its spending on compensation, J.P. Morgan estimates that it represented 50% of expenses in the first quarter of 2022, while compensation was 65% of expenses at Robinhood in the same period. Stock-based rewards likely account for 35% to 50% of total compensation at each company.
At current stock prices, Worthington estimated, continuing to reward employees with stock at the same pace would lead to annual dilution of 10% to 15%.
“However, we expect both firms will reduce the equity granted to employees in the form of [restricted stock units], but we estimate share creep from RSU issuance will drive dilution to a still substantial 7% pace annually in coming years,” the analyst said. Five consecutive years of dilution at 7% would knock 30% of the value off each company for existing shareholders.
This is also a relatively conservative call. J.P. Morgan laid out three scenarios for dilution in the near term: a bad scenario of weaker market conditions but lower expenses; an improving scenario of a business recovery with rising hiring and compensation but a higher stock price; and a scenario of weaker market conditions coupled with higher investment and compensation.
Depending on the three scenarios, Worthington estimates annual share dilution at Coinbase coming in at 6% to 15%, with a range for Robinhood of 8% to 18%. The forecasts make 7% dilution, delivering 30% value lost in five years, seem relatively attractive.
But these outcomes aren’t inevitable. The companies do have alternatives to reducing issuance of restricted-stock units, Worthington said.
The first option J.P. Morgan outlines is simply to pay employees less. Both companies announced head count reductions in the second quarter of 2022, and Worthington sees Coinbase and Robinhood possibly lowering overall compensation given the tough operating environment. The risk is that the companies could lose talent and existing workers could be less productive, Worthington noted.
Coinbase and Robinhood could also award more cash, and less stock, in the balance of overall compensation. This isn’t a panacea, however, because while it would reduce share dilution, it would put pressure on cash flow. For Coinbase, which has corporate debt trading at distressed levels, cash flow concerns already exist among investors, and paying employees more cash could heighten these worries, Worthington said.
The companies could also change their compensation strategies, paying employees in out-of-the-money stock options. This would reduce share dilution, but would give option holders disproportionately more of the benefits if the stocks’ prices recover.
It’s a tough choice for the leadership at companies that have already lost so much of their market value in the past eight months.
Write to Jack Denton at jack.denton@dowjones.com