The article is penned by Charles Edwards. He is an investor in mispricing and reports on stock & crypto news, strategies and opportunities as they arise. This is a shortened version of the full article on Medium. You can follow Charles on Twitter (@caprioleio) and Medium (@charleswedwards).
Estimating the Value of the Nexo Token
Cryptocurrencies are notoriously difficult assets to value. The vast majority don’t provide the investor with tangible cash flows, but because the NEXO Token pays out dividends, cash-flow based valuation can be used to identify its fair value.
Building off Part One of this series, “The NEXO Token is a 30c Dollar”(found here), this article makes an estimate of the fair value of the NEXO Token based on the net present value (NPV) of forecast dividend payments and given the information that is publicly available today.
The valuation finds that the NEXO Token has a fair value of $0.26. At a current trading price of $0.077, the NEXO Token offers the intelligent crypto investor a 240% return opportunity. Hence, NEXO is a 30-cent dollar.
The Discounted Cash Flow Model and Approach
For common stocks, the Discounted Cash Flow (DCF) model calculates the fair value (intrinsic value) of a firm as the net present value (NPV) of all future free cash flows. In a similar way, the Nexo dividends values can be forecasted and then discounted back to present day to identify the fair value of the Nexo Token.
Given that Nexo is a young business, a 10-year forecasting model has been selected to perform this valuation. Using a 10-year model requires forecasting 10-years’ worth of revenues, profits and dividends. The 10-year model allows for higher growth rates in earlier years, which then taper down to a more sustainable terminal growth rate – typical of start-ups. The Dividend Terminal Value is calculated using the Gordon Growth Model.
The fair value is calculated using the following approach:
- Forecast Total Loans Processed
- Top line forecasting is performed on the ‘Total Loans Processed’ from Nexo’s inception. Given Nexo frequently publishes ‘Total Loans Processed’ (and does not yet report revenues or operational costs), this is currently the most meaningful top-line metric to track and model.
- Forecast Total Loans Open
- Total Loans Open by year = (Total Loans Open at end of prior period x Loan Continuance Rate) + change in Total Loans Processed
- Key assumptions*: Loan Continuance Ratе
- Forecast Revenue
- Forecast Revenue per year = (average Forecast Total Loans Open during year) x (Average Borrower Rate)
- Key Assumptions*: Average Borrower Rate
- Forecast Profit and Dividends
- Dividends per year = 30% Profits = 0.3 x (Forecast Revenue x Net Margin)
- Dividends Per Token = Dividends per year / tokens eligible per year
- Terminal Value of Dividend payments is calculated using the Gordon Growth Model
- Key Assumptions*: Net Margin, Percentage Tokens Eligible for Dividends, Terminal Growth Rate (G)
- Calculate Token Fair Value
- Token “Going Concern” Fair Value = Present value of 10 years of dividends + Present value of Dividend Terminal Value
- Token Fair Value = Going Concern Value x (1 — Default Risk) + Liquidation Value x Default Risk
- Calculate token opportunity Internal Rate of Return (IRR)
*Key Assumptions
To estimate the value of a NEXO Token, the following key assumptions are made:
Loan Continuance Rate: estimated at 70% p.a.
This is the estimated number of loans open from year to year. 70% was chosen in alignment with American consumer expected credit repayment rates and Credissimo’s^ rate.
^Credissimo is an online platform offering traditional fiat currency loans. Credissimo and Nexo have a number of similarities which allows for useful comparison. Both companies have several of the same executive leadership team, and their businesses and technology platforms are similar.
Average Borrower Rate: 8.85% p.a.
The Average Borrower Rate is the weighted average interest rate Nexo receives on all loans issued to customers. This rate, multiplied by the average Forecast Loans Open during a period, gives Nexo’s revenue. Using a 95% Nexo repayment rate gives an Average Borrower Rate of 8.85% p.a.. This Average Borrower Rate also yields a Net Margin in line with Credissimo (see below point).
Net Margin: 35% to 25% over 10 years
The Net Margin ratio can be back calculated from Nexo’s prior December 2018 and August 2019 dividends. Given the above estimated Average Borrower Rate, the required Net Margin to achieve the distributed dividends to date is 39%. This is in line with Credissimo’s Net Margin which was also 39% in 2016 and 2017.
Over time it is expected the Net Margin will reduce as the business expands and competition requires further internal investment. The average US Regional Banking sector Net Margin, per analysis by Aswath Damodaran in 2019, is 28.99%.
In the interests of being conservative, Net Margin is forecast to fall linearly from 35% to 25% over the 10-year forecast period.
Nexo’s Reported Profit and Estimated Net Margin
Percentage of Tokens Eligible for Dividends: 70% to 90% over 10 years
Only Nexo Tokens stored in the Nexo Wallet are eligible to receive dividends, which is approximately 60% of circulating tokens for the last two dividend payments.
For the below forecast, the Percentage of Tokens Eligible for Dividends is estimated to increase linearly from 70% to 90% over the 10-year forecast period. These figures were applied assuming all tokens (one billion) are circulating by 2022.
Terminal Growth Rate: 4%
The Terminal Growth Rate (G) is used to forecast dividend growth rates into perpetuity.
A 4% Terminal Growth Rate seems fair for Nexo given the high scalability of the Nexo product and in line with the long term US banking sector Net Income growth rates.
Calculating the Fair Value of the Nexo Token
- Forecast Total Loans Processed
In 16 short months, Nexo has processed over $700M loans. The last three months alone represent an annualised growth rate of over 280%.
Nexo Loans Processed
These growth rates are extremely high and are unsustainable in perpetuity. In line with the 10-year forecast model described above, the annual growth rate in Total Loans Processed has been forecast to decline from 60% p.a. in 2020 (i.e. a quarter of the current growth rate) to 15% p.a. over 10 years.
- Forecast Total Loans Open
Total Loans Open is deduced from the Forecast Total Loans Processed = (Total Loans Open at End of prior year x Loan Continuance Rate) + Change in Total Loans Processed through the year.
- Forecasting Revenue
Using the above Average Borrower Rate and Net Margin, the revenue growth rate is forecast to fall from 38%p.a. in 2020 to 6%p.a. in 2029. This revenue growth rate profile also lines closely with Credissimo’s from 2014.
Nexo Forecast Revenue Growth Rates versus Credissimo Actuals
- Forecast Profit and Dividends
Nexo incurs costs related to sales, general operations, marketing and administration and pays corporate tax. Due to the limited reporting information currently available, these figures cannot be calculated and individually forecasted for. For this reason, the Net Margin ratio is used to estimate profit.
As outlined in the above Key Assumptions and in an effort to be conservative, Net Margin is assumed to fall linearly over the forecast period, while the Percentage of Tokens Eligible for Dividends is forecast to increase linearly as shown in the below figure.
Conservatively Forecast Declining Net Margins and Increasing Token Eligibility
Profit is calculated by multiplying each year’s Forecast Revenue by its corresponding Net Margin ratio, as shown in the below figure. Note the Year 10 estimated revenue of $400M.
Forecast Nexo Revenue and Profit
Once profits are calculated from the Net Margin, dividends per year for the 10-year period are simply calculated as 0.3 x Profit per year. Dividends Per Token are then calculated by multiplying by the Percentage of Tokens Eligible for Dividends.
- Calculate Token Fair Value
Finally, all of the above steps are brought together to calculate the opportunity that the current Nexo Token price represents given the forecasted dividend payouts per token:
- An Internal Rate of Return (IRR), the percentage rate of return the current Nexo Token price offers investors today, and
- The percentage difference between the current Nexo Token price and its fair value.
To calculate the fair value, a discount rate (investor required rate of return, or “WACC”) of 10% is used. Note that risk is accounted for later using the Damodaran Decision Tree for Survival Uncertainty.
The NPV formula, assuming Nexo is a “going concern” (has no default risk) is:
The DCF Valuation Model
The going concern fair value assumes negligible default risk. However, all businesses carry default risk. Since the 1920s, the average life span of companies has reduced from 67 years to just 15 years in 2012. In addition, while the cryptocurrency industry is extremely promising, its establishment as a key long-term financial sector is far from a certainty in 2019. For this reason, the Damodaran Decision Tree for Survival Uncertainty is used to incorporate default risk into this valuation.
Decision Tree for Survival Uncertainty
Bond default rates can be used to estimate the probability of distress for a business. Over 10-year periods, bonds have the following probabilities of default:
Bond Ratings and Probabilities of Default (1971–2001)
In terms of security, Nexo states that 95% of crypto assets are kept in cold storage which should minimise the impact of a potential hack. Nexo are also covered by $100M insurance.
A broad-brush default risk is chosen for the Nexo Token by drawing parallels to a pseudo “B” credit rating, and noting Credissimo’s current BBB rating. Per the above table, this suggests a 33% default risk probability for Nexo. This default risk should be considered a guide only.
Completing the above process yields the following valuation for the Nexo Token:
- Token Fair Value: $0.26
- Token IRR: 23.1% p.a.
Value of the Nexo Token
Feasibility of this Valuation
This valuation considers interest income to be Nexo’s only revenue source. Due to the high collateral requirement that borrowers must post to take out a Nexo loan, it is possible that Nexo is earning additional income from default events. However, due to a lack of any supporting data on potential liquidation profit as of writing, this has not been considered in this valuation in an effort to be conservative.
In the US alone, the 2019 consumer loans industry is estimated by the Federal Reserve at $1600B. Based on this, if Nexo’s Total Loans Open were to grow to circa $4.5B globally in 10 years, that would represent less than half a percent of today’s US loan market, and Nexo is not restricted by country borders. Similarly, annual revenues of $300-$500M in 10 years’ time would be comparable to revenues of other online fiat credit firms today like LendingTree ($202M), SoFi ($547M), LendingClub ($694M) and Prosper ($104M). While not perfect, these numbers help to confirm that the 10-year revenue projections for Nexo are within the realm of possible.
Unlike common stock, limited financial data is currently publicly available on Nexo’s business. This valuation is based on all information available as of 21 August 2019. According to Nexo’s proposal for listing on the Binance DEX in July 2019, their accounts and reserves are currently in the process of being audited. In addition, Nexo has only been around a little over a year. As a result, forecasting off this limited data has a wide error band and the fair value of Nexo Token may change as more financial data becomes available.
However, it is worth bearing in mind that with increased valuation certainty will also likely come greater trading volume, and greater trading volume could diminish the opportunity identified by this valuation.
Conclusion
Nexo has achieved a unique trinity in the crypto space. A high growth, profitable business which has consistently paid out dividends.
This valuation has found the Nexo Token as having an IRR of 23.1%, and a Fair Value of $0.26. As more information becomes available, the fair value of Nexo will change. But it is also likely that the opportunity gap identified here will also start to close.
Ultimately, it is up to each individual investor to assess if the value presented by the Nexo Token offers an acceptable margin of safety for investment their portfolio.
This is a submitted sponsored story. CCN urges readers to conduct their own research with due diligence into the company, product or service mentioned in the content above.
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