We do not know yet what Coinbase’s public market valuation will be. In a Direct Listing, the valuation will be decided by the market not by few big investment banks.
So all we can do at this stage is to assess whether Coinbase is a good business. At the end I will set some valuation ranges to assess whether Coinbase will be a good investment. It could be a great business but a bad investment.
Here are criteria I use to assess whether Coinbase is a good business:
- Is Coinbase big enough to be public? Yes. It will be easy for Coinbase to have a market cap higher than $2 billion. Below $2bn a company is classed as microcap, meaning most funds are not allowed to invest (they are in “small cap hell”) and the costs of being public become a significant drag on earnings.
- Strong Balance Sheet? Yes. As with most venture backed companies, Coinbase has a strong Balance Sheet, with lots of equity capital and very little debt. It is mature public companies that have often loaded up on debt for buybacks and bad acquisitions.
- Good revenue quality? This is the big one. The best definition of revenue quality comes from a VC called Bill Gurley in a post from 2011 called All Revenue is Not Created Equal: The Keys to the 10X Revenue Club
Gurley defines 10 attributes of ventures that deserve a 10x revenue multiple. (It was written in 2011, so references to actual valuations seem quaintly out of date today, but the attributes are still totally relevant).
As Bill Gurley puts it:
“What drives true equity value? Those of us with a fondness for finance will argue until we are blue in the face that discounted cash flows (DCF) are the true drivers of value for any financial asset, companies included. The problem is that it is nearly impossible to predict with any accuracy what the long-term cash flows are for a given company; especially a company that is young or that might be using an innovative and new business model. Additionally, knowing what long-term cash flows look like requires knowledge of a vast number of disparate future variables. What is the long-term growth rate? What is the long-term operating margin? How long will this company hold off competition? How much will they be required to reinvest? Therefore, from a purely practical view, the DCF is an unruly valuation tool for young companies. This is not because it is a bad theoretical framework; it is because we don’t have accurate inputs. Garbage in, garbage out.
Because of the difficulty of getting DCF right, investors commonly use a handful of other shortcuts to determine valuations. “Price earnings ratio” and “enterprise value to EBITDA” are common shortcuts, with their own benefits and limitations. I want to argue that for a variety of reasons, the price/revenue multiple is the crudest valuation tool of them all.”
Although price/revenue multiple is crude, we can apply it to early stage companies. The key is the quality of that revenue. Gurley defines 10 attributes. Read his post to understand more. I added my comments and a simple weighting system, which you can access here.
So how will the market value Coinbase? According to 2011 rules, a max of 10x revenue means around $10 billion. I suspect it will be a lot higher than that.
Two big unknowns;
- How will Coinbase perform as a public company? What will their Q-Q Revenue growth look like? We will have to wait and see.
- How will Coinbase manage their strategic headwinds aka their risks? For this, stay tuned for next week’s Part 3 analysis.
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