Silvergate Capital SI
November 11, 2022 - 1:04pm EST by
cfavenger
2022 2023
Price: 30.00 EPS 0 0
Shares Out. (in M): 31 P/E 0 0
Market Cap (in $M): 930 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT 0 0

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Description

Please forgive the state of this writeup but given a rapidly moving situation I thought it would be best to post first and refine in comments/questions.  The stock was at 27 when I started banging this note out but things move fast.

Silvergate Bank is an FDIC regulated and insured US bank which specializes in serving the crypto-currency ecosystem.  Unsurprisingly, given the backdrop for Crypto, Silvergate is down from 220 to 30 over the past year.  I am a crypto-skeptic.  I’ve never found a compelling use-case that didn’t make me laugh or just respond “but that’s really only good for tax evasion and money laundering.”  The runway for crypto mattered when Silvergate was at 200, 150, or even 75.  At 30 the stock is a highly asymmetric value play.

Let’s discuss what Silvergate actually does.  The bulk of Silvergate deposits come from participants in the crypto-trading ecosystem.  In 3Q22 Silvergate reported having $12 billion average zero-interest digital asset customer deposits.  The reason SI collects most of these deposits is due to its SEN (Silvergate Exchange Network) network which is a platform which facilitates the easy transfer of US dollars between trading participants.  In 3Q22 there were $113 billion in SEN network volumes.  SI takes these deposits and for the most part invests in a boring portfolio of government bonds. In fact, it’s near zero-cost for deposits and its highly liquid balance sheet make Silvergate (and this is not hyperbole) perhaps the single most rate sensitive bank in the country.  

They do have a small credit allocation of ~600MM in SEN leverage loans which are over-collateralized by digital assets. These are effectively margin loans in which SI will lend customers 65% of the value of their Bitcoin (and ONLY Bitcoin). SI requires customers to turn over custody of the collateral to them so that they have the ability to sell the assets and de-leverage their customer should the loan-to-value breach their limits. Given that this lending program has been in place over a period in which BTC has gone from $67,700 to $15,700 with sometimes violent moves to the downside and Silvergate has not only never suffered a loss, a default or even had to foreclose on assets and sell on behalf of their customers, it is reasonable to conclude this lending program as been stress-tested. In a statement earlier this week the company reiterated this credit performance in the wake of the most recent volatility While strange things can happen, I don’t expect any significant credit losses on this portfolio.  

That’s it.  The core story of this company is that this is a deposit taking bank which invests in government securities. They had a great ability to gather cheap money deposits with a value-added technology platform and they grew a lot over the past few years. 

So what happens now?  Twitter would have you believe this bank is on the verge of failure.  I’ve been investing in small-ish banks like this for decades.  I’ve learned to never say never in this business.  Could there be an “unknown unknown” risk here I am not seeing?  Maybe.  But what I see as “a bank-guy” is an institution with a very liquid asset book trading below tangible book. It is worth noting that adjusted of OCI (the marks banks take on their Available For Sale securities) Silvergate’s TBV is over $46 per share and roughly $30 with AOCI.  They may end up losing a lot of deposits if crypto goes into a long winter in which case earnings will shrink.  But tangible book will increase under almost any reasonable economic or even crypto-scenarios. 

And what about the upside?  First, last year Silvergate purchased the Diem platform from Facebook when it was clear the company (META) was too hated in Washington to get anything done in the financial system. Diem is a network designed in partnership with a laundry list of partners that have something in common; they pay a tremendous amount to Visa and Mastercard in the form of interchange. Diem investors like Uber, Lyft, Spotify and Shopify are hopeful the stablecoin technology can help them avoid the credit and debit card networks and facilitate payments for virtually nothing. This is an enormous TAM as it has the potential to give Silvergate access to $10s or even $100 of billions in cash that they can invest in government overnight funds and earn a very high margin spread.   

In 3Q the company disappointed investors by saying that while Diem was fully developed on the technology side, regulatory approval was taking longer than expected.  There are indications that the regulatory headwinds are precisely because the sheer potential scale of Diem is so large that Treasury wants to make sure there are safeguards around the impact it could have on capital markets.  At this price, you have a free claim on future Diem optionality.  Even if Diem was worthless, shutting down the project would save around $30 million per year in expenses (roughly $1/share) which currently has no offsetting revenue.

Second, Silvergate has the SEN network and a general treasure trove of IP/relationships in the crypto ecosystem.  There is a universe in which the utter debacle at FTX et al forces the crypto/block-chain universe to heavily regulated and transparent entities like Silvergate/SEN.  What is this worth?  Hard to say.  Crypto could cease to exist.  Or this could be like the other 10 times that we all said “ah this must finally be the end” but it does seem to have an ability to rise like a phoenix from the ashes again and again.

Which is why SI is so interesting at these levels.  I think that heads I am buying a liquid balance sheet that can be liquidated for relatively close to the current price.  I believe many banks would be happy to make a deal for SI, which would be book value, EPS and capital accretive and comes with all of the IP/technology and optionality for free.  So, I don’t see a fundamental reason why the bank should trade at a discount to tangible book.  On the other hand, if history rhymes and this is like the other 1000 times crypto was “over” only to bounce back then the stock can have massive returns from hereThere are certainly scenarios where the problems at FTX drives more crypto business into transparent regulated institutions like Silvergate.

If you are a zealot that crypto is deceased for good here then you may well be right and this isn’t your stock.  Even if tangible book plus some value holds there will be more interesting things for you to do with your money.  Personally after investing for several decades I’ve become much more skeptical about absolute certainty about anything.  I like to find situations where I can find a lot of upside exposure to something happening without a lot of fundamental downside risk.  SI is a fast evolving situation but I think that’s what we have here. Downside risk from here should be a function of market-to-market psychology and technicals rather than fundamentals.  In upside scenarios this returns to the valuation of a high-growth high return differentiated financial institution worth several multiple of book value for 2x-4x type returns.  In your blue sky scenarios, Diem takes off and you can add to that the value of a high growth technology company.  

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

The storm passes and they are still standing.  

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