Coinshares International Ltd

STO:CS

Earnings Call Transcript 2022-Q4

[Operator]

Thank you for standing by, and welcome to the CoinShares' Q4 Earnings Broadcast. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your host, Jeri-Lea Brown. Thank you.

[Jeri-Lea Brown, executive]

Thank you, operator. I would like to welcome you all to CoinShares' 2022 Q4 Earnings Call and Webcast. Speaking from management today will be Jean-Marie Mognetti, Chief Executive Officer; and Richard Nash, Chief Financial Officer. All those joining today are encouraged to look into the live event where you'll be able to view the accompanying presentation during today's call. Alternatively, the results and a copy of the presentation are available for download from the Investor Relations section of the CoinShares' website. A replay of the webcast will be available for 30 days following the live call and the transcript will be posted on the company's website as soon as it is available. Following the presentation, we will host a short Q&A via the webcast platform. Should you wish to submit a question to the management team, please provide your name and company affiliation. We will do our best to get to as many of these as we can within the allotted time. Lastly, our safe harbor statement. CoinShares would like to remind everyone that except for historical information contained herein, statements made on today's call that would constitute forward-looking statements are based on currently available information. The company assumes no responsibility to update any such forward-looking statements, and I would like to point you to the risk factors associated with our business as detailed in our prospectus. At this time, I will turn the call over to Jean-Marie.

[Jean-Marie Mognetti, executive]

Good afternoon and thanks for joining today's CoinShares Q4 2022 financial earnings call. After returning to profitability in Q3, CoinShares was impacted by the collapse of FTX in Q4. However, we remain financially robust and successfully graduating to Nasdaq Stockholm's main market. FTX's unexpected fall from grace and subsequent collapse into bankruptcy took the entire digital asset space by surprise. At the time, FTX had to withdraw GBP 26.6 million of our assets remain there. Asset recoverability remains uncertain, and claims are trading around $0.15 on the dollar as we speak, up from $0.02 in the dollar to the up to the bankruptcy. As a prudent and conservative measure, we wrote down the entire balance in our Q4 financials. While the group's financial health remains solid, providing for these amounts in full as impacting our financial performance for both Q4 and 2022 as a whole. 2022 will be remembered as a turning point for the industry. We believe that company is capable of being public listed and regulated our best place to emerge as the winners in our industry. Having graduated to Nasdaq Stockholm will probably cut ourselves in this category. So let's take a quick look at the market. Post FTX, the value of digital asset has now stabilized and the FTX gap has been killed. Forecasting the future of Beacon price remains at more than the science, especially in the current uncertain macroeconomic climate. This being said, Big Corner on 25k with the most recent SEC declaration and 2 years treasury, just below 5%, is a very strong start of resilience. Despite these difficulties, Bitcoin is becoming a valuable addition to investment portfolios. Its volatility is no longer perceived as a drawback to some, but rather a feature and a benefit in a diversified strategy. Bitcoin is more than just a risk on asset. It is increasingly perceived as an interest rate-sensitive asset like gold. On the dollars soften, investors seeking a slightly more volatile option instead of gold will likely return to Bitcoin. Taking a quick look at Ethereum following Ethereum Q2 [indiscernible] in September, the Ethereum Foundation is to unlock with dual capabilities from the stacking notes in H1 2023, a massive milestone for this protocol. As such and to maintain fairness and transparency towards product investors, we reduced management fees for CSDS Ethereum product to 0 in anticipation of undertaking function becoming accessible. 2023 will be a year for structuring, consolidation and development for the industry and consequently for CoinShares. We anticipate the arrival of institutional players in the second half of 2024 as regulation in Europe, the U.S. and the U.K. start to come into force. Strangely, it will also coincide with the next bitcoin having cycle. I will share with you further updates on my second part. But for now, over to Richard to speak about Q4 financials. Richard, over to you.

[Richard Nash, executive]

Thanks very much, Jean-Marie. So as has already been made clear, the quarter has been somewhat overshadowed from a financial perspective by our exposure to FX. And this, coupled with the events of Q2 when we experienced a loss in respect to the collapse of UST as a impacted the year as a whole. I think the one point that is important to not lose sight of in amongst these 2 events is the health and robust nature of the underlying business of the group. But taking a look at Q4 on its own, we generated revenue gains and other income of GBP 14.5 million. Approximately 60% of this figure came from our asset management business and about 38% of this came from our capital markets business. As has been the case consistently since we initially listed on NASDAQ First North back in March 2021, these are our core business units, and it is here where we are re-shifting our focus moving forward now. Given the Q4 market conditions, the top line figure of GBP 14.5 million is solid. And when looked at against our direct costs and our admin expenses, which were $1.7 million and $4.8 million, respectively, the underlying business generated adjusted EBITDA of positive GBP 7.9 million, but this is obviously prior to considering 2 significant figures being a goodwill impairment and the FTX provision itself, which we'll talk about in a bit more detail shortly. The direct cost of the group comprised custody fees, trading fees and issuer expenses incurred by the 2 issuing entities of the group ETPs. These have shown a quarter-on-quarter decrease in 2022, in line with the reduction in capital markets activities and reduced custody fees arising from decreased AUM following digital asset price declines over the year. Admin expenses of the group have been relatively consistent throughout the year at an average of approximately GBP 1.8 million per month and GBP 21.2 million for the full year, with the key expenses being salaries, marketing costs, professional fees and rent. We've managed to keep the underlying cost of the business fairly consistent with 2021 despite our growth and the significant work undertaken to achieve the admission of the company's shares to trading on Nasdaq Stockholm's main market. Despite this underlying performance and stable costs, our FTX provision and the goodwill impairment has resulted in an adjusted EBITDA loss for the quarter of GBP 23.5 million. And unfortunately, this has negated our year-to-date performance using the same metric to an adjusted EBITDA loss of GBP 6.5 million. So now a little bit more information on the goodwill impairment charge that we see in the quarter. In consultation with the CoinShares Brands leadership team during the quarter, the difficult decision was taken to cease the group's consumer platform activities. While we saw positive steps being taken throughout the year, it became clear following the collapse of FTX that the landscape have changed significantly. The level of ongoing investment required to support trading and other consumer platform initiatives would be better directed into supporting the core business units of the group. And as a result of this, we, therefore, recognized a sizable impairment charge against the goodwill held in respect of these activities, which were recognized on the acquisition of Napoleon back at the end of 2021. And now on to the FTX provision, which has already been touched upon by Jean-Marie earlier and announced that in November. So we elected to provide against 100% of our FTX exposure, which is in total GBP 26 million. While we remain hopeful of a meaningful level of recovery, the quantum and the timing of such an event remains entirely unclear. Therefore, we deem our prudent approach regarding our provision to be the most suitable way forward at present. Obviously, we will continue to monitor the situation closely along with the wider industry and keeping the market up to speed with any meaningful developments that will have an impact on this balance and its recoverability. Of course, we're disappointed by the overall financial result we've seen in 2022, 2 of the most significant events that hit the industry during the year, which were felt by many were also felt by us. We have felt these both directly through our own exposure and indirectly by virtue of the impact on the wider industry. And these events both act as a [ stock ] reminder of the pitfalls of this continually evolving landscape within which we operate and the importance of ensuring our risk framework continues to evolve. So now looking at our asset management platform in a little bit more detail. And as a reminder, the components of this business unit are the XBT Provider ETPs, CoinShares' physical ETPs and the CoinShares Blockchain Global Equity Index or BLOCK Index. So the platform generated combined management fees over the quarter of approximately GBP 8.5 million, and this is around 1/3 of the comparative quarter back in 2021 due to the markedly different levels of pricing we've seen during 2022, particularly towards the end of the year. That being said, we've continued to capture inflows within CoinShares Physical. And even despite such price declines, the CoinShares Physical platform revenues are actually higher than those seen during Q4 2021. This also continues to represent a more material contribution to overall management at least quarter-on-quarter. In Q3, it was 6% and in Q4 is now 8%. And we are continuing to diversify our product suite and management fee streams. And this is shown by this -- the increase in this percentage that we're seeing quarter-on-quarter. On to XBT Provider, after August 2022, brought the first month of net inflows since early 2021. We have seen outflows largely stem completely in the product as the number of underlying noteholders continues to increase. The net outflow for the entirety of Q4 for XBT Provider stood at just $48.1 million. The flows for both ETP product suites and also those of our key competitors is published in our weekly digital funds flow report, which is available on our website. The overall gross profit margin of the group's asset management platform has remained largely consistent with 2021. While we have seen increased fees relating to the expansion of the product suite and the growth of the team, these have been offset marginally by cost savings elsewhere within the business unit. And as a quick recap and summary for the end of the year, the level of AUM across the 2 ETP platforms, XBT Provider and CoinShares Physical stood at approximately GBP 1 billion with an additional GBP 440 million of AUM within the BLOCK Index. This total figure is down approximately 25% from the end of Q3, although we have already begun to see signs of recovery moving into 2023. Now on to capital markets. So 2022 was a challenging year within the market, and Q4 was no exception. The overall performance of Q4 was, as we've already stated, impacted by the FTX provision and the performance for the year also impacted by the UST loss, which are both classed as exceptional items in the table that we're looking at now. So these events, coupled with the conditions of Q4 have resulted in an operating loss of GBP 22.2 million, bringing the operating loss for the full year to GBP 28 million. And to put that in context, the full year 2021 saw an operating profit of GBP 50 million. Looking at the performance of the quarter, independently of the FTX provision allows us to shine a little bit of light on the business unit. So liquidity provisioning gains of GBP 0.5 million on the quarter [ arose ] from supporting the XBT Provider ETPs, and this is down a little bit when compared to previous quarters as the level of flow. As previously mentioned, we're seeing on XBT is getting lower and lower as we're stemming the outflows. The Delta Neutral Trading Strategies performed well in the quarter as we commenced exploring futures trading on the CME at the beginning of the quarter, and this contributed toward gains of GBP 3 million for the quarter, and this is an activity that has also continued moving into the new year. Fixed income activities also generated positive returns through a combination of interest generated on USD amounts posted as margin in respect of our CME activities and a small amount of digital asset lending, bringing the results for the quarter to GBP 1.8 million. As we move into the new year, we have a limited exposure to exchange and lending counterparties. And as the capital markets team looks to explore more opportunities in Q1 2023 and onwards, it will be doing so in conjunction with the revised risk framework that will focus on minimizing counterpoint the risk to safeguard the balance sheet of the group. And now while I provide some closing comments, if you can take a look at the quarterly performance of the group since the start of 2020, which helps visualize the most recent year and the impact of the Q2 UST loss and the Q4 FTX provision. And I would also like to take this opportunity to remind everyone that all of the information we've touched upon here is included within the earnings report that we released earlier today. So to summarize 2022, the core business unit of Asset Management by virtue of the legacy product, XBT Provider and the ongoing product launches and diversification provided by CoinShares Physical and the BLOCK Index managed to generate management fees in excess of the entirety of the group's costs in a very, very turbulent year with a lot of downward pricing pressure. And this is again complemented by the Capital Markets team who continue to seek new opportunities in order to generate gains from our sizable balance sheet. These core components of the business operated well, and we also achieved a heavy lift of completing admission that the company's shares to trading on Nasdaq Stockholm's main market. The financial benefit of these activities was, however, effectively negated in full by the Terra Luna incident and the FTX incident, which has in turn, brought our focus back onto our core businesses and importantly, how we approach risk and exposure moving forward while being cognizant that such frameworks have to evolve at the pace of the wider industry. While the financial performance of the year inclusive of 2 material hits has effectively resulted in a small total comprehensive income gain of GBP 3 million. We remain at the helm of an underlying business whose revenue and gains are comfortably in excess of its costs. The simplistic view of 2022 is, therefore, profitable performance that has been negated by 2 significant events that hit the wider industry. And this view is also illustrated by the lack of any material movement in the net asset position of the group between the start of the year and the end of the year. The start of the year was GBP 200 million, and at the end of the year is GBP 203 million. So we continue to build and evolve alongside an industry and look forward to returning to hopefully the consistent profitability that we have historically evidenced. And now back over to Jean-Marie.

[Jean-Marie Mognetti, executive]

Thanks, Richard. 2022 marked a pivotal moment for CoinShares despite the overall adversity. Crisis management is not something I shy away from, which is also a time when we discovered our identity and what sets us apart from the rest. With a reviewed sense of purpose, we've refocus on our strengths and aspirations, streamlining them for greater impact. This has consequences for some of our operations and our value proposition. These will be outlined in our upcoming annual report and will give the occasion to offer a comprehensive update on our long-term strategy. Despite the challenges faced in the fourth quarter, we proved our leadership in the European digital asset management business. We have also used the second half of the fourth quarter to review and strengthen our risk policy in capital markets. So let's dive in. First, our business asset management activity. Our commitment to launching properly structured and innovative ETPs as well as our expertise in distributing these products paid off in 2022. Our combined asset management businesses generated GBP 8.3 million in top line in Q4, solidifying our position as a leader in the industry. So let's look a bit more closer to our product family. First, CS physical. In Q4 2022, the CoinShares physical product line demonstrated its strength by capturing 48% of the market share of net inflows in Europe, serving as a true testament to our success. Then let's look at our legacy product, XBT Provider. As previously stated in our Q3 earnings, an XBT Provider observed small inflow during August of Q3. Moving into Q4, we have seen net outflow return. Also, the decline was modest in light of Q4 market overall sentiment. XBT Provider continues to be a recurring source of revenue for our company and has maintained its position despite the increase of new competitors in 2022. Moving on to the BLOCK strategy. Our joint venture of Invesco and [ the #1 crypto equity ] strategy worldwide. We experienced a negative written of 8.5% in Q4. Our performance [ declined ] by 6.4%, and we suffered net outflows of $25 million via the Invesco use ETF. Comparison is [ not reason ]. But to put things in perspective, our largest American [indiscernible] was down 18% and software outflows around $60 million in the same period. The higher diversification of our index from a geographical and sector point of view, coupled with a concentration and higher quality name in the [ last for balances ] gave us a better protection on the downside. Second, let's look at our Capital Markets business division. Despite a significant drop [ including ] liquidity and activity, capital markets business [indiscernible] the GBP 4.6 million in gains and income in Q4. A sizable provision relating to our assets held on FTX has overshadowed this figure, resulting in a negative performance for the quarter of GBP 20.6 million. The FTX-event underlines the [ inherent ] level of counterparty risk that continues to exist across the entire digital asset space. Given the ongoing and rapid evolution of the industry as a whole, we recognize the importance of having a risk framework that must evolve and improve along sales changes. Acting on the first principal basis, we have significantly reduced all our counterparty exposure. Consequently, at the end of Q4 2022, over 80% of our entire digital asset holdings were we [indiscernible]. To be clear, we are talking about companies holding, no clients holding. These holdings are at all time in [ third party ] studies such as [indiscernible], our joint venture with ledger and number. We will also continue to strengthen our culture and processes around cybersecurity risks. Human error will always be a key risk. To that degree, Galata's expansion is focused on risk, pre and post frac governance in addition to its original best execution mission. Third, let's look at our consumer solution. The FTX event was a setback and had a significant impact on our capacity to deploy [indiscernible] training in Europe. Since FTX was controlling 75% of the market after [ Biden's future offers ] shutdown. In light of these events, we took the necessary decision in consultation with the local senior management to terminate CoinShares' consumer activity. We also realized that CoinShares DNA was not fixed for the significant and upfront marketing investment needed to support a starting consumer activity. And fourth, let's take a quick look at our principal investment. Our principal investment portfolio was negatively affected by market movement in Q4 2022. And as a reminder, we start all principal activities as early as the end of Q1. On the more positive side, in our portfolio, it's our strategic investments. [indiscernible] competitor sizable funding round and showed a positive impact on [ volume ] and valuation. Flow bank showed continued growth. The experienced an average 35% growth rate in new clients per quarter since Q1 2021. Their 2022 revenue is up [ 73% ], reaching [ 27.7 million ], and we now hope to see FlowBank continue to progress and reach a breakeven position in 2023. Few other item to mention before we conclude. We executed a comprehensive branding in December. This rebranding was driven by the marketing team we hired in 2022. As many of you realize, it's a direct reference to the Conway's Game of Life. On a different topic, and with regard to buybacks, we continue to review the most prudent use of our capital. Since CoinShares stock is still trading below the asset value. We continue to believe that buying back our shares remains an excellent investment, and we have resumed our buyback in Q1 '23, coupled with the capacity to execute BLOCK trade off market. So to wrap up these remarks, alternatives to the poorly regulated native crypto platforms are needed. The collapse and fraud that plays the industry in 2022 and brought a new facet of caution to the market with investors now seeking trusted regulated institutional players. Our solution to these problems going shares offer a familiar risk policy to traditional financial players and a commitment to providing a secure and regulated investment experience for the long term. As a CEO of CoinShares, I'm enthusiastic about the future of our company. Whilst not minimizing the amount of work ahead, there are opportunities on the road in 3. We will endeavor to solidify our position as one of the leaders in the industry, both in Europe and globally. To achieve this, we will be introducing innovative products that meet the evolving needs of our investors. And we will also actively explore strategic measure and acquisition to drive our global growth. It's now up to our team to demonstrate CoinShares leadership and deliver on our promise to provide a safe and transparent investment solution in the digital asset space. This is closing our Q4 2022 remarks. Operator, you can now open the call for questions.

[Jeri-Lea Brown, executive]

We've got a number of questions received from Eden -- the first being, what measures do you think are necessary across the digital asset market to avoid another FTX-like collapse? Well, regular publication have [indiscernible] to be sufficient.

[Richard Nash, executive]

I'll take this one, Jean-Marie. Will regular publication proved reserves to be sufficient? The short answer to that question is no. [indiscernible] is a very useful tool in this industry. It provides a lot of transparency and comfort to stakeholders but it's not completely infallible. It doesn't give the full picture of a company or its financial position. It doesn't do with any liabilities that, that company may have, doesn't go into a great amount of detail about the location of various assets. So while it's a very useful tool, it's not the be all and end. And it should be viewed alongside other things such as financial audits and other transparency measures that a company may take. We've been involved with some proof reserves work since middle of 2020, [ and it's ] been a very useful tool for us, but we view it as another piece of our ammunition alongside our audit and our list status to try and give comfort to our shareholders and our stakeholders. In terms of avoiding another FTX-like collapse. It's -- you can never [ freely ] mitigate the risk of something such as that and traditional financial markets are no exception. These kind of events can occur regardless of whether we're talking about digital assets or traditional finance. But I think items and activities such improved reserves that go a long way in shining a lot of light on our operator in space to help reduce that risk, but you can never mitigate that fully.

[Jeri-Lea Brown, executive]

Thank you very much... Next question, how will the move away from unregulated trading venues impact, market opportunities, your capital markets infrastructure segment?

[Jean-Marie Mognetti, executive]

[indiscernible] I think the key point here is first to say that our traditional source of alpha is not driven by the financial marketplace is unregulated. So whether the marketplace is regulated or unregulated, we shouldn't see the [ position ] in our capacity to generate alpha. What is more interesting, however, is our capacity to move from pre-trade to post trade financing marketplace. And if anything, since [ FTX incident ] happened, we have been able to add CoinShares to renegotiate and redeploy our capital with counterparties, which are [indiscernible] post-trade settlement more than anything else. So we are -- if we are favoring this kind of counterparty first when it comes to who do we want to trade with.

[Jeri-Lea Brown, executive]

Next question, do you -- will you consider selling your FTX bankruptcy play that some investors are willing to buy these for around $0.15 to $0.20 on the dollar.

[Jean-Marie Mognetti, executive]

That's a Rich question. That's definitely following to Galatea yesterday. So Rich?

[Richard Nash, executive]

Sure. Again, short answer would we consider that on the FTX bankruptcy claim. Yes, we would consider this. And I think the levels mentioned there around $0.15 to $0.20 on the dollar are fairly consistent with what we're seeing. However, we're in a position currently, unfortunately, where we're not in any rush to sell that. We're financially sound, and we are monitoring the recoverability of that balance as we move forward. It's an ever-evolving situation. I think the one thing to note is in event, we do recover some of that balance, whether that be through recoverability or through selling the bankrupt particularly, any upside that we do see from that will now directly go to the P&L given the fact we've already provided for the balance in full. So interest we would consider it not at the current levels and not in the current environment, but it's something we monitor on an ongoing basis.

[Jeri-Lea Brown, executive]

Final question from Edison. How do you find to leverage taking [indiscernible] following the Shanghai upgrade for your CoinShares' Physical ETP, your XBT Provider [indiscernible] and your capital markets infrastructure strategies?

[Jean-Marie Mognetti, executive]

I can take this one, Rich. I think we're going to answer that specifically for CoinShares Physical. First of all, we have been doing – [ staking ] with a number of CoinShares Physical listing in the past. This listing has been -- this listing has been stake via different staking provider. We have a very, I would say, a [ severe ] due diligence when it comes to that. Our 2 favorite partners and vendors at that point or [indiscernible] stake, which we are working with regard to [indiscernible] staking as well. We put our fees down to 0% management fees already on [indiscernible] physical, and we are looking forward to be able to bring to our CoinShares Physical investors part of the reward of the staking as soon as it becomes available. So we are definitely very focused on that.

[Jeri-Lea Brown, executive]

Great. Thanks Jean-Marie. That wraps up our questions for today. We'd like to thank everyone on the call for joining. I wish you all a good rest of the day. Thank you very much.