CoinShares International — An attractively priced option on crypto adoption

CS reported and adjusted EBITDA loss of £8.2m in Q222 (vs a £28.6m profit in Q221) and its adjusted net loss came in at £11.4m (vs a £26.6m profit in Q221), mostly due to a one-time loss of £17.7m arising from the UST stablecoin de-pegging (see our previous note for details). Its total comprehensive loss was minimal at £0.1m in Q222 (vs a £26.6m profit in Q221), assisted by a currency translation gain of £11.3m arising from the appreciation of the US dollar (in which CoinShares Capital Markets (Jersey) Limited is denominated) against sterling.

CS recognised the loss on UST in its Capital Markets Infrastructure segment (under ‘other’ activities) but has so far avoided any further large losses from the contagion spreading recently across the digital asset markets, as it has no direct exposure to the troubled players such as Celsius, Three Arrows Capital, BlockFi or Voyager. The company has significantly reduced its DeFi positions, notably in institutional lending protocols such as Maple and TrueFi. Together with the lack of income from the Anchor protocol following the UST collapse in May, this translated into a decline in DeFi income to £4.9m in Q222 from £6.3m in Q122. CS has also successfully recalled most of its balances in its fixed income activities outside of DeFi to limit losses from defaulting counterparties (generating a £0.8m income in Q22 compared to £1.2m in Q122 and £1.7m in Q221). The CEO highlighted during the earnings call that most of the contagion in the form of counterparty risk arising from poor risk management of several large players in the sector has likely materialised. This particularly applies to Europe and the United States, while some incremental risk may still materialise in the case of Asian players.

Income from liquidity provisioning for the XBT Provider products was £1.6m, down from £2.0m in Q121 and £3.3m in Q221, influenced by lower digital asset prices. With most of the trading capital tied up in DeFi in the earlier part of the quarter, CSCM did not generate any meaningful income/gains from delta neutral strategies, where it booked a small loss of £1.3m in Q222. This arose from opening a long futures position to take advantage of historically low annualised premiums to maintain the required exposure related to XBT Provider products, with the potential to reduce CS’s interest expense and/or invest the cash in higher yielding strategies. The Value at Risk on CSCM’s derivative book stood at £125k at end-June 2022.

As a result of the above, CSCM reported a loss of £11.4m in Q222 (or a £6.3m profit excluding the UST loss). Together with the reduced capital markets activity, CS paid down all revolving credit lines it has with brokers. As a result, it had a net amount due from brokers of £38.1m at end-June 2022, compared to a net amount due to brokers of £205.2m at end-March 2022. We understand that CSCM has remained cautious in terms of activity so far in Q322, which if sustained would result in a significant reduction in interest expense.

CS booked £14.2m in asset management revenue in Q222 (vs £19.6m in Q221). The vast majority of fees still comes from the legacy XBT Provider products (£13.0m in Q222), but with gradually increasing importance of the CoinShares Physical platform and the equities platform (£0.6m each).

We note that despite the turmoil in the digital asset markets, CoinShares Physical enjoyed net inflows of US$105m (excluding seed assets) in H122, of which US$86m was in Q122. We believe that this demonstrates the strength of the platform’s value proposition. During the quarter, CS launched five new products based on the following assets: FTX Token, Chainlink, Uniswap, Matic and Cosmos (the last two with embedded staking mechanism), bringing its current suite within CoinShares Physical to 14 products. We estimate that all the new CoinShares Physical products launched in 2022 year to date had a combined AUM of c US$66m at end-June 2022 (of which c 84% are seed assets of Solana and FTX Token ETPs provided by FTX). Net outflows from XBT Provider seen throughout FY21 and in Q122 continued in Q222 at around US$132m (vs US$246m in Q122), according to our calculations. The decline in net outflows is likely driven by lower digital asset prices, but also may have been driven by the declining share of unit holders who invested before the latest bull run, which started in 2020. CS’s equities platform saw a c US$60m net outflow in Q222, bringing the H122 balance to c US$35m of net inflows.

CS’s AUM stood at £1.66bn at end-June 2022, of which 58% was attributable to XBT Provider, 8% to CoinShares Physical and 34% to the equities platform. This represents a decrease from £3.95bn at end-March 2022, affected by the decline in digital asset prices, and has translated into lower custody fees, resulting in lower direct costs of CS’s asset management platform at US$0.5m in Q222 vs US$1.4m in Q122. Coupled with a reduction in administrative expenses to £1.1m in Q222, from £1.9m in Q221, this translated into a still robust operating profit of the segment of £12.6m (vs £16.3m in Q221).

Both CS’s equity investments and proprietary digital asset holdings were written down during the quarter, resulting in a principal investments loss of £5.1m in Q222 (vs a £4.1m gain in Q221). Major drivers were 3iQ Asset Management (revalued downwards by c US$3.5m in Q222 to US$2.5m), whose valuation was affected by the fall in AUM amid lower digital asset prices, as well as CS’s proprietary holdings of Solana tokens (down by c US$1.4m to US$0.7m). This was partially offset by c US$0.6m of carried interest from CoinShares Fund II booked in Q222 (US$3.0m in total in H122).

The largest holding within CS’s principal investments portfolio remains its 32.06% stake in the online bank, FlowBank, which is basically a Swiss provider of online trading services with a local banking licence. Its carrying value at end-June 2022 was US$29.1m (out of CS’s total portfolio of US$44.2m) and the stake is accounted for using the equity method. During a recent interview (released on 25 May 2022), FlowBank’s CEO highlighted that he expects the company to be profitable on a monthly basis starting from the second half of 2022 or even earlier (possibly in May/June). In Q222, CS recognised a minor £0.1m loss from its share of joint venture and associate profits/(losses), which we understand consists primarily of its stake in FlowBank and Gold Token SA.

CS continued the integration of the Napoleon Group (acquired in Q421) and successfully launched a beta version of NapBots (trading bots) on 11 July 2022, with a formal relaunch and rebranding planned for Q322. Furthermore, on 4 July 2022, CS completed the acquisition of Napoleon Asset Management, the first crypto asset manager in Europe with an Alternative Investment Fund Managers Directive licence. Management highlighted that the B2C platform remains in its infancy and that the £0.8m operating loss in Q222 is a function of costs incurred to drive growth of this business line.

We have retained our mid- to long-term digital asset adoption assumptions, as we see enough evidence that digital assets have established themselves as another distinct asset class. Further adoption signs include the recent deal signed by BlackRock with Coinbase to provide its clients access to digital assets (by connecting Coinbase to its Aladdin platform). Consequently, we have made only limited adjustments to our FY25e forecasts, with our new adjusted EBITDA expectation down 10.8% vs our previous forecasts published in June. For FY22, however, we have reduced our adjusted EBITDA forecast from £41.0m to £20.0m, primarily due to lower CSCM income/gains (£6.9m vs £31.8m previously) given the lower Q222 results compared to our expectations (even though the latter accounted for the UST loss) and CS’s expected muted trading activity in Q322. We assume a gradual pick-up in CSCM activity from Q422, but expect somewhat lower income and gains in FY23e and FY24e, as we factor in more moderate activity in the broad digital asset markets compared to FY21 following the current ‘crypto winter’. The weaker CSCM forecast for FY22 is partially offset by lower administrative cost assumptions given the reversal of bonus accruals CS booked in Q222 and more limited direct costs amid lower CSCM activity and AUM of CS’s asset management business (translating into reduced trading fees and custody fees, respectively).

We now arrive at CS’s fair value per share of SEK80.0 based on our discounted cash flow (DCF) model (compared to SEK85.0 previously). This implies a significant upside to CS’s current share price of SEK34.65. Consequently, we believe that CS represents an attractively priced option on the prospective digital assets adoption. We estimate that CS’s market capitalisation of £204m (on a fully diluted basis) is at present at least 85% covered by the sum of CS’s cash at bank (£13.9m at end-June 2022), net amounts from brokers (£38.1m) and the accrued management fees related to XBT Provider products (we estimate the current balance at c £120m). Moreover, CS is now trading at c 0.93x book value. With a steady fee income and good equity position (£220.9m at end-June 2022), we think CS is well-placed to be one of the beneficiary survivors of the current ‘crypto winter’.

We note that the upgrade of the Ethereum network (often referred to as ‘The Merge’), which will involve migrating the network from a proof-of-work to a proof-of-stake (PoS) consensus algorithm, is now scheduled for September. We believe that, in line with other CoinShares Physical ETPs based on PoS blockchains, CS is likely to offer a fixed percentage staking yield to Ethereum ETP holders at some stage, retaining any excess yield. However, at this stage we do not account for any excess staking yields CS could earn on its CoinShares Physical Ethereum ETP AUM, given the limited visibility in terms of the exact staking yields on the Ethereum network following The Merge (which will depend, among others, on the proportion of total Ether (ETH) supply being staked on the network). For illustrative purpose, we estimate that every 10bp excess yield on CoinShares Physical Ethereum ETP AUM would raise our CS valuation by c 1.5%.