Is This Crypto Bank Massively Undervalued?
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Originally Posted On: https://summamoney.com/investing/the-spotlight/silvergate-capital-deep-dive/
The concept of currency dates back to the dawn of civilization. Over the centuries, everything from salt to dolphin teeth has been assigned value for the purpose of buying and selling goods and services. Gold and silver might hold the record for most-widely-accepted currency, but metals were eventually deemed impractical for everyday use. Enter paper bills, which became the legal tender of choice until credit cards were introduced in 1950.
For the next 60 years, the methods of exchanging funds became more advanced as new technology was introduced, but there were no fundamental changes to the underlying financial infrastructure. Governments produced and regulated currencies, and centralized banks served as intermediaries for currency transfers. There were no realistic alternatives to the global financial system.
In 2009, something remarkable happened. The mysterious Satoshi Nakamoto, who has never been definitively unmasked, created a new store of value: bitcoin. Bitcoin is a cryptocurrency that is managed through blockchain technology – no government or financial system involvement required. It’s an opportunity for individuals to exchange funds on a peer-to-peer basis rather than relying on an intermediary.
The concept was dismissed as a fad or a foolish experiment for years, but soon the trickle of Bitcoin users became a flood. Bitcoin increased more than 13,000 percent in value, and thousands of additional cryptocurrencies were introduced.
Just a handful of these new additions took off – for example, Ethereum (ETH), Litecoin (LTC), Cardano (ADA), Dogecoin (DOGE), and Tether (USDT) – but as a group, they established the legitimacy of the cryptocurrency concept. In recent years, cryptocurrency ATMs have been made available, and businesses have started accepting select cryptocurrencies as payment.
In a particularly extraordinary move, the country of El Salvador made Bitcoin legal tender. The cryptocurrency market peaked soon after El Salvadore’s law went into effect. In November 2021, it was valued at nearly $3 trillion. Clearly, cryptocurrency is no fad.
As cryptocurrency gained widespread acceptance, a number of supporting industries grew up around it. Trading platforms were developed to buy and sell cryptocurrency, and entire companies were created or repurposed to develop better technology and infrastructure to support digital currency.
Silvergate Capital, parent to Silvergate Bank, is one such company. In 1988, it was founded as a traditional bank, and it was one of the very first in the industry to embrace cryptocurrency. Now Silvergate is ready to launch its own digital currency, a “stablecoin”, based on technology that originated with the exceptionally talented software engineers of Meta (formerly Facebook).
Silvergate started public trading in November 2019, and its stock has since gained more than 800 percent as of early February 2022. So, what exactly does Silvergate do, and what’s next for the leader in cryptocurrency exchange infrastructure? More importantly, from a retail investor’s perspective, is Silvergate stock a buy?
Silvergate: The Crypto Bank
Silvergate Capital is, at its core, a holding company for Silvergate Bank. While the bank offers traditional financial services, it is best known for its early adoption of cryptocurrency. Back in 2013, when naysayers were still convinced that the concept would stay on the fringe of the financial world, Silvergate began actively pursuing digital currency clients. Today, it serves more than 1,300 cryptocurrency and fintech clients, including some of the largest names in the global digital currency industry.
Among other products and services that set Silvergate apart from competitors in the traditional and digital financial industry, Silvergate accepts Bitcoin as collateral for loans when those loans are made to large corporate clients like Block (formerly Square), Coinbase, and PayPal. It is the first and only bank that offers this option, making it the lender of choice for some of the biggest companies in the world.
Silvergate is largely focused on disruptive innovation, and it is leading the way when it comes to developing the infrastructure and technology required for cryptocurrency exchange. It operates the Silvergate Exchange Network (SEN), which gives account holders the ability to trade with each other around the clock. That’s critical for the large crypto trading platforms that rely on SEN, such as Gemini and Coinbase.
One of the most interesting developments in Silvergate’s strategic plan was its decision to acquire the assets and intellectual property of Meta’s (formerly Facebook) Diem Group. Diem was originally charged with developing a stablecoin for Meta, and Silvergate was heavily involved in the project.
Like other cryptocurrencies, stablecoin is all-digital. However, unlike Bitcoin and similar cryptocurrencies, stablecoin is far less volatile. Its value is tied to an underlying asset, for example, the US dollar, making it far more appealing to the risk-averse.
Silvergate intends to introduce its stablecoin by the end of the year. Though these digital assets are primarily used for trading crypto right now, Silvergate’s long-term plan is to expand opportunities to use stablecoin in everyday transactions. If successful, Silvergate will be one of the first to bring its stablecoin to market, increasing the likelihood of becoming the market leader.
Silvergate’s primary sources of revenue include returns on loans and other investments made with client deposits. As deposits continue to grow, Silvergate’s ability to generate revenue will grow, too. The company also earns revenue through transaction fees associated with the digital currency exchange. More clients and increased transaction volume will continue to push fee revenue up.
Silvergate Moat Hinders Competitors
Whether or not the stablecoin project is successful, Silvergate still has an enviable moat. The biggest is its early entry into the market. Silvergate offered the infrastructure that made the rise of cryptocurrency possible, and along the way, it collected a number of valuable clients. That adds a networking moat for Silvergate, as the Silvergate Exchange Network only facilitates transfers between members.
With leaders in the digital currency industry relying on Silvergate Exchange Network, there is little doubt that Silvergate will keep its competitive edge – and that’s if competitive hopefuls can overcome the barriers to entry at all. In fact, analysts suggest that would-be competitors are far more likely to attempt an acquisition of the Silvergate Exchange Network before trying to build a new version of the platform.
Traditional banks have dipped their toes into the crypto waters, but most are still staying out of the digital currency market. However, there are a handful of banks that have made crypto a priority – Signature Bank, for example – and it is possible that they could pose a threat to Silvergate in the future with enough resources or a smart acquisition.
Silvergate: By The Numbers
Silvergate announced its fourth-quarter and full-year results on January 18, 2022, and the reception from investors was frosty. Though the company was still profitable, it missed analysts’ expectations for revenue and earnings per share by a substantial amount.
Highlights of the fourth-quarter report include:
- Net income of $21.4 million – lower than the previous quarter’s $23.5 million, but higher than fourth-quarter 2020’s $9.1 million.
- Net income per diluted common share totaled $0.66 – lower than the previous quarter’s $0.88 per diluted share, but higher than fourth-quarter 2020’s $0.47 per diluted share.
- A quarter-over-quarter increase of 35 percent in the volume of transfers handled by the Silvergate Exchange Network. The network processed $162 billion in transactions for Q3 2021 and $219.2 billion for Q4 2021.
- A year-over-year increase of 270 percent in the volume of transfers handled by the Silvergate Exchange Network. The network processed $59.2 billion for Q4 2020 and $219.2 billion for Q4 2021.
- Fee income from digital currency customers came in at $9.3 million – an increase over the previous quarter’s $8.1 million and a significant increase from the previous year’s $3.8 million.
- Number of digital currency customers totaled 1,381 by the end of the fourth quarter, as compared to 1,305 for the previous quarter and 969 as of December 31, 2020.
Highlights of the year-end report include:
- Total net income for 2021 came in at $78.5 million as compared to 2020’s $26.0 million.
- Net income per diluted common share totaled $2.91 for 2021 – an increase over 2020’s $1.36 per diluted share.
- The Silvergate Exchange Network facilitated $787.4 billion in transfers for 2021 – a sharp rise relative to 2020’s $135.7 billion.
- Fee income from digital currency customers came in at $35.8 million for 2021 – more than triple 2020’s $11.1 million.
These results demonstrate that Silvergate is growing rapidly, which begs the question, why did Silvergate stock go down? More importantly, will Silvergate stock recover?
Will Silvergate Stock Go Up?
After its November 2021 peak, Silvergate stock began to decline alongside Bitcoin and other cryptocurrencies. That’s to be expected, given Silvergate’s dependence on the digital currency market.
However, the 25 percent drop just after Silvergate’s fourth quarter and full-year earnings call had investors a bit concerned – especially since analysts had given them every reason to believe Silvergate stock would go up. It seems that the missed net interest income target was the metric that got the most attention rather than the rapid growth in other areas of the business.
Analysts responded en masse to defend their buy ratings and 12-month price targets, and they remained adamant that Silvergate stock will recover. In fact, the consensus was that the lower price presented an opportunity for investors to position themselves for impressive returns, as the stock was trading below its true value.
Examples of analyst comments on Silverlake stock post-earnings report include the following:
- Steven Alexopoulos of JPMorgan elected to lower the price target due to what he called a “sizable miss” for fourth quarter’s net interest income and expenses. He indicated that in the short-term, growth will come in spurts rather than move at a steady pace, and he said he believes that the current low valuation is an opportunity for investors.
- David Chiaverini of Wedbush reaffirmed his Outperform rating, but he lowered the price target for Silverlake stock. He based his guidance on the mixed fourth quarter, and he specifically noted the slowing of momentum in deposit growth.
- Steve Moss of B. Riley reaffirmed his buy rating, stating that the Q4 targets were “bullish” and minimizing the importance of the misses. He pointed out that the dramatic decline was an overreaction, particularly considering the many positive elements of the report.
- Will Nance of Goldman Sachs reduced his 12-month price target but changed his rating from neutral to buy. He cited the stock’s low valuation, stating that Silverlake was being treated like a traditional, slow-growth bank rather than the rapidly growing cryptocurrency leader it is.
- George Sutton of Craig-Hallum reaffirmed his buy rating, though he lowered the 12-month price target. He explained that it is clear that Silvergate is growing, but the earnings report demonstrated that the growth will not necessarily occur at a steady pace.
All in all, the message from analysts is clear – Silverlake stock is likely to go up, and at current prices, shares are likely undervalued.
Is Silvergate Stock A Buy?
Cryptocurrency values are exceptionally volatile, which is also true of certain stocks. However, there is an important distinction. Cryptocurrencies aren’t tied to anything, so it is simply not possible to predict trends with any sort of accuracy.
There is no business being conducted, so analysts can’t look at traditional fundamentals. Though crypto prices do respond to industry and coin-specific news, there are plenty of ups and downs that appear completely random. On the other hand, stocks – no matter how volatile – represent an underlying business. That means analysts can examine historical price trends and financial factors to make reasonable assumptions about future movement.
Investors who want to avoid direct purchase of cryptocurrency but don’t want to be left out of this multi-trillion dollar market have alternatives to gain crypto exposure without excessive risk. Options include:
- Cryptocurrency exchange stocks – e.g., Coinbase and PayPal
- Companies that hold cryptocurrency in addition to cash – e.g., Block (formerly Square) and MicroStrategy
- Companies that mine Bitcoin – e.g., Marathon Digital
- Cryptocurrency-focused ETFs – e.g., ProShares Bitcoin Strategy ETF (BITO), Grayscale Bitcoin Trust (GBTC), Bitwise 10 Crypto Index Fund (BITW), Global X Blockchain & Bitcoin Strategy ETF (BITS)
- Companies that provide the tools and infrastructure for cryptocurrency – e.g., Nvidia
The beauty of Silvergate is that it falls into several of these categories, in addition to conducting other business. Its multifaceted approach to digital currency puts it in a strong position to grow and expand in multiple directions. The bank has generated profits for 21 consecutive years, and there is no reason to believe that streak is going to end now.
Finally, Silvergate is currently trading nearly 25 percent below what it was a year ago and about half of its price when it peaked in November 2021, which means shares are available at something of a discount. The company has a solid foundation and a promising future, which has prompted most analysts to rate Silvergate stock a buy at this price.