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BitGold: Great Product, Over-Priced Stock

Below is an excerpt from a commentary posted at www.speculative-investor.com on 3rd May. Excerpts from our newsletters and other comments on the markets can be read at our blog: http://tsi-blog.com/


A popular view is that gold has no monetary role to play in a modern, technologically-advanced economy. This view is wrong in many ways, including that, thanks to technological advances, gold is now better suited to being money than it has ever been. This is because technology has eliminated the inconveniences that would otherwise limit gold's usefulness as money, with BitGold being the latest evidence.

In a TSI commentary back in 2010, here's how I summarised the reason that gold is better suited to being money today than it ever has been in the past: "[The key is that] technology [now] allows gold ownership to simply and instantly be transferred without the need to physically move bullion. Almost all the monetary gold could remain locked in vaults, with ownership to a quantity of gold -- anywhere from a tiny fraction of a gram to many kilograms, depending on what is being purchased -- being effected electronically." Previous attempts have been made to create platforms that enable gold to be a convenient medium of exchange, with ownership instantly transferred electronically when a transaction is done, but BitGold is the first attempt that stands a good chance of being successful.

The choice of the name "BitGold" was obviously influenced by the growing popularity (and notoriety) of Bitcoin, but BitGold and Bitcoin have almost nothing in common aside from being ways to store purchasing power and make electronic payments outside the banking system. Importantly, BitGold doesn't have Bitcoin's flaws, the most serious of which is that a Bitcoin, like a dollar or a Yen or a Ruble, has no use outside of its role as a medium of exchange.

Rather than being an electronic medium of exchange itself, BitGold is a platform for trading a substance (gold) that has historically been the world's premier medium of exchange. Putting it another way, users of the BitGold system are not trading computer 'bits', they are trading ownership to specific pieces of physical gold stored in a vault.

To be fair, Bitcoin has one significant advantage over BitGold. The beauty of Bitcoin is total decentralisation. There are no intermediaries. There is also no need to jump through the personal ID (Know Your Customer) hoops established by the banking system at the behest of government. With BitGold there are intermediaries (vaults and insurance companies), and all the usual banking-system requirements apply.

As far as I can tell, there is no way to use technology to quickly/efficiently transfer ownership of gold without using intermediaries responsible for storing the gold and keeping it safe. On the plus side, with BitGold the storage is outside the banking system and there are several options regarding geographical location.

I'm not going to explain all the benefits of BitGold and how it works, because that's already been done in a number of places on the internet. For example, Bob Moriarty provides a good overview HERE. I like BitGold, the product, a lot, and will probably open an account in a couple of months if it operates smoothly during the intervening period. But BitGold, the stock, is a different kettle of fish.

BitGold shares (TSXV: XAU) listed at the same time as the company opened its virtual doors to customers. This is strange. Normally, a company will have operating history before it lists on a stock exchange. Was it a deliberate ploy to float the company on the stock market before there were any hard data that could be used to value the shares? If so it worked, because the shares immediately attained what appears to be a very high valuation. I say "appears to be" in the previous sentence because, with no operating history to go by, it is impossible to even guesstimate what the company is worth. What I can do, however, is roughly determine the amount of success built into the current stock price.

At last Friday's closing price of C$4.14 and with around 37M shares outstanding, XAU's market cap is C$153M. This equates to US$126M at the current exchange rate. How many users would BitGold need to justify this market cap?

BitGold makes money on transaction volume -- on the purchase/sale of gold. Specifically, it takes 1% of every purchase and every sale of gold made through the BitGold system. Users of the BitGold system are not charged anything for gold storage and insurance, meaning that all costs of running the system must come out of the aforementioned 1% and that whatever is left becomes BitGold's gross profit. For the purposes of this exercise I'm going to ignore these costs and make the assumption that due to its strong growth potential the company is worth 10-times its annual sales revenue. Based on this assumption, the current market cap of US$126M would be justified by annual sales of roughly US$13M. To get $13M of sales, BitGold would need annual transaction volume of US$1.3B.

Now, the company guesses that its average annual transaction volume per user will be $1000-$2000. If I divide this range into the $1.3B implied by the current market cap, I get a range of 650K-1.3M. In other words, this method of valuation suggests that the current share price is discounting a customer base in the 650K-1.3M range.

As an aside, it is clear that BitGold will need a fairly high average transaction volume per user to be meaningfully profitable. However, it's a good bet that many of the users will initially be 'goldbugs' who will use the service to make long-term investments in physical gold. Based on its current fee structure, BitGold would be more likely to lose money than make money from this type of customer.

Taking another valuation approach, BitGold has been likened to PayPal so perhaps it would make sense to compare BitGold's valuation to PayPal's valuation. PayPal is apparently being valued at $84 per user, but there are three reasons -- not even taking into account the fact that PayPal is a major success while BitGold's success is not yet assured -- that BitGold's valuation should be significantly lower than PayPal's. The first is that PayPal has no storage and inventory costs to absorb. The second is that PayPal is solely a vehicle for transferring a medium of exchange whereas many of BitGold's customers will use the service for store-of-value purposes*. The third is that the BitGold service is not available to US citizens. I'll therefore assume that BitGold's per-user value is a little lower than PayPal's.

Assuming $70/user, BitGold's current market cap implies a user base of 1.8M.

Based on the valuation methods outlined above and the company's own growth projections, it seems to me that if all goes well then BitGold could grow into its CURRENT market cap in 2-3 years. This means that great success has already been priced in, leaving plenty of risk and no valuation-related upside for new buyers of the shares. Of course, there will always be upside potential due to the pool of greater fools, especially considering that the supply of XAU shares is small at this time.

The bottom line is that BitGold, to me, is like Amazon.com: I love the product, but hate the stock's current valuation.


*Gresham's Law is an obstacle to BitGold's profitability, in that the sort of people who would want to own physical gold would be more likely to spend their fiat currency than their gold. That is, they would tend to hoard their gold and spend their dollars, euros, etc., thus reducing BitGold's revenue per user.


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