The Nexo Token is a 30c Dollar (Part 2)
[UPDATE 8 JUNE 2021: The below article from 2019 remains unedited. The NEXO token achieved the 30c valuation target (and 290% gain) in just over one year from publication, and quickly grew as high as $4 in 2021. However, sadly today the NEXO team has removed their dividend model and stripped away much of the token value. As a result, the below assessment and valuation technique should no longer be consider appropriate for NEXO going forward.]
Part 2: A Deep Dive into the Intrinsic Value of the Nexo Token and Why it is Worth 240% More.
Cryptocurrencies are notoriously difficult assets to value. The vast majority do not provide the investor with tangible cash flows. However, 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 forecast and then discounted back to present day to identify the fair value of the Nexo Token.
Given 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, which is typical of start-ups. The Dividend Terminal Value is calculated using the Gordon Growth Model.
The fair value is of the Nexo Token is calculated using the following sequenced 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.
2. 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 Rate
3. Forecast Revenue
- Forecast Revenue per year = (average Forecast Total Loans Open during year) x (Average Borrower Rate)
- Key Assumptions*: Average Borrower Rate
4. 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)
5. 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
The 2018 Deloitte audited Credissimo financial statements have been highly leveraged to support the valuation of Nexo. Credissimo is an online platform offering traditional fiat currency loans. While Nexo is a separate legal entity to Credissimo, and Credissimo operates in the fiat credit market, Credissimo and Nexo have a number of similarities which allows for useful comparison. Both companies have several the same executive leadership team, and their businesses and technology platforms are similar[9]. Credissimo and Nexo are also of similar magnitude[5],[10].
Nexo is valued assuming all investors are “long term investors” and store their Nexo Tokens in the Nexo Wallet to receive both the Base and Loyalty Dividends, and therefore achieve the highest rate of return. The Nexo Token will be worth less to those who store their tokens in a private wallet or on an exchange.
To estimate the value of a Nexo Token, the following key assumptions are made:
- Loan Continuance Rate
- Average Borrower Rate
- Net Margin
- Percentage of Tokens Eligible for Dividends
- Terminal Growth Rate
Loan Continuance Rate: 70% p.a.
Nexo regularly publishes figures on its Total Loans Processed, which includes both repaid loans and those still accruing interest[1].
However, no information is currently available on the number of loans open from period to period. To estimate this, total loans open is determined assuming a Loan Continuance Rate, the percentage probability that a borrower will maintain their loan from one year to another.
The Nexo loan continuance rate is estimated at 70%, and taken as the lower of the following comparable metrics:
- 73% of Credissimo customers were returning customers between 2016 and 2018[10]. Note: 60% of Credissimo’s customers are below 30 years old[10], this is also in line with average age bracket of Bitcoin investors who are mostly younger than 30[11]
- 70% of Americans with credit card debt admit they can’t pay it off in 2019[7]
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.
Nexo has confirmed that most, but not all, borrowers repay their loans with Nexo Tokens to achieve the lowest loan rate[1]. Based on this, it is assumed that approximately 95% of loans are repaid with Nexo.
Using a 95% Nexo repayment rate gives an Average Borrower Rate of 8.85% per annum. This Average Borrower Rate also yields a Net Margin in line with Credissimo (see below point).
Net Margin: 35% to 25% over 10 years
As no information is currently published on Nexo’s operating costs, profit is estimated from revenue using the Net Margin ratio.
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[10].
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%[4].
In the interests of being conservative, Net Margin is forecast to fall linearly from 35% to 25% over the 10-year forecast period.
Percentage of Tokens Eligible for Dividends: 70% to 90% over 10 years
Only Nexo Tokens stored in the Nexo Wallet are eligible receive dividends. Those held in private wallets, or traded on exchanges, do not receive dividends. For the last two dividend payments, approximately 60% of circulating tokens were eligible to receive dividends[3],[6].
It is conservatively assumed that as Nexo grows, dividend awareness will also and, the majority of Nexo Tokens will end up being stored on the Nexo Wallets to benefit from the dividend.
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.
For Nexo, the Terminal Growth Rate is determined by looking at the US banking sector Net Income growth rates, as the US has more reliable and long-term data available than most other major markets. Over the last 30 years, the average 10 year rolling compound annual growth rate (CAGR) for FDIC insured US bank Net Income was 4.1%[14]. This is also not far off the global GDP growth rate of 3.6%[12].
A 4% Terminal Growth Rate seems fair for Nexo given the high scalability of the Nexo product. Nexo has the ability to permeate across the globe and service almost all markets with minimal barriers to entry and minimal/no requirement for physical offices in those locations.
As a result, 4% is the chosen Nexo Terminal Growth Rate.
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%.
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. Note: this is not the same as revenue growth rates, which are calculated below and are significantly lower.
2. Forecast Total Loans Open
Total Loans Open is deduced from the Forecast Total Loans Processed.
Total Loans Open by year = (Total Loans Open at End of prior year x Loan Continuance Rate) + Change in Total Loans Processed through the year.
3. Forecasting Revenue
Revenue = average Forecast Total Loans Open during year * Average Borrower Rate.
Average Total Loans Open during each year is the average of the Total Loans Open at the beginning of each forecast year and the Total Loans Open at the end of each year.
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[10].
4. Forecast Profit and Dividends
At a high level, profit is simply calculated as revenue less costs through each forecast period.
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 calculate 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.
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.
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.
5. 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. The opportunity that each Nexo Token presents to an investor is calculated as both:
- 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.
Both the IRR and fair value methods use the exact same NPV formula. The only difference is that the fair value method specifies a discount rate, whereas the IRR method solves for the discount rate.
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 going concern fair value assumes negligible default risk. However, all businesses carry default risk - the possibility of failure. Since the 1920s, the average life span of companies has reduced from 67 years to just 15 years in 2012[15]. 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.
In terms of security, Nexo states that 95% of crypto assets are kept in cold storage[2] which should minimise the impact of a potential hack. Nexo assets are also covered by a $100M insurance policy. As Nexo’s open loan values increase, this analysis assumes the insurance policy will increase in unison.
To assist in estimating Nexo’s Default Risk, the Credissimo comparable is again drawn on. Credissimo has a BBB bond rating[9], which over a 10-year period has approximately a 4.3% probability of default[16]. Over 10-year periods, bonds have the following probabilities of default:
There is currently no public information on Nexo’s credit rating but, given Nexo is paying profits, it is assumed that the business is at least meeting its current financial commitments. As defined by Standard and Poors[13], a “B” creditor:
“currently has the capacity to meet its financial commitments. Adverse business, financial, or economic conditions will likely impair the obligor’s capacity or willingness to meet its financial commitments on the obligation.”
A broad-brush default risk is chosen for the Nexo Token by drawing parallels to a pseudo “B” credit rating, measurably lower than Credissimo’s credit rating. Per the above table, this suggests a 33% default risk probability for Nexo. This default risk should be considered a guide only, and ultimately it is up to each investor to determine if the final opportunity offered by the Nexo Token meets an acceptable margin of safety given the risks involved in the cryptocurrency industry.
Completing the above process yields the following valuation for the Nexo Token:
- Token Fair Value: $0.26
- Token IRR: 23.1% p.a.
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. If Nexo does earn additional revenue from default events, this valuation should be considered a lower limit for the true value of Nexo.
In the US alone, the 2019 consumer loans industry is estimated by the Federal Reserve at $1600B[19]. 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[17]), SoFi ($547M[18]), LendingClub ($694M[20]) and Prosper ($104M[21]). 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[8]. 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.
Things to Watch: A Checklist for the Future
As more data becomes available the fair value of the Nexo Token may change. In particular, publication of the following would be valuable data points to track the progress of Nexo’s business and the validity of this valuation:
- Continuation of profitability and twice-yearly dividend payments
- End-2019 Total Loans Processed (current target: $1B+)
- End-2019 Profit (current target: $11.2M+)
- Audited financial statements, which will allow more granular valuation
- Consistent communications and product innovation
- Nexo Credit Rating
Conclusion
Nexo have 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.
References
[1] Per www.nexo.io online chat, 13 August 2019
[2] https://nexo.io/earn-interest/
[3] https://medium.com/Nexo/Nexo-interim-report-december-15-2018-85b58088f858
[4] http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/margin.html
[5] Calculated using data from www.nexo.io
[6] https://medium.com/nexo/nexo-token-holders-receive-us-2-409-574-87-in-dividends-4dfd580f2c96
[7] https://www.cnbc.com/2019/03/19/70-percent-of-people-with-credit-card-debt-cant-pay-it-off-this-year.html
[8] https://community.binance.org/topic/980/proposal-for-listing-Nexo-on-binance-dex/2?source=post_page
[9] https://Nexo.io/assets/downloads/Nexo-Whitepaper.pdf
[10] Found or calculated from https://credissimo.com/downloads/Credissimo_Company_Overview_and_Financials.pdf
[11] https://cointelegraph.com/news/bitcoin-users-who-they-are-and-what-they-do
[12] https://www.bloomberg.com/news/articles/2019-05-06/where-will-global-gdp-growth-come-from-over-the-next-year
[13] https://www.standardandpoors.com/en_US/web/guest/article/-/view/sourceId/504352
[14] https://banks.data.fdic.gov/explore/historical?displayFields=STNAME%2CBANKS%2CASSET%2CDEP%2CNETINC%2CINTINC%2CEINTEXP%2CTPD&selectedEndDate=2017&selectedReport=CB&selectedStartDate=1934&selectedStates=0&sortField=YEAR&sortOrder=desc
[15] https://www.bbc.co.uk/news/business-16611040
[16] http://people.stern.nyu.edu/adamodar/pdfiles/papers/distresspaper.pdf
[17] https://www.prnewswire.com/news-releases/lendingtree-reports-record-4q-2018-results-300801968.html
[18] https://www.wsj.com/articles/sofi-reports-disappointing-earnings-as-loan-performance-suffers-1518220801
[19] https://fred.stlouisfed.org/series/CONSUMER
[20] https://www.prnewswire.com/news-releases/lendingclub-reports-fourth-quarter-and-full-year-2018-results-300798179.html
[21] https://www.cfo.com/fraud/2019/04/fintech-lender-settles-with-sec-for-overstating-investor-returns/
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