Sunday, April 2, 2023

Restrained and Enjoined: My Coinbase Short Thesis

Standard caveat: I'm short Coinbase via a various array of long put positions/spreads, mostly in June, September and January '24 options. I'm not a financial advisor and this isn't financial advice. And depending on where Coinbase ends up trading, this whole post could be considered financial comedy.  

On March 22, 2023, I declared Coinbase a "generational (put) buying opportunity". While I might have been facetious with the phrasing, I was not with the underlying premise of Coinbase being an attractive short candidate. This was largely due to everything around Coinbase in the crypto-sphere blowing up. For instance, FTX, Binance, Silvergate, SBNY, to name a few. Entities in the Coinbase orbit were in flames, and I saw no reason why a few smoldering ashes wouldn't drift toward COIN and set it too ablaze. 

As sheer luck would have it, COIN disclosed that afternoon that it was on the receiving end of an SEC Wells Notice, which gives COIN until April 5th to submit a response. COIN was trading around $82 prior to the disclosure, then opened around $62 and rallied to $68 and closed at $66. It's currently trading around $67/share, a 15% discount to where it was prior to receiving the notice, but nearly 100% higher than where it was trading at the end of December '22/beginning of 2023. 

I'm of the opinion that the risk of SEC action is not even remotely close to being fully priced into the stock. It's almost as if no one 'hodling' and/or buying COIN has read any of the other SEC complaints that other crypto outfits have been slapped with such as the Ripple/XRP complaint, Gemini/Genesis complaint, Justin Sun/Tron/Bittrex complaint, or most recently, the Beaxy complaint. Had the COIN 'hodlers' read those complaints, they would have noticed the language that all four complaints share, which Coinbase stands a fair chance of finding itself subjected to:

(bold and underlined emphasis added)
Unless Defendants are permanently restrained and enjoined, they will continue to
engage in the acts, practices, and courses of business set forth in this Complaint and in acts,
practices, and courses of business of similar type and object.

I'm far from a business expert, but I imagine it's hard to run a business when there's a court order preventing a portion or majority of a business to operate. Coinbase leadership, its CEO Brian Armstrong and Chief Legal Officer Paul Grewal have made it clear that they will not be trying to settle any potential charges with the SEC, but will instead fight the SEC. This sounds great in theory, but becomes problematic in practice, especially when trying to make money running a business. Ripple Labs was hit with enforcement action in December of 2020, that case is still ongoing and has cost Ripple Labs an estimated $100m in legal costs in the first year and a half of litigation. Coinbase could be looking at a years-long protracted court battle, and while the court battle plays out, they could be "restrained and enjoined" to continue business as they have been. Coinbase revenues are already on the downswing, and not only do Coinbase revenues face risk of decline if their business practices are restricted by the courts, but they'll also have to fund their court battle. 

The risk of being "restrained and enjoined" begs the question, who on Earth would want to use Coinbase as a crypto platform if it's restricted from operating, when they could use a number of other platforms not facing enforcement action, such as Fidelity? Even without SEC action, Coinbase is already rated an "F" with the BBB. I find it hard to believe that the Coinbase user experience will get any better should the SEC take action. For those reasons, Coinbase is subject to bank-run risk ala Silicon Valley Bank, while also staring down the barrel regulatory action ala Signature Bank of NY. Coinbase has the worst of both worlds. Yet the stock is down only 15%? The legal and business risks here are immense, and the stock should be trading at a heavy discount to reflect those attendant risks. I think it should be trading at least at a 50% discount, so the current $67 would imply a fair value of $134, if assuming the current price is 50% of where it should be. I feel like $40 could be a fair discount, but since it's facing what's been described as an "existential crisis" I think a minimum discount greater than 50% is warranted. For this reason, I currently consider Coinbase at $67/share to be a lot like Wile E. Coyote who has run off the edge of the cliff, but gravity hasn't caught up yet. I imagine that if Coinbase is hit with an SEC complaint, the stock will in fact find gravity. Insiders appear to be taking advantage of the current stock price to unload shares, based on recent Form 4 filings

Also notable is that on March 17th Bloomberg reported that insitutional clients of Coinbase "were contacted by the firm about plans to potentially set up a new crypto-trading platform overseas". This preceded the SEC Wells Notice by five days, and the SEC "crypto investor alert" by six days. I think it's fair to say that Coinbase management is fully aware of the "existential risks" faced by their US-based business, yet this hasn't fully caught up to the stock yet. My opinion here is that Coinbase is essentially a "Juul vape pen, but on the blockchain". Juul was privately valued around $38b or so, until FDA regulatory action took a chainsaw to its business model, cratering Juul's valuation by nearly 90%. I think Coinbase will find itself in similar camp with its valuation should the SEC follow through with enforcement. 

As far as a timeline for potential enforcement action goes, the SEC has 180 days to take enforcement action after issuance of a Wells Notice. The SEC could potentially take action as late as September 18, 2023, based on the Wells Notice being issued on March 22, 2023. However, given the carnage in cryptoland, I'm guessing the SEC will move faster should they choose to take action. My opinion here, but the carnage in cryptoland has killed whatever regulatory/political goodwill crypto may have had in the US, and the timing of potential SEC action for Coinbase couldn't be any worse for the company. Some notable crypto carnage denting crypto goodwill:

The list could go on.. Now as far as bull cases go, I could only find two:

1. Seemingly no apparent bull case; and,
2. Kevin O'Leary noted in August of 2022 that he's been bearish on Coinbase

I'm all ears for why Coinbase is a buy here, so please send them along for why I've totally missed the mark. I mean, obviously someone thinks Coinbase is a solid buy at $67, but it's not me. I wouldn't be surprised if we get some insight on this prior to the end of April, but I suppose time will tell.

Restrained and Enjoined: My Coinbase Short Thesis

Standard caveat: I'm short Coinbase via a various array of long put positions/spreads, mostly in June, September and January '24 op...