Bitcoin, bleeding edge, blockchain, Cosmos, crypto, DeFi, digital gold, Ethereum, fiat money, Galaxy Digital Holdings, George McDonaugh, KR1, KR1 plc, network effects, Owner-Operator, Peter Thiel, Polkadot, proof of stake, venture capital
My main 2020 investment thesis is the assumption this #pandemic does not herald new & permanent societal change. But it will reinforce & accelerate existing trends, with #cryptocurrency/#blockchain innovation, development & adoption poised to benefit hugely. It’s just three years since my first & last crypto post (& Bitcoin‘s only twelve years old!), but its progress since has been astonishing…
We kicked off with a spectacular crypto-bubble in late-2017, with the launch of Bitcoin futures triggering the devastating early-2018 collapse…which fortunately played out in less than a year. Fidelity, Coinbase & Bakkt launched institutional-grade digital custody platforms & even the OCC confirmed US banks can now offer digital custody services. Crypto exchanges like Binance, BitMex, Coinbase, Huobi & Kraken now boast hundreds of millions/billions of dollars in daily crypto volume. Libra was announced by Facebook. More & more hedge funds are getting involved – Mike Novogratz launched Galaxy Digital, with Paul Tudor Jones & even Stan Druckenmiller buying into Bitcoin as a digital asset/inflation hedge – not to mention, family office/college endowments (are pension funds & sovereign wealth funds next?). Square & PayPal now accept crypto & more payment companies will follow. Proof of stake has emerged as a green alternative to crypto-mining. Grayscale‘s listed crypto funds now boast a $14 billion+ aggregate market cap (alas, most of the US fund industry still awaits SEC crypto approval), while Total Value Locked Up in #DecentralizedFinance is also at a $14B+ all-time high (& doubling every month/two since June!). Stablecoins are also emerging as stable-value/high-volume bridges to the fiat world. We’ve even seen listed companies like MicroStrategy & Square buy Bitcoin as a corporate treasury asset. And Bitcoin’s now only 6% off its all-time high…
The volte-face in attitudes has also been impressive, with the crypto sector recognizing that embracing (& promoting change in) existing financial/regulatory regimes offers a slice of an infinitely larger pie. While regulators are also more open too – though US regulators may remain as schizophrenic & over-reaching as ever – with central banks (like the PBoC, Fed & BoE) now floating (& trialing) digital currency proposals, to co-operate/compete with crypto. As for investors, the Bitcoin survival debate’s dead…it’s been anointed digital gold & nobody could disagree it’s not a contender. While the mantle of blockchain innovation passed to Ethereum (& the imminent Ethereum 2.0), plus the smart-contract projects & infrastructure being built atop it (3,750 DApps & counting, mostly on Ethereum). And #DeFi is shaping up as a killer app for blockchain…to join forces with #fintech & eventually #BigTech to challenge the legacy financial services/payments industry. [Maybe even value investors get this…look at bank valuations!?] Its IPO may be on ice, but Ant Group‘s still a prescient reminder (for the West) of how easily bank-customer relationships & economics can be cannibalized by disruptive technology & business models.
But hey, I’m not here to sell crypto…there’s countless evangelists, articles & Twitter feeds to convince you of its merits. Assuming you’re (even remotely) open to investing in a new foundational technology, a nascent asset class, and/or a potential store of value, we’ve now reached a point where a modest 3-5% crypto allocation arguably makes sense in any portfolio. [And yes, it’s an allocation – don’t be red-herringed by its technical intricacies/ideological arguments – most investors can & should buy crypto just like they buy a sector/country/thematic ETF, i.e. for its big picture exposure & potential]. And so, I am here to revisit afresh one of my highest return investments…a stock you might consider owning too, regardless of whether your current crypto knowledge/experience is professional-grade, or close to zero! I present:
Long-time readers will remember I first wrote it up in Sep-2017, just days before Bitcoin/crypto went exponential:
‘Kryptonite Even Superman Could Love…’
And if you want to read that piece, I first recommend this crypto/blockchain stock primer. It highlights how few viable pure-plays were available to equity investors – and frankly, it’s much the same today – and offers valuable context on why I homed in on KR1 as a unique crypto investment company.
KR1’s origins are in Guild Acquisitions plc…a former vehicle of (the late) mining investor Bruce Rowan. [A nano-cap* listed shell: Just £0.1 million equity, minimal admin. expense/cash/debt & no outstanding options/contingent liabilities]. In Jul-2016, in a deal sponsored by Rupert Williams & Jeremy Woodgate of Smaller Company Capital – both appointed directors, along with new CEO George McDonaugh – the company announced a £0.1 million placing & a new blockchain investment strategy. By year-end, it was renamed Kryptonite 1 plc, and completed another £0.3 million in placings & participated in its first initial coin offering (just £6K in SingularDTV!).
[*UK Adjustment: e.g. Median AIM market cap is barely £25 million, so I re-classify nano as sub-£5M, micro as £5-20M & small-cap as £20-100M here!]
McDonaugh’s background is in marketing…’til he discovered Bitcoin & fell down the crypto rabbit-hole. While Keld van Schreven is a serial startup guy – he became a director in 2017, but was a consultant from the start & is now a fellow MD/Co-Founder. Janos Berghorn is the third & final team member…in true crypto spirit, KR1’s a lean decentralized operation that’s otherwise outsourced to external crypto consultants (as needed) & advisers/service providers.
Here’s George & Keld recalling the brave beginnings of KR1, and an interview with McDonaugh which is a good overall introduction to KR1, its portfolio & investment approach:
Finishing 2016 with just £0.4 million of equity, the company obviously needed to bootstrap itself via further placings…but what’s amazing is that KR1’s only completed three placings since. All told, it’s raised just £2.7 million in its lifetime, with no further placings since Dec-2018!
[NB: It also completed a 19-for-1 share consolidation in Apr-2017 – note when consulting prior RNS/results. And in 2018, we learned Superman didn’t actually love Kryptonite 1, so they ‘…changed its name to KR1 Plc at the request of a global entertainment company which has trademarked the word ‘Kryptonite’ in relation to a fictional alien mineral associated with the weakness of a particular superhero’!]
And the operational progress of the KR1 team since has been nothing short of extraordinary! Here’s a visual summary of their investments to date:
And for reference, here’s KR1’s current investments (43 in total), by vintage – yes, you can ignore the excruciating detail – focus instead on total portfolio value (per market/latest funding round valuations, or cost/adjusted cost) as of end-June & today (20-Nov-2020):
[i) Coinmarket pricing used (if possible) for all tokens, 2019/20 funding round valuations used for certain equity investments, a 0.7x multiple (vs. cost) for all other 2017/18 investments (per average vintage multiple, exc. outlier multi-baggers), and cost for all other non-traded 2019/20 investments.
ii) Token holdings (as of 20-Nov-20) may exc. tokens earned staking, and are generally unchanged vs. end-June except for subsequent investments/sales/staking (see recent RNS).
iii) NB: Polkadot, Nexus Mutual & Dfinity held at cost as of end-June – all started trading Jul/Aug (Dfinity still a grey market IOU pre-launch).]
And it’s actually 56 investments in total, summarized as:
[NB: KR1’s RNS always focused purely on reporting actual investment purchases & sales – and compared to the blue sky crap many nano-cap companies issue, this was actually my first/big positive signal re management! It meant some immaterial investments & non-purchases/sales (like bonus allocations/staking/etc.) weren’t reported along the way – but KR1’s made a much better effort this year to identify staking/lockdrop rewards & exact token holdings in its RNS.]
And those partial/full exits (29 individual sales) boast some incredible multiples along the way…and yes, I mean multiples of cost!
The bad news: A (small) zero, a 10% loss & a break-even sale…any VC worth their salt would sigh in relief at such exits! Otherwise, exit multiples range from 2x for Nash Exchange, 21x for Polkadot (last month), 35x for OMG Network, all the way up to an astonishing 51x for Cosmos…and notably, many of the team’s (best) exits occurred long after the late-2017 crypto bubble!
In aggregate, KR1 boasts an average 15x exit multiple to date.
But what have its realized & unrealized portfolio gains delivered for shareholders since inception? Well, here’s KR1’s reported equity/NAV per share to date:
[NB: Initial 20-Jul-2016 NAV per share reflects end-Jun £0.1 million equity & KR1’s first £0.1M placing vs. 30M shares outstanding (adj. for subsequent 19-for-1 consolidation.]
2017 was like shooting tuna in a barrel, crypto investors enjoyed unprecedented bubble profits…while 2018 was the unavoidable collapse. But overall, KR1 investors have still enjoyed a massive crypto tailwind/adoption curve since Jul-2016. For perspective, let’s compare KR1’s NAV & share price performance vs. Bitcoin itself:
Just marvel at Bitcoin’s return…94% pa! And with KR1 racking up such amazing 76% pa & 89% pa NAV/share price absolute returns – and remember, that’s net of all expenses/performance fees/taxes/etc. & not forgetting initial unavoidable equity dilution – is it churlish to ask, where’s the alpha?
Except there’s a hell of a kicker here…
Remember, three of KR1’s top holdings (Polkadot, Nexus Mutual & Dfinity) were still held at cost as of end-June. And so, inevitably, we need a current NAV estimate – using interim & today’s portfolio valuations, we can (re)construct KR1’s balance sheet as of end-Jun & today (20-Nov-20):
[i) ETH were time-locked to earn Edgeware & Plasm tokens.
ii) KR1’s registered as a 0% tax Isle of Man company (see 2016 annual report), but management was maybe naive about ensuring it did not have a UK permanent establishment & was ultimately subject to UK tax. Noting the resignation of two UK-resident directors last year, the drastic fall in office rental & decentralized nature of KR1’s business, and the absence of any current tax liability, I’ve actually confirmed a majority of the board are now non-resident. [And KR1 does have losses it can realize too]. I’m still applying 50% of an estimated 19% UK tax liability here – but would hope to see a lower tax charge at year-end.
iii) NB: All Headline NAVs. For a fully diluted NAV, deduct deferred C shares £0.3 million nominal value (deferred D shares are specifically designed to have zero economic value) & adjust for outstanding 9.9M option grant.]
Today’s estimated NAV/share of 20.55p (that’s a 232% gain vs. a Jun-2020 NAV/share of 6.18p) may seem like an astonishing windfall in just months…except it’s an accounting mirage, with valuable holdings still held at cost as of end-June. And attentive KR1 investors anticipated these gains (via grey market pricing) back in June/earlier this year. In fact, tracking crypto sector commentary, company updates & project milestones, it’s clear KR1 enjoyed steady underlying value creation/accretion ever since invested in Polkadot et al. back in 2017/18, but it’s only fully recognized today. So, let’s assess performance again, from inception to today:
Wow, even Druckenmiller would be impressed…now he’s a crypto-head! It’s an extraordinary achievement to bootstrap a £0.2 million nano-cap – despite an initially slow investment phase & disproportionate expense ratio, a UK corporate tax (& performance fee) liability & unavoidable equity dilution along the way – and end up with £27 million of net equity & boasting absolute 120% pa & 116% pa NAV/share price returns! Bitcoin’s the obvious beta…but KR1 was the real alpha bet to make!
Alas, I missed the first year of KR1’s journey, but from Sep-2017 (& despite the crypto collapse), I’ve still enjoyed a +288% gain…that’s a 4-BAGGER in barely 3 years! And yes, I believe there’s one hell of a crypto adoption curve still ahead – so if KR1 delivers even a fraction of its 120% pa NAV returns to date, shareholders today would also enjoy exceptional returns (& an almost inevitable re-rating).
So…can the KR1 team keep delivering?!
Well, the numbers are compelling…but that question requires a qualitative assessment. But first, we gotta look a gift horse in the mouth: If our NAV estimate is 20.55p/share, why’s KR1 trading at 16p/share…a 22% NAV discount?! Well, let’s break it down:
Skin In The Game:
Shouldn’t the KR1 team have more #skininthegame?
Blame the annual report, which lacks relevant shareholdings/options disclosure. Again, it’s all in the RNS: i) George McDonaugh‘s 2.6 million shares & Keld van Schreven‘s 0.7M shares, ii) Smaller Company Capital‘s 5.0M shares & Jeremy Woodgate‘s 1.4M shares, iii) in lieu of compensation, a 2017 grant of options to acquire 9.87M shares (at their 0.19p nominal value, ’til Jun-2027), with 20% being awarded to each of McDonaugh, Woodgate & Rupert Williams, and the remaining 40% being awarded (I’d presume) to van Schreven & Janos Berghorn. [Woodgate & Williams both resigned as directors last year, but they/SCC remain as consultants – and this could present an opportunity to consider adding a new independent non-resident/non-crypto director]. In aggregate, that’s a 15%+ stake in KR1’s fully diluted ordinary share capital.
[NB: In terms of free float, also note these significant long-term holdings: a) Roshan Ashok Vaswani (rep. a UAE/African family office), 15.1 million shares, 11.5%, b) Adam Powell (of Neopets fame), 8.8M shares, 6.7%, and c) (estate of) Bruce Rowan, 4.8%.]
KR1 also has a bonus scheme (clearly disclosed in the annual report): A 15% performance fee, based on net asset gains (adj. for new capital), with a high water mark. [A 20-30% fee’s normal for similar private crypto VC/hedge funds, that require a significant min. investment & offer far less liquidity]. The only bonus paid to date (£1.3 million) was in 2017, when KR1’s equity increased from £0.4M to £13.6M. [Puts the high water mark at £14.5M, to inc. KR1’s final £0.8M placing in 2018 & misc. share issuance re options/services rendered]. Per the scheme, the team opted to receive part of the bonus as an across-the-board allocation of unlisted tokens. Unusual for a UK-listed company, but entirely normal for a VC firm, and it was designed for a nano-cap to attract/retain actual crypto-heads & ideally pay them via unlisted holdings, rather than cash/traded crypto it needed to fund new investments.
Frankly, I was delighted with this bonus allocation – crypto’s an emerging sector that can still expect radical change & volatility, so I sleep better knowing the team lies awake at night worrying about the value, security & staking potential of both KR1’s and their own personal holdings. And experiencing the same economics – many of KR1’s unlisted tokens soared & collapsed since, but just like shareholders, the team’s Polkadot allocation turned out to be the primary multi-bagger winner for them too.
I mean, what better skin in the game is there than that?!
And don’t under-estimate the retention aspect: With such a small & incredibly successful team, the real worry is that someone/all of them depart (or get aqui-hired). Except…they’d be hard-pressed to find remotely the same personal economics elsewhere (or be their own bosses)!
Those are beautiful digital gold handcuffs…
Between the bonus, options & their shareholdings, the KR1 team are true owner-operators. My only proviso is the bonus trigger – it makes no provision for KR1’s market cap. And since incentives drive behaviour, the board should consider amending the scheme to appropriately incorporate both KR1’s market cap and net assets growth, for even closer alignment with shareholders. They should also recognize the biases of investors…many of whom value options exercised (& held) far more than a bonus & value actual shareholdings even more again. Noting their 2017 bonus & resulting Polkadot holding, plus a potentially larger bonus again this year, it would be a great time & signal from management to exercise their options and make an open market share purchase/two!
More recently, I’ve focused on founder/family/owner-operator run companies – nobody would dispute they deliver some of the best long-term returns! Except investors buy their strengths…then immediately cherry-pick their weaknesses. I mean, why can’t they deliver excellent performance and go out & pump the stock to Kingdom come?! Except the share price only really matters when they raise fresh capital, or finally make an exit. And founders are entrepreneurs…they believe that if they take care of the business, the stock will take care of itself!
And it’s the same with KR1: You can’t choose an owner-operator & suddenly expect a promoter. [Who invariably fail to deliver…so careful what you wish for!] Some patience is needed..’cos in the end, share prices really do catch up with exceptional performance. But meanwhile, when George & Keld are in front of investors, they could & should focus less on selling crypto…and focus more on selling KR1 as a compelling crypto play regardless!
That being said – to be fair – we see a lot more IR effort & general engagement with the crypto/financial media in the last 12-18 months, which should pay off. Of course, a jazzy new website would obviously help too..!?
KR1 still does not provide a detailed portfolio breakdown (by units & value). Or a regular NAV update – except via its results, months later! However, KR1’s RNS do provide a detailed history of new investments, partial/full exits & its more recent time-lock/staking activities – work through ’em & you’ll nail/track the portfolio pretty accurately (as per above).
Alas, that’s a passion project for hard-core shareholders…
Unfortunately, most nano/micro-cap (investment) companies start out this way. And in an emerging sector like crypto, with a venture capital portfolio, there were & arguably still are good reasons for not providing a regular portfolio/NAV update. [But KR1 does offer a monthly Medium update & an active Twitter account]. But four years & 4 dozen+ investments later, KR1 now has a £21 million market cap & some major winners driving its portfolio value – it’s time to open the kimono!
And ultimately, it’s about attracting a much larger pool of potential investors now ready to finally consider/add some crypto exposure. With its compelling track record & uniquely diversified portfolio, KR1’s the obvious candidate…but that’s irrelevant if new investors don’t know it trades on a NAV discount (vs. a 2.6 P/B multiple, based on KR1’s last reported NAV), or simply reject it as a #blackbox they just can’t get comfortable with!
Aquis Stock Exchange Listing:
Which brings us to the other obvious reason more investors haven’t discovered & bought KR1…it’s listed on the Aquis Stock Exchange (formerly, NEX). Um, you what now?! Actually, it’s one of only two active/UK-focused Recognized Investment Exchanges – yes, the London Stock Exchange (inc. AIM) and Aquis both operate under essentially the same regulatory regime! But NEX did a poor job of its trading technology & direct relationships with the major (online) UK brokers, so even today buying KR1 may require a full-service deal – i.e. phoning a broker to trade – which, let’s face it, is a tall order for today’s investors!
Aquis Exchange plc (AQX:LN) only acquired NEX in March, and per CEO Alasdair Haynes‘ record (as CEO of Chi-X Europe), we can believe his transformation plan – which explains KR1 recently noting: ‘…the intention of making improvements to the exchange infrastructure in regards to electronic trading, higher volumes, deeper liquidity and allowing for a more global investor base. We are looking forward to seeing how the new Aquis Exchange team implements their plans for improving the legacy NEX Exchange over the months to come’. Such loyalty’s understandable…but again, let’s not under-estimate investor biases. How long before the average investor realizes Aquis is not some grey/OTC market, or that the sins of NEX (& previous failed incarnations) are irrelevant today? Yeah, I think you know the answer…
An up-listing is the solution…i.e. an AIM/LSE listing. [And/or even a US OTC listing, which could deliver a drastic valuation re-rating – albeit, it might still require significant time/money to attract US investors]. That doesn’t necessarily guarantee better spreads & trading volumes, but would bestow a seal of approval on KR1…in the eyes of a much larger pool of investors. And if this is another crypto inflection point – as KR1 surely believes – you have to speculate about the revaluation potential of an up-listing, let alone the chance to maybe/finally raise fresh capital at an NAV premium. Therefore, an up-listing’s something KR1 now urgently owes its shareholders. A new option grant contingent on an up-listing (but with an up-to-date NAV strike) would be an appropriate management incentive in this scenario – announcing this with a planned up-listing would be a great signal to the market of KR1’s under-valuation & ambitions.
OK, let’s recap:
– Board to consider amending bonus scheme to also reflect market cap growth, exercising their options & making open market purchase(s).
– Focus less on selling crypto & focus more on selling KR1 to new investors!
– Provide a quarterly portfolio breakdown & NAV estimate to shareholders.
– Announce & proceed with an AIM/LSE listing (and/or even a US OTC listing) as soon as possible, tied to a new/contingent (NAV strike) option grant.
The first two are nice-to-haves, while the last two are must-haves if KR1 wants to attract (vs. wait for) a much larger pool of investors. If you’re a shareholder, I encourage you to endorse these recommendations to the team. But remember, they’re still icing on the cake…’cos owner-operators are right: ‘Once the business does well, everybody does well!’. Which brings us full circle:
So…can the KR1 team keep delivering?!
Yes, absolutely, is the short answer! And that’s not just some crypto bet…the long answer lies in the same original reasons I homed in on KR1 as a truly unique crypto/blockchain investment company.
[Again, I recommend this post – still a good primer on choosing between various crypto investment alternatives & separating the wheat from the chaff (& outright duds/frauds)!]
First thing I noticed was KR1’s expense ratio. An odd metric, but emerging sectors attract lots of promotional nano/micro-cap investment companies – they have no real operating business, management’s focused on getting paid & returns (if any) invariably fail to overcome an absurd expense/cash burn hurdle. Whereas KR1’s total staff costs in 2019 were just £269K & its total £0.7 million cost base puts its expense ratio at just 2.6% today! This frugality & focus on performance-based pay was a big positive signal…since then, I’ve always been impressed with the team’s integrity & no-nonsense under-promise/over-deliver approach.
But today…what expense ratio?! ‘Cos from day one, KR1 had no intention of being a Bitcoin/crypto miner (or tracker). Instead, it focused on investing in smart-contract/token economies, esp. those relying on a ‘Proof-of-Stake network that, unlike Proof-of-Work networks, such as Bitcoin, does not require enormous computing power & energy consumption to guarantee the security & censorship-resistance of the network’ (per recent Kusama RNS). Proof of stake now looks set to be a dominant blockchain technology – esp. with Ethereum 2.0 ready to go live – and if you’ve read about/had a friend lecture you about Bitcoin energy consumption eating the world, then KR1’s a genuine green/ESG crypto investment for you (& your friend) to consider!
Last year, KR1 earned £242K from Cosmos, its first staking opportunity. It’s now earning Polkadot staking rewards at a current $1.7 million annual run-rate, and just confirmed $124K in annual Kusama staking rewards, with Dfinity & Ethereum 2.0 to also offer staking soon. In fact, its $1.5 million Kusama holding was itself a zero-cost Polkadot airdrop…and similarly, KR1 earned ChainX & Phala tokens, is earning Edgeware & Plasm from lock-drops, and expects similar rewards via Acala & other projects. Not to mention, it earned £181K in advisory revenues from Vega Protocol, another 2019 investment – notably, many projects hail the KR1 team for working with them pro-bono from day one, and this will undoubtedly produce more advisory revenues (and/or preferential token access & pricing) to come.
So KR1 now boasts a recurring revenue of something like $2.3 million, vs. an existing expense base of $0.9M. And as the Kusama RNS noted, these ‘staking activities do not impose any overhead or additional operating costs to the company’! That’s a substantial intangible asset/business missing from the balance sheet. Accordingly, if we capitalize* recurring net income at a reasonable 12 P/E, it could imply an adjusted NAV of 29.5p/share, that’s 44% ($15.5M) higher than my current NAV estimate! Not to mention, the valuable inverse correlation in staking rewards vs. portfolio values – i.e. if staking yields drop, it generally implies higher usage/demand & token values!
[*You may ask if this is double-counting…but it’s wayyyy too early in the crypto game to treat staking as merely equivalent to a passive yield embedded in asset values/prices. Crypto can offer utility, currency & investment in a single token, and staking’s not some default earnings stream at this point, it obviously requires intangible investment (time/flexibility/experience) & it can transform an expense ratio into recurring revenue/profits – all of which makes KR1 an even more uniquely diversified crypto portfolio & earnings opportunity today vs. the rest of the listed crypto universe (many of which boast none of the above).]
Maybe the biggest misconception about crypto investors is the binary assumption that a lucky few were blessed with incredible multi-baggers, while the unlucky were eviscerated by frauds. In reality, the phrase ‘luck is a matter of preparation meets opportunity’ (& its inverse) are obviously true! Most equity frauds are simply un-investible companies to begin with & the rest invariably belong in the ‘too hard’ tray. The same’s true in crypto…it just takes a little common sense & a trusty investment checklist. Sure, the KR1 team’s had investment losses along the way, but their investment process has been exemplary – they’ve consistently avoided the obvious frauds & absurd promotions.
KR1’s multi-baggers can also be credited to its investment checklist process. Assessing a team’s experience & reputation is the most important step…as with any startup, their ability to pivot, execute & scale is critical. Next is the project itself: How innovative is the technology, how difficult is the actual development & implementation, what’s the potential timeline, scale & commercial opportunity, and who else may be targeting similar applications & space? Ideally, you want a credible team, an exciting project & plenty of white space to exploit! And finally, there’s an evaluation of the actual crypto economics – both the short term supply/demand dynamics, plus the longer term utility, demand, inflation & store of value potential of the token.
Diversified #BleedingEdge Portfolio:
The diversity & number of investments in KR1’s portfolio is quite unique – globally, maybe a handful of crypto VC/hedge funds come close, while listed crypto & blockchain portfolios aren’t remotely as diversified! And regular VCs can’t match that blistering investing pace. The naysayers assume a shotgun approach is fine for crypto – but again, checklist it – you need a rifle, patience & lots of hard work for the portfolio and consistent/spectacular returns KR1’s actually delivered.
And from day one, KR1 eschewed Bitcoin & focused on seed/early stage investment in token economies/blockchain projects. Because Bitcoin’s ultimately a bet on price…while investing in blockchain is a bet on innovation! [And I’ll always choose innovation – that’s why I bet on KR1, vs. Bitcoin]. It’s a classic picks & shovels strategy…or should I say, roads & rails: With the boom/land grab so young, they focus on the architecture & infrastructure of this new crypto world, and projects that complement & leverage off existing investments. Hence, smart-contract tools/DApps/platform projects built on Ethereum, interoperability as an incredibly successful theme (via Cosmos & Polkadot), investments in the emerging ecosystem around Polkadot itself…and of course #DeFi, now exploding as the ultimate killer app for crypto. Here’s van Schreven with a great overview:
Of course, now everyone wants to invest in those themes & projects…
Except you really had to anticipate this crypto-evolution back in 2017/18, and discover/invest in what were bleeding edge projects at the time! As Gretzky said: ‘I skate to where the puck is going to be, not where it has been’. Or as Steve Jobs joked…Henry Ford was dreaming up the Model T, when most people thought they wanted a faster horse! And that’s the #bleedingedge KR1 focused on starting out…and and are still laser-focused on today.
[And accordingly, shareholders should scan KR1’s portfolio/new buys now & again for emerging hidden gems…even a $0.2 million holding is meaningful if it ultimately turns into a potential multi-bagger!]
Venture Capital Economics:
Let’s re-iterate: KR1 is not some Bitcoin tracker, it focuses on seed/early stage investments in crypto/blockchain projects…and enjoys the same economics as the best VC funds! As Fred Wilson of Union Square Ventures describes it:
‘I’ve said many times on this blog that our target batting average is “1/3, 1/3, 1/3” which means that we expect to lose our entire investment on 1/3 of our investments, we expect to get our money back (or maybe make a small return) on 1/3 of our investments, and we expect to generate the bulk of our returns on 1/3 of our investments.’
And it’s maybe even more skewed, with a Pareto-like 80% of VC returns coming from just 20% of their holdings. KR1 investors need to embrace this: You can’t celebrate its multi-baggers…and then curse its losers! ‘Cos they’re inevitable. And huge winners are ultimately the key – as returns reflect a lognormal/power-law distribution, that looks something like this:
The secret’s in the right tail…a massive winner/two pays for all the losers, duration, expenses & carry, and still pays out exceptional returns. Or as Peter Thiel put it (time to read ‘Zero To One’ again!):
‘The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined.’
And today that’s an ever more dominant phenomenon as the world’s embraced online business models/platforms & their network effects. And blockchain takes it to a logical extreme, as crypto projects: i) are mostly open-source, recognizing value doesn’t reside in their IP, it’s ultimately created/embedded in their platform & network effects, and ii) exploit blockchain’s trust-less & decentralized technology to eliminate intermediaries & connect/reward users directly. That’s why equity (which traditionally owns/exploits IP) is rare & tokens are the dominant investment mechanism – ‘cos they’re both currency and investment – i.e. they’re speculative trading chips, a potential store of value, a utility token for transactions/services, and/or a direct investment in the increasing value (creation) of a network.
It’s a marriage of 21st century technology (blockchain) & a centuries-old technology (mutuality)! Not only can you eliminate middlemen, you can eliminate (traditional) ownership entirely, and this is a multi-trillion dollar opportunity for blockchain to re-allocate profits to users/consumers. [Picture Facebook with no shareholders, where its net revenue/profits belong to its most important stakeholders…i.e. users, who actually generate all its content. Likes could have evolved into the world’s most valuable utility token!] But instead, #DeFi may be the killer app – the (legacy) financial services/payments industry is an incredibly compelling target in terms of global profits (not to mention dissatisfied customers!).
But no matter how prescient your investment strategy, or effective your investment checklist process, it’s nigh impossible to know a priori which of your fledgling investments ultimately become huge winners. And that’s why, in such an emerging/early adoption phase, KR1’s highly diversified portfolio gives it such a unique competitive advantage, in terms of past & future returns!
VC Economics on Speed:
In 2017, I described KR1’s special crypto sauce as…flipping ICOs! This time ’round, I’ll describe it as VC on speed!
Because KR1 enjoys VC economics – which usually play out over a 10-14 year life-cycle – on a hyper-accelerated schedule. In 2017, this happened in weeks/months via an ICO, often based solely on a white-paper. Now, the pace is more measured – at least with reputable/best-in-class projects – they rely on small private seed/early stage funding rounds, establish & execute technical/project milestones, evolve through various beta stages, before finally launching (& maybe raising more funds) publicly. This plays to KR1’s strengths & eliminates direct ICO competition – i.e. crypto’s evolving towards a more traditional VC model & (initially) shutting out regular private investors.
Which enhances the economics: On the front-end, it’s cheap to capitalize/finance a team & project in development/beta for a couple of years. While on the back-end, crypto VCs can still expect a liquidity/exit opportunity in 1-3 years – with the resulting supply/demand imbalance even more turbo-charged as a global pool of investors fight to access/discount potential multi-baggers & the network effects of successful projects. Just look at equities…they’ve been around for centuries & yet the same supply/demand equation still ensures IPO profits/flipping are the easiest & most lucrative source of alpha on the planet!
But let’s not forget the intense regret of missed sales. Some investors are still bitter KR1 didn’t dump its portfolio wholesale in Dec-2017…surely the worst kind of hindsight/back-seat driving. [Who would care if they’d sold their own KR1 shares at the top?!] I’ll offer a more positive perspective & food for thought. Here’s that KR1 exit multiples chart again:
And here’s the actual multiples on KR1’s Top 5 holdings today:
As KR1’s stated: ‘We bring city discipline to exiting our positions, and we put the proceeds back into further investments’. For many projects, that’s a sale of 25% of their holding – often to recover their original cost. But let’s get real, there’s no discipline in the City that would actually keep you in a 10-bagger, let alone a 50-bagger! I mean, WWYBD: What Would Your Broker Do?! You know he’d have you in & out a dozen times & you’d miss at least half the ride! You never go broke taking a profit…who better than Buffett to remind you how foolish that advice can be. Or Thiel:
‘This implies two very strange rules for VCs. First, only invest in companies that have the potential to return the value of the entire fund. This leads to rule number two: because rule number one is so restrictive, there can’t be any other rules.’
And if you hire KR1 as crypto fund managers, should they even/ever be considering cashing out some/all of their holdings? Is it part of the job description…a question fund investors & academics have debated for decades. There’s no easy answer, or hard & fast rules. But yes, I obviously expect the KR1 team’s learned from the bubble & figured out an actionable game-plan accordingly – recognizing that’s an ambitious challenge when crypto presents such asymmetric risk-reward. And in the end, as shareholders, don’t forget the final sell decision’s always up to us…
Network & Reputation:
And we need to appreciate KR1’s network & reputation. That’s the master key to everything & another highly valuable intangible asset for investors to appreciate. Fortunately, while crypto’s global, it’s still a relatively small world – crypto-heads live in/near the same few cities, attend all the same conferences & are perfectly happy working/connecting in a totally decentralized manner (pre & post-COVID)!
In fact, the KR1 team’s core activity is literally networking…that’s where the deal flow comes from. And how they evaluate a team – the most critical aspect of the investment process – they already know the people, or know people who know them. That’s how/why they often work pro-bono with startups from day one – it’s sweat equity they know pays off in terms of seed/early-stage access, pricing & valuation discounts, friends & family allocations, air-drops, early staking access, potential advisory revenues, and helping them find & leverage off related projects. Again, it’s all about accessing VC economics & figuring out what’s comes next – everyone talks, shares ideas & gives back in the crypto community, recognizing that a larger pie benefits all – and finding the bleeding edge projects already heading in that direction.
And how you network, give back & follow through as a VC investor is how you establish & grow your reputation. KR1’s always punched well above its weight – it’s been extraordinary to see a nano/micro-cap company access & invest in some of the biggest & best projects, alongside Andreessen Horowitz, Pantera Capital, Polychain Capital, Union Square Ventures, Winklevoss Capital, et al! And its success will now open new doors…as testament to the team, they’re now invited to consider seed investments in some of the hottest new projects, esp. in the burgeoning Polkadot ecosystem.
So yes, I absolutely believe the KR1 team can keep delivering! And you can bet they do too. It’s a unique story, a unique company & a unique opportunity…
…and maybe another unique moment for crypto?
I mean, just look at the Bitcoin chart! Maybe this is what the trajectory/adoption of a new asset class looks like…who knows really, ‘cos how often in human history have we seen a new asset class emerge?! [And a $0.5 trillion crypto market is literally still a rounding error in terms of global financial assets, while the listed crypto/blockchain sector’s a rounding error again in terms of crypto itself. Those are really tiny exit doors if more & more investors rush to leave fiat…] And when I say emerge, it’s happening at warp speed – like everything else we’ve done in the last two centuries, let alone the last 20 years (& we’re still accelerating, read your Kurzweil), vs. the otherwise glacial pace of human progress:
And this recent Pantera slide is a spectacular reminder of the actual scale of Bitcoin’s price/adoption cycles (& reversals) to date:
And the goalposts keep moving…now Bitcoin’s surpassed $18.5K again, with just the $20K #alltimehigh left as a major technical hurdle. If/when Bitcoin blows through that level, this time ’round institutional buying will be driving it, and I reckon the media & general public will scarcely even notice…i.e. the next great crypto bubble only inflates at much higher Bitcoin levels (maybe even reaching $318K by end-2021, per Citibank?!). I mean, look at the Bitcoin Google Trends chart…where’s the bubble, let alone the interest?
Noting some of the crazy sector multiples/bubbles we’re seeing, the absurd Robinhood trading (in bankrupt stocks!), the #YOLO #revengespending & trading boom still to come post-COVID, the trillions in money printing/spending in this new whatever it takes MMT world…well, it’s not all that hard to picture crypto as a new store of value and possible mother of all bubbles to come!
Soooo…how do we go about pricing KR1?!
Well, with a incredible 4 year record under its belt…what’s KR1’s peer group exactly?! Think about the largest & most obvious (genuine) crypto stocks out there, the only one remotely similar is Galaxy Digital Holdings (BRPHF:US)…yes, an ambitious comparison, but the difference is mostly scale. Sure, Galaxy’s an obvious large-cap* listed crypto pure-play for investors. [*Actually, the listed Galaxy Digital Holdings Ltd. (with a 27%+ stake in the LP) market cap is only $0.4 billion – if you see a $1.5 billion market cap, it reflects the underlying Galaxy Digital Holdings LP]. But its potentially volatile trading (& nascent asset management) businesses require substantial personnel & balance sheet investment, so Galaxy now has a 14% pa expense ratio hurdle to clear…and here’s its actual NAV record to date (as of end-June):
End-Sep NAV looks better at $1.54/share…but stated NAVs inc. non-controlling interests, so its actual NAV is $1.39/share. Fortunately, they can now raise fresh capital at an NAV premium – a potential future opportunity for KR1 – so last week’s $50 million PIPE enhances NAV by 5%, to $1.455/share. But take a look at the price chart:
Galaxy actually traded on a 33% NAV discount at end-2019…but the share price is up +496% YTD, vs. a mere +20% YTD NAV gain, leaving Galaxy now trading on a 3.3 P/B multiple! [And yes, other/large (non-passive) crypto stocks trade on even higher average multiples, with even the (passive) Grayscale Ethereum Trust (ETHE:US) trading on insane premiums this year!] The scale of the revaluation’s just extraordinary. Now, you could argue it reflects potential revaluations of unlisted holdings, the value of intangible assets, the stand-alone value of its operating businesses & the potential for multi-bagger crypto gains. But the same is true of KR1! And do not under-estimate how much a £21 million market cap can rally if & when a larger pool of new investors finally discover it. Esp. if it’s KR1, which boasts a uniquely diversified bleeding-edge crypto/blockchain VC portfolio, a valuable staking operation that’s missing from its balance sheet/NAV, a crypto network & reputation that’s also a valuable intangible asset…and most astonishing, its shares still trade on a 22% NAV discount, despite a 4 year+ record of 120% pa NAV returns!? Yes, let’s all enjoy that chart again…
Based on KR1’s record & assuming it can deliver even a fraction of those returns going forward – and noting Galaxy now commands a 234% NAV premium – it makes sense to allocate (say) two thirds of that premium to KR1 (rounding down, that’s a 150% NAV premium), i.e. a 2.5 P/B fair value multiple. Therefore:
20.55p NAV/Share * 2.5 Price/Book = 51.4p Fair Value per Share
Which implies a 221% Upside Potential, vs. the current 16p share price.
And sure, right now that obviously seems like a price target that’s far too ambitious & aspirational…and may require an up-listing as a necessary step? But again, that’s icing on the cake. Forget the value gap – a common value investor failing – instead, focus on KR1’s compounding potential! If the KR1 team/portfolio keeps delivering a mere fraction of its 120% pa NAV CAGR to date, the share price will ultimately blow right through that price target, regardless of its multiple. And in the end, does it really matter how you get there:
If you recall, when KR1 was trading at only 4.125p/share back in Sep-2017, I set an even more ambitious 23.6p a share/473% upside potential as an ultimate fair value price target…which it surpassed less than three & a half months later!
And don’t worry too much about keeping tabs on an up-to-date NAV estimate – this KR1 Top 5 Holdings NAV Proxy (which I tweet periodically) is a nice quick & dirty estimate. It obviously assumes all other holdings/crypto liquidity/cash/staking/etc. assets are offset by potential tax/performance fee/etc. liabilities – at 18.7p/share, it’s pretty accurate/conservative vs. my actual 20.55p NAV estimate:
But again, I should stress: KR1’s a £21 million micro/small-cap stock listed on Aquis, with a relatively wide spread & limited daily volume – though sentiment, spreads & volume will inevitably improve (as they have before) as the share price rallies – and crypto/crypto stocks will remain volatile, regardless of their ultimate trajectory. Only buy a position you can actually live it…and you may have to balance price vs. patience when buying. On the other hand, note the #spillovereffect: Bitcoin tends to suck in all the money & interest when it’s rallying, but then house money spills over into Ethereum & then KR1’s portfolio/rest of the crypto universe. This summer Bitcoin hit $12K, but it took another month for ETH to peak at $480 & KR1 to reach 18.5p/share. Now Bitcoin’s $18.5K+ & ETH looks like it finally bust $480 today, so with KR1 closing at 16p/share…well, maybe there’s a #freelunch on the table for new investors?
You may be able buy online/directly via your AQSE broker…otherwise, you’ll have to pick up the phone & actually call a broker, who may in turn need to call a (London) counter-party to complete the deal. [And yes, this should work for non-UK clients & brokers – KR1 settles via CREST, just like any LSE share]. [And if you’re a UK investor, you can buy via a tax-free ISA]. And if they say they can’t trade KR1, it probably just means they don’t want to trade KR1…so be persistent!
For most investors, I’d recommend considering KR1 as some/all of a reasonable 3-5% crypto allocation in your portfolio. But personally – reflecting my strong level of conviction, plus my gains to date – I now have a 10.5% portfolio holding in KR1 plc (KR1:PZ). And despite some inevitable volatility, when I look at the KR1 team, portfolio & valuation – plus the current crypto market – I’m comfortable with that risk allocation today. Remember:
Regardless of your level (or lack) of crypto knowledge & expertise, you have a near-zero chance today of otherwise accessing/assembling a portfolio like KR1. Bitcoin is a bet on price…but KR1 is the #crypto #alpha bet on blockchain innovation. Maybe it’s time to buy & #HODL..?!
- Market Price: 16p per Share
- Market Cap: GBP 20.9 Million
- P/B Ratio: 0.78
- Target P/B Ratio: 2.50
- Target Fair Value: 51.4p per Share
- Target Market Cap: GBP 67 Million
- Upside Potential: 221%
Fair play Wexboy, it’s very generous of you to share all this research openly like this, I’m ashamed to say I didn’t read fully when you first released this but the recent share price has re enforced everything you mention here and on your thesis of putting in the work yourself to find the value, am locked and loaded now:) Hope you’ve made a tidy sum from this and that the twitter sphere gives you the kudos ya deserve
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Thanks for a great write-up.
I stumbled into GLXY at a slight discount to NAV earlier this year, and though I put it on small it’s since grown to become my third largest position. Still holding that one, as I think both a rising bitcoin and an uplisting from Toronto to NASDAQ could propel this much higher.
All that to say that the parallels to KR1 are clear. I’ve painstakingly built a small position over the past two weeks. Trading on this “exchange” was not a good experience: I had to phone in orders only to see them ignored for days while lower bids got filled. You’re obviously right that relisting on a proper exchange would catalyze a significant repricing.
Well done. I would be interested in taking a punt on this. My broker doesn ‘t seem to have this exchange on their platform. I am with Interactive Investors .I was looking to change brokers any recommendation. Not too worried by fees as I don t do alot of trading
Thanks for the tip on CPL . I had a few euro in there. Staying in Donegal Investment too, (have to support local)
Keep up the great work , blog is great.
Best of luck
Thanks – glad to hear Cpl & Donegal Investment Group have worked out well for you too! Actually, Interactive Investors IS an Aquis member broker:
So yeah, you should be able to buy KR1, albeit perhaps via a full-service phone deal. However, if you’re an Irish investor/signed up via their Irish website/biz (now defunct?), unfortunately & arbitrarily this may not be true, by default…again, I’d persist & try do a full-service deal with them to buy KR1.
Otherwise (& if you want a new broker anyway), it’s not clear which UK brokers you can sign up with as a new client, so an Irish broker may be best. There’s some comp. websites out there: DEGIRO’s clearly the best value, but note you prob won’t be able to buy KR1 through them (& I don’t think they even offer full-service dealing?). For a full-service broker, I always recommend the biggest & best – so that’s Goodbodys & Davys – but if you’re an infrequent trader, you should still understand if they charge a/c fees regardless/how you might avoid them.
And it’s easy for a broker to give you a default ‘no, we don’t trade that’ – which, frankly, just means ‘no, we don’t want to trade that for you’ – so giving them a heads-up you may want to buy KR1 if/when you’re opening an a/c is prob a good idea, so they can hopefully ensure you’re handled/documented appropriately as a client.
Any problems, feel free to email & I’ll try offer relevant feedback.
Pi Colossus (@PiColossus) said:
Top class analysis Wexboy – Good to see your current thinking on this. I see a big upping in your weighting on KR1 since the summer. KR1 is such a crypto bet – I feel there’s a missing part of jigsaw – what part does this play in your overall exposure to crypto? Did you have to do a lot of deep thinking when assessing how to view crypto as a single separate standalone sector – or multiple sectors?
Thanks, Pi – much appreciated.
Well, KR1 is pretty much my overall exposure to crypto! I do have one other portfolio holding with a sprinkling of pixie crypto dust, but that didn’t exist/wasn’t part of my original investment thesis when I bought it.
Depending on your knowledge/experience/level of conviction, a (much) higher allocation may make sense – a 10.5% portfolio allocation to KR1 is appropriate for me – but I’m serious when I say the average investor should consider a 3-5% crypto allocation for now. ‘Cos it’s early days yet…and it’s obviously impossible to know how big & quickly the sector may evolve the next 5-10 years, or what direction(s) it will take, not to mention the huge multi-bagger bubbles & horrific bear markets it will likely still endure along the way.
Similarly, I think it’s far too early to think about crypto in terms of multiple (sub) sectors…not least because Bitcoin will likely continue to inevitably/unavoidably dominate the success/trajectory of the rest of the crypto universe. So finding the best fund (or two) is the obvious way to implement your allocation…i.e. outsourcing your allocation to an active manager with a diversified portfolio (and diversified is key…nobody necessarily knows anything when it comes to the eventual big winners in the sector).
And that’s what makes KR1 so unique…they offer easy access to a highly diversified seed/early-stage portfolio that NO experienced/let alone inexperienced crypto investor could hope to assemble themselves!
Great post, thank you. As discussed on Twitter I think the ‘add the capitalised staking revenues’ is double-counting. But those who agree with me might be prepared to value those staked assets on a yield/multiple (you proposed 12x) rather than their price: roughly what is the NAV of the staked assets, please? How much higher/lower is the value using the ’12x the earnings’ method?
As I said above, it’s early days yet…you gotta think about the investment alternatives here (& risks/rewards). The vast majority of investors & currencies/projects in the crypto universe are still NOT earning any kind of staking rewards. And for most investors today, the only choice they’re aware of is an undiversified/passive holding in BTC or ETH (and/or maybe one/two other currencies) – e.g. over 92% of the Bloomberg Galaxy Crypto Index is still allocated to just 3 crypto-currencies. I’m not sure these investors would consider my analysis of KR1’s staking operation/profits as mere double counting..!
Just look at the Grayscale Ethereum Trust – investors have $4.0 billion now invested in $ETHE, even though its ETH holdings are worth $1.6 billion! If they’re prepared to pay a 2.5 P/B multiple for a passive/undiversified/zero staking revenue investment vehicle with a 2.5% expense ratio, would they consider my net staking yield analysis to be double-counting…and/or what kind of premium would they pay on potentially discovering KR1?!
If we did treat staking yield as a mere currency yield:
First, note I capitalized KR1’s NET staking income on a 12x multiple – i.e. I treated KR1 as a zero-cost investment vehicle, offsetting its entire expense base against its estimated staking revenue & taxing it, to arrive at a +$15.5 million NAV adjustment for its staking operation/profits. But if we look at crypto purely in terms of yield, I’d obviously focus on staking REVENUE: Picking out the three main staking drivers (Polkadot, Cosmos & Kusama), their estimated staking revenue is $2.15M – at an 8.33% yield, that’s equivalent to a $25.8M principal value, nearly identical to their $26.6M value at the time. Except we live in a world of near-zero rates, where trillions of sovereign bonds trade with negative yields…so if you insist on applying a currency perspective, wouldn’t it be logical to perhaps presume/anticipate (for example) a 4% crypto yield (implying a $53.7M value for those three KR1 holdings), a 2% yield ($107M), or even a 1% yield ($215M)!?
In the end, we don’t need to argue, the proof will come…via the crypto market & its future trajectory! And you’ll note I did NOT actually adjust my KR1 NAV estimate to arrive at a fair value target price. Instead, I highlighted ALL of KR1’s intangible assets (inc. its staking activities), each of which has obviously contributed to its unique 120% NAV CAGR to date – noting the average/extreme multiples elsewhere in the listed crypto/blockchain sector, the tailwind of KR1’s staking net income today, and presuming it can continue delivering even a fraction of its returns to date, a 2.5 P/B multiple is a real possibility for KR1 (regardless of how you want to consider its staking revenue/profits), if/when more investors discover it.