CoinShares International — Becoming a dividend payer

CS reported a strong Q423 adjusted EBITDA of £25.7m, versus a £23.8m loss in Q422 (due to the impact of the FTX collapse) and £9.9m in Q323. This brought CS’s FY23 adjusted EBITDA to £56.9m, which is the second-best result in the company’s history after 2021 (ie the peak of the previous strong bull market). The company’s Q423 earnings were mostly supported by a combination of digital asset price appreciation driving up CS’s management fees (with the BTC price up c 56% vs end-September 2023 and 156% y-o-y), limited outflows from XBT Provider products (see below), as well as good results in the Capital Markets Infrastructure (CSCM) division (Q423 gains and income at £12.7m vs £5.2m in Q422). The CSCM results were mostly supported by the £8.0m income from staking (primarily ETH, up from £4.8m in Q323), but also trading gains (delta neutral strategies gains of £0.9m, largely from CME futures trading) and lending (included in the £1.5m from fixed income activities, which also reflects interest on broker balances and treasury bills).

Furthermore, CS booked a £7.6m net gain from its principal investments in Q423 (vs £0.5m in Q422) on the back of the agreed full disposal of its stake in Canadian ETP issuer 3iQ (resulting in a £2.5m gain), the partial sale of SBG, which holds a stake in Choice/Kingdom Trust (following a merger with another trust company), as well as the unwinding of the discount to the last funding round valuation for digital asset custodian Komainu (on the back of the digital asset market recovery and business progress). This more than offset the loss on Swiss-based online neo bank FlowBank, which resulted from significant provisions FlowBank made in its FY22 accounts ‘to meet potential challenges and guarantee the stability of its future operations’, according to the company’s press statement from 18 October 2023.

The healthy growth in CS’s revenues, gains and other income was accompanied by only a modest c 9% y-o-y increase in operating expenses in Q423 (excluding goodwill impairment and exceptional items booked in Q422), with the full-year costs up just 2% y-o-y. This allowed CS to realise significant operating leverage effects, with its EBITDA margin at 77% in Q423 (66% in FY23) vs 54% in Q422 excluding goodwill impairment and exceptional items, according to our calculations. CS’s total comprehensive income (which accounts, among others, for the currency translation differences on the accrued XBT Provider fee income) stood at £15.3m in Q423, affected by FX headwinds from the weakening US dollar against sterling. Consequently, the company recouped nearly all the losses from the 2022 crypto winter, with net assets of £238.8m at end-2023 vs £240.6m at its peak in Q222.

CoinShares Physical saw an acceleration of net inflows with c US$159.4m in Q423 (out of a total US$884m in Europe), translating into 2023 net inflows of US$213.2m (vs US$140.8m in 2022), representing c 73% of end-2022 assets under management (AUM). This compares with 21Shares and ETC Group (CS’s two largest competitors in Europe by AUM) at US$366m (46% of end-2022 AUM) and US$427m (134% of end-2022 AUM), respectively. The main catalyst for the accelerated inflows across the digital assets space was the court win of Grayscale (the largest digital asset manager globally), which proved to be a prelude to the bitcoin spot ETFs approval by the US Securities and Exchange Commission.

Meanwhile, net outflows from CS’s legacy XBT Provider products were relatively moderate at U$37.4m in Q423 and US$125m in 2023 (vs US$446m in 2022 and US$1,173m in 2021). We discussed the underlying drivers for the diminishing net outflows in our August 2023 note. Invesco CoinShares Global Blockchain UCITS ETF experienced minor outflows of US$29m in 2023, bringing the ETFs AUM to US$754m at end-2023. This compares with total net inflows into blockchain equity ETPs of US$458m in 2023 (according to CS data), of which US$388m was into Amplify Transformational Data Sharing ETF, which at end-2023 was the largest product in this group with US$1,072m AUM. All the above has led to an increase in CoinShares Physical’s share in CS’s total AUM to 19% at end-2023 versus c 10% at end-2022 (see Exhibit 2). This is in line with management’s intention, given that CoinShares Physical is a more modern, institutional-grade product.

Effective from 1 February 2024, CS reduced the fee on its CoinShares Physical Bitcoin ETP from 0.98% to 0.35% pa, which is visibly below some of the major competing products in Europe. For instance, ETC Group’s Physical Bitcoin ETP charges 2.00% pa, while the 21Shares Bitcoin ETP currently charges 1.49% pa. 21Shares also offers a lower-fee Bitcoin Core ETP (with a fee of 0.21% pa), but we note that the structure of this product allows for lending out the BTC held as collateral (which exposes the unit holders to a certain degree of counterparty risk). Moreover, the new fee on the CoinShares Physical Bitcoin ETP is now only moderately above the fee for the recently approved US spot bitcoin ETFs (0.19–0.30% pa, except for the Grayscale Bitcoin Trust, which charges 1.50%). CS’s move to reduce the fees on its Bitcoin ETP are in line with our expectations (discussed in our initiation note) that as single-asset BTC and ETH ETPs become a more commoditised product, their management fees should gravitate towards levels common for precious metals ETPs at c 0.00–0.40% for most major providers. That said, the reduction was quicker and slightly more pronounced than what we had included in our previous forecasts (0.75% by FY25 and 0.50% by FY30). We note that the fee on XBT Provider products (Bitcoin Tracker Euro and Bitcoin Tracker One) remains unchanged at 2.50% pa.

In early 2023, CS introduced a 0.00% fee on its CoinShares Physical Ethereum ETP to accumulate further AUM while it worked on introducing a mechanism to pass on some of the staking rewards to unit holders. Eventually, it implemented a staking reward of 1.25% pa effective from 1 February 2024. Any excess reward earned on the staked ETH will be an income to CS. The current staking yield as per CoinDesk’s Composite Ether Staking Rate stands at c 3.72% (broadly in line with CS management’s end-2024 expectations of c 3.50%) and has moved in a 3.30–4.00% range since autumn 2023. Based on earlier discussions with CS’s management, we understand that CS aims to at least offset the reduction in management fee on the CoinShares Physical Ethereum ETP (which initially stood at 0.98%) with the excess staking rewards.

Together with the Q423 results announcement, the company has introduced a dividend policy to pay out between 20% and 40% of its total comprehensive income adjusted for currency translation differences. Payments will be made in SEK in four quarterly instalments, subject to an assessment by CS’s board of the financial health and cash requirements of the company prior to each payment being made. We calculate that this would imply a dividend paid out of the FY23 earnings of £9.2–18.5m, or a dividend per share between £0.14 (SEK1.81) and £0.27 (SEK3.62), which at the current share price implies a healthy dividend yield of c 3.4–6.8%.

We note that the cash conversion level of CS’s earnings in any given year is determined by the extent of redemptions of XBT Provider products (which still generate the majority of fee income for CS). As discussed in our previous notes, the XBT Provider fees are charged by CS on a daily basis, but the corresponding cash inflow occurs only on redemption by an investor. That said, we also note that CS now has a significant recurring income stream from ETH staking rewards, as it stakes a meaningful part of the ETH held as collateral for the Ether Tracker One, Ether Tracker Euro and CoinShares Physical Ethereum ETP. As highlighted above, CS receives all staking rewards in excess of the 1.25% pa on the latter’s AUM. Moreover, it retains all the staking rewards for the Ether Trackers. For purely illustrative purpose, assuming 1) a staking yield of 3.5%, 2) AUM of CS’s Ether products in line with end-2023 level (when the ETH price was c 40% below the current spot price) and 3) that ETH equating to 50% of the AUM is staked, we arrive at an annual ETH staking income of c £15m. This excludes any capital gains on the staked ETH, which we understand are at least partly included in CS’s recently reported CSCM staking gains. Finally, CS has several further ETPs based on proof-of-stake digital assets with a similar mechanism for sharing the staking rewards, as in the case of the CoinShares Physical Ethereum ETP.

Management highlighted during the Q423 earnings call that dividends will be the primary form of distributions to shareholders going forward and that it does not expect to launch another buyback programme beyond the current one (which will be completed on 30 May 2024).

On 12 January, CS announced that it exercised its option to acquire Valkyrie Funds, the investment advisory business of US digital asset manager Valkyrie Investments. The acquisition is subject to the completion of satisfactory due diligence, the finalisation of legal agreements and CS’s board approval, with management expecting deal closure in early Q224. Valkyrie manages several US-domiciled products that would complement CS’s European product offering.

First, the Valkyrie Bitcoin Fund (ticker BRRR) was among the spot bitcoin ETFs approved by the SEC in January this year, with trading commencement on 11 January. Spot bitcoin ETFs had a good start, attracting net flows of US$7.9bn to 4 March 2024 even after accounting for the US$9.3bn of net outflows from the Grayscale Bitcoin Trust (ticker GBTC, which converted its existing bitcoin trust into a spot ETF), according to Bloomberg data. The GBTC outflows were likely due to 1) profit taking, as some investors held on to their GBTC units (which had traded at a discount to NAV during the recent ‘crypto winter’), 2) the sale of significant holdings in GBTC of the bankrupt exchange FTX and 3) some rotation out of the higher-cost GBTC into other bitcoin spot ETFs. We note that these net inflows may not fully reflect the onboarding of several major US wealth management platforms and registered investment advisors (RIAs) as they first need to complete a product due diligence phase before they can start offering these ETFs. Valkyrie Bitcoin Fund is one of the smaller players at present, with a c US$213m AUM as at 4 March 2024 (after attracting c US$140m of net inflows). This compares with GBTC at US$28.1bn and BlackRock’s iShares Bitcoin Trust (ticker: IBIT) at US$11.5bn (see Exhibit 3). BRRR charges a fee of 0.25% pa, broadly in line with most competitors.

Moreover, Valkyrie manages the Valkyrie Bitcoin Miners ETF, investing in listed digital asset mining equities, with c US$90m AUM as at 4 March 2024. Finally, its actively managed Valkyrie Bitcoin and Ethereum Strategy ETF (which invests in CME futures on BTC and ETH) had c US$55m AUM as at 4 March 2024. The potential acquisition of Valkyrie Funds, together with CS’s decision in September 2023 to enter the North American market through the launch its Hedge Fund Solutions business, illustrates CS’s ambition to become a global player in the digital asset industry.

We have raised our forecasts for CS’s adjusted EBITDA by c 19% in FY24, c 12% in FY25 and 10% in FY26, largely on the back of higher AUM driven by the recent appreciation in digital asset prices. Moreover, we have revised our Capital Markets Infrastructure forecasts to reflect a greater portion of the gains and income generated from staking. We note that our forecasts are now based on year-end BTC prices in FY24e and FY25e of c US$53,500 and US$77,000, respectively (vs the current spot price of c US$67,000). Our year-end ETH price assumptions stand at US$3,600 in FY24e and c US$6,000 in FY25e (vs the current spot price of c US$3,700). These are derived from our assumed allocation of global portfolios to digital assets at 1.10% in FY24 and 1.60% in FY25, as well as our assumed BTC and ETH dominance factors. The FY24 price assumptions are broadly in line with our previous forecasts, while the FY25 assumptions are c 8–9% below previous estimates.

Consequently, we arrive at a fair value per share for CS of c SEK82.7 (broadly in line with the previous valuation). Here, we note that we exclusively reflected the existing ETP and capital markets activities. We have not accounted for any valuation impact from the potential Valkyrie deal and the Q423 launch of CS’s Hedge Fund Solutions. With respect to the latter, CS’s management highlighted during the earnings call that the Hedge Fund Solutions division introduced Bitcoin and Ethereum Integrated Strategies Funds, which aim to outperform their benchmarks by 20% pa. The Bitcoin Integrated Strategies Fund has shown some initial promising results as it outperformed BTC by over 7% since August 2023.