CoinShares — Strong earnings and new activities in Q421

We consider CS’s total comprehensive income and adjusted EBITDA as more relevant than its reported net income (see our initiation note for details). CS reported total comprehensive income of £29.5m in Q421, ahead of our estimate of £23.7m and significantly above the £6.2m in Q420 (see Exhibit 1). The company has consistently delivered strong performance in each quarter throughout FY21, with the Q421 figure being ahead of both Q221 and Q321 (£26.6m and £26.2m, respectively), and only slightly below the particularly strong £32.1m in Q121. This brings its FY21 total comprehensive income to £114.3m, a more than sixfold increase from £18.6m in FY20.

CS also started reporting an adjusted net income (included in an alternative statement of comprehensive income), which is broadly similar to its total comprehensive income under IFRS but excludes currency translation differences and fair value gain/(loss) on investments (which are part of the other comprehensive income under IFRS). This non-IFRS net income stood at £110.5m in FY21 compared to £20.4m in FY20.

Asset management fees reached a record-high level of £25.5m in Q421 versus £7.1m in Q420 and were still largely driven by CS’s legacy XBT Provider products (£24.4m), with CoinShares Physical and the CoinShares Global Blockchain Equity Index contributing a further £0.5m and £0.6m, respectively. The improvement in fee revenue versus that achieved in each of the previous quarters of FY21 was assisted by higher average assets under management, which reached c £4.2bn at end-December 2021 versus £3.7bn at end-September 2021 (despite the sell-off in crypto markets, which started around mid-November 2021), primarily due to the rising price of Ether in Q421. We also note that due to sizeable XBT Provider redemptions amid profit taking by noteholders (see below), CS collected £28.8m in cash, which mostly represents accrued management fees. Following the acquisition of Napoleon in December 2021, the company recognised first subscription-based revenues from this business at £0.3m during the quarter.

CSCM has also performed well with total income/gains of £16.2m in Q421, ahead of our estimate of £8.6m and the £5.2m posted in Q420. Its delta neutral (ie non-directional) strategies generated a gain of £5.3m in Q421 (£1.8m in Q420) as CSCM continues to benefit from the volatility in digital assets. While the result is somewhat lower than the exceptionally strong gain in Q121 and Q221 (which saw a particularly high level of market activity and volatility), it is visibly ahead of the Q321 figure of £2.6m.

As highlighted in our previous update note, CS started to engage in yield farming in the decentralised asset space, in particular from activities in peer-to-pool lending protocols (such as Compound, Aave and Maple Finance) and liquidity provisioning on decentralised exchanges. Based on our discussion with management, we understand that CS is deploying a diverse range of DeFi strategies (including straight lending/liquidity provisioning, liquidity mining of tokens, as well as arbitrage strategies) across multiple blockchains. DeFi was a considerable contributor to CSCM gains in Q421 with £3.6m (nil in Q420); according to management the average annualised percentage yield achieved on these activities was c 12.0–12.5%. We believe this illustrates the company’s expertise in pursuing new profitable opportunities arising in the rapidly evolving digital assets sector. Interestingly, apart from being active on lending platforms dominated by retail borrowers, CS also provided liquidity to market makers and clients through Maple Finance’s new institutional DeFi lending protocol. Moreover, CS supported the launch of Aave Arc, a permissioned lending protocol for financial institutions verified through a ‘know your customer’ procedure, designed to be compliant with anti-money laundering regulations.

Finally, CS achieved a y-o-y improvement in its result from liquidity provisioning related to the XBT Provider units and its fixed income activities (which are primarily reverse repo operations) to £2.4m and £3.5m in Q421, respectively. Overall, CS’s capital markets infrastructure operations delivered sizeable income and gains of £62.2m in FY21 (£16.8m in FY20), with US$32bn worth of notional traded (up 305% versus FY20) across 20 venues.

CS’s gains on principal investments stood at £0.7m in Q421 (versus a £0.4m loss in Q420), assisted mostly by 3iQ (£1.6m revaluation gain) and Solana tokens (£0.5m), in part offset by a reduction in the value of Kingdom Trust (held indirectly through SBG, written down by £1.1m during the quarter). We note that after the balance sheet date, CS announced that it increased its stake in FlowBank from 9.02% to 29.3% (which represents voting rights equal to 32.06%) by investing CHF24.7m – see our initiation note for details on FlowBank.

The company’s administrative expenses excluding D&A rose to £10.0m in Q421 (and £31.1m in FY21) versus £4.2m in Q420. This was primarily the result of 1) higher custody fees associated with the higher value of digital assets held on behalf of XBT Provider and CoinShares Physical unit holders; 2) headcount increase to 80 at end-2021 versus 42 at end-2020; 3) professional fees incurred in preparation for the uplisting; and 4) increased accruals for staff payments as a function of group performance. Consequently, CS’s adjusted EBITDA reached £32.9m (close to the all-time quarterly high of £34.2m in Q121 and versus 7.8m in Q420), with an adjusted EBITDA margin of 77% (65% in Q420).

We estimate that the total AUM of Western European digital asset ETPs reached c US$9.7bn at end-2021, significantly up from c US$3.1bn at end-2020, with CS products having a c 50% share (vs c 74% at end-2020). According to CS’s Digital Asset Funds Flow Weekly report, the XBT Provider platform saw c US$1.15bn of net outflows throughout 2021 to 17 December (the date of the dataset included in the last available edition of the report for 2021), driven by profit taking from investors who purchased the units before 2021 (these products were introduced between 2015 and 2017). CoinShares Physical attracted c US$210m of net inflows (or US$485m including the seed assets provided by CS). Meanwhile, CS’s main European competitors, 21Shares and ETC Group, attracted c US$1,027m and US$685m of respective net inflows during this period. Here, it is important to note that (as highlighted last year by CS’s management) the XBT Provider products also experienced meaningful gross inflows during 2021 (even if these were more than offset by redemptions) and that the number of individual holders grew significantly (tripling from c 24k at the beginning of 2021 to 72k at the time of releasing the Q321 results). Moreover, CoinShares Physical was in a ramp-up stage as it was launched in early 2021, while the flagship ETPs of 21Shares were introduced in 2019 and ETC Group’s Bitcoin (BTC) ETP was launched in June 2020 (its Ethereum (ETH) ETP was launched in February 2021). In 2022 ytd (to 4 March 2022), net outflows for XBT Provider products continued with c US$209m, while CoinShares Physical saw a US$19m net inflow (21Shares saw ytd inflows of US$42m, while ETC Group experienced net outflows of US$139m).

It is worth highlighting that the stronger net inflows of 21Shares in 2021 were partially supported by a high number of new single-asset ETP launches during the year, including some popular tokens such as Solana. CS has not launched any new ETPs between April and December 2021 (despite the quite receptive market), as management highlighted that it prioritises the design of products with the highest quality and transparency over seeking quick gains in terms of short-term AUM inflows. In Q421, the company received regulatory approval to add a further 46 digital assets to the main CoinShares Physical prospectus (bringing the total figure to 50). Consequently, in January 2022, CS launched two new single-asset ETPs under its institutional-grade CoinShares Physical platform, referencing the native tokens of Tezos (a smart contract-enabled blockchain competing with ETH) and Polkadot (an interoperability protocol). This was followed by the launch of an ETP tracking Cardano (the native token of another Ethereum contender) in March 2022.

The Tezos, Polkadot and Cardano blockchains are all based on proof-of-stake consensus algorithms and all three CS products were designed to offer a transparent mechanism for sharing rewards from staking (ie locking the digital assets on the blockchain as a kind of collateral to secure the network). This feature distinguishes CS’s new ETPs from similar products launched by its European competitors, which do not disclose the exact staking yield (if any) allocated to ETP investors. For CS’s products, the staking rewards are currently being distributed in two forms: through a reduction in management fee to 0.0% and a reward accruing daily to the value of the ETPs (3% pa for the Tezos and Cardano ETPs and 5% pa for the Polkadot ETP). CS will retain the balance of the generated staking rewards (current staking yields are c 5.4% for Tezos, c 5.3% for Cardano and 14.0% for Polkadot, according to stakingrewards.com). For now, these products represent a minor part of CS’s AUM at c US$8.7m combined as at 17 March 2022.

We also note that Invesco launched its first physical BTC ETP, with CS acting as index sponsor (the ETP will track CS’s Bitcoin Hourly Reference Rate Index) and execution agent. While this ETP (as well as a similar product recently introduced by Fidelity International) may be considered to be in direct competition to CS’s own Physical Bitcoin ETP, CS’s management highlighted that the Invesco Bitcoin ETP is aimed at attracting Invesco’s existing base of large institutional clients, which would anyway be difficult for CS to approach directly. By supporting Invesco in launching the product (which had an AUM of c US$123m as at 16 March 2022), CS will receive part of the fees charged to ETP holders.

During the preliminary FY21 earnings call, CS’s CEO provided an update on the strategic priorities of the business going forward. Firstly, CS’s emphasis will be on further leveraging the company’s unified technology framework (now called ‘Galata’) as a bridge to connect a wide range of clients operating in the traditional financial system to the digital asset ecosystem. Its strong and constantly developed technological backbone providing connectivity to a large number of trading venues will be used as the foundation for growing CS into a provider of 1) asset management solutions (B2B2C, such as its existing XBT Provider and CoinShares Physical platforms) deriving revenues from fees charged on AUM; 2) business solutions (B2B) with a licensing model (platform-as-a-service); and 3) consumer solutions (B2C) in a subscription-based (software-as-a-service) model.

The expansion into the B2C sector is of particular importance, as it should also allow CS to have a more direct interaction with retail customers and in turn improve the company’s understanding of their needs to drive an enhanced user experience of its products. CS recently entered the B2C sector by acquiring Napoleon, a French crypto-focused fintech company, which offers, among others, pre-built portfolios and algorithmic trading strategies. Napoleon’s software solution is a social trading platform in the form of a non-custodial meta layer that is venue-agnostic (ie can be used on top of a crypto trading venue’s app, for example Binance, Bitfinex, FTX and Bitstamp). Napoleon has a recurring, subscription-based revenue model, offering three packages at different price levels (Silver – €19/month, Gold – €50/month and Platinum – €99/month). The current average revenue per user (ARPU) at €87/month and its user base currently consists of 5,000 clients (90% of which are French), translating into an annualised revenue of c €5.0m. However, we note that the current customer lifetime value (LTV) stands at just €300 (implying a high monthly churn of c 29%).

CS aims to integrate Napoleon’s product with Galata to facilitate improved connectivity and optimal trade execution. It also intends to scale the business globally across other European countries, the United States and the Asia-Pacific region. Furthermore, it plans to improve both ARPU and LTV through a combination of customer education and better user experience. Finally, CS considers entering partnerships with existing exchanges, as well as co-marketing activities with local exchanges to drive customer acquisition in selected regions. CS acquired Napoleon for a total consideration of €13.9m as a combination of a partial equity swap (issuing c 363.6k at a price of €10.8 per share ie valued at c €3.9m) and cash.

While CS reported strong Q421 numbers, we note that digital asset prices have significantly declined from the November 2021 peak, with BTC and ETH down c 40–45% (or c 50–55% from peak to the local trough in late January 2022). At this stage, we do not assume a crypto bear market like the one in 2008 in our base scenario given the continued progress in digital assets adoption and a return to net inflows to related investment products after a temporary period of net outflows in late-December 2021/early January 2022 (based on CS data). We also retain our expectations in terms of the global allocation to digital assets at 2.0% and 2.5% by 2025 and 2030 respectively. Nevertheless, we have reduced our near-term assumptions in terms of allocation to digital assets, which now imply a BTC price at c US$48,300 at end-2022 (US$63,600 previously and a current spot price of c US$40,700) and an ETH price of c US$3,700 at end-2022 (c US$4,200 previously and a current spot price of c US$2,750).

The net outflows from XBT Provider products in Q421 and so far in Q122 are broadly in line with our expectations. Consequently, we have made only minor changes to our assumptions for the coming years. We now assume net outflows of US$0.9bn in FY22e and US$0.8bn in FY23e (US$1.0bn in both 2022 and 2023 previously). We consider the net inflows into the CoinShares Physical products as moderate so far, though we acknowledge that these were launched quite recently and that between December 2021 and February 2022 inflows were affected by the overall weaker sentiment towards crypto investments. We now assume net inflows of c US$250m and US$450m in FY22e and FY23e respectively (vs US$365m and US$550m previously). We have also reduced our AUM and management fee assumptions for the equity index. As a result of the above, we now forecast CS’s management fees in FY22e and FY23e at £76.4m and £76.2m compared to £100.1m and £94.6m previously.

We have now included revenues from the recently acquired Napoleon in our forecasts, assuming £4.6m in FY22e and £5.6m in FY23e (based on a customer base of 5.5k and 6.9k respectively, driven by intensified marketing activities). We also assume a moderation of monthly churn from the current c 29% to 10% by FY23e and 5% in the long term.

We have raised our forecasts for CSCM income/gains to £54.9m in FY22e (vs £41.5m earlier) and £60.3m in FY23e (vs £46.5m earlier), primarily to reflect income from CS’s recently initiated DeFi activities (we assume an income of c £17.5m pa in both FY22e and FY23e). We still cautiously do not include any profit/losses from CS’s principal investments going forward as we consider them difficult to predict. Hence, potential further profits in this segment constitute a potential minor value catalyst.

As a result, we now expect CS’s EBITDA to reach £88.9m in FY22e and £92.9m in FY23e (vs £107m and £103.4m previously). Having said that, we note that fees generated on XBT Provider Trackers (which remain one of the key earnings drivers) are accrued until investors redeem the certificates, at which stage they are released in cash to CS. The company collected £28.8m in cash from XBT Provider products in FY21 (mostly from accrued management fees) and we expect this cash flow to remain strong in FY22e at £30.5m (our previous assumption was £20.4m) as investors who have invested before 2021 realise their gains amid the current unstable economic and geopolitical environment. Our valuation in SEK terms was supported by the strengthening of the US dollar since we last published in November 2021, translating into a 6% higher US$/SEK rate assumed in our forecasts. Consequently, we currently value CS at SEK117.2 per share (slightly down from SEK119.8 per share previously) based on our DCF model, representing c 53% upside potential. We have also updated our ‘Crypto Winter 2022’ scenario (see our initiation note for details), which now implies a CS value of SEK72.9 per share (unchanged from our previous valuation).