Putting a price on Ripple equity

Disclaimer: I own a bunch of Ripple common stock thanks to being an employee there for nearly five years, so I’m absolutely talking my book with this article.

Ripple’s common stock has always traded at a significant discount to the value of the company’s assets. In this article, I’m gonna break down how to value Ripple’s stock; what it might be worth on a sum-of-parts basis; and what it might be worth in various scenarios once the SEC lawsuit is resolved.

This article is not going to try to put a value on XRP. The value of Ripple’s lump of XRP is an input here, not an output. And don’t expect any “XRP to da moon!” sentiments or rocket emojis; save that for Twitter.

With that out of the way… what is Ripple’s stock worth?

TL;DR

1. Ripple common stock is currently trading at $28/share;
2. Valuing it a couple of different ways (sum-of-parts and a scenario analysis) justifies a valuation between $145 and $210/share;
3. The discount exists because the secondary market is illiquid and lopsided (most participants are employees seeking exit liquidity);
4. The market seems to be overpricing the risk of an unfavourable outcome with the SEC;
5. The most likely catalyst for a re-rating would be a decision in the SEC case, currently scheduled for 1H 2023; alternatively, Ripple has capacity to increase the pace and price of its buybacks.

What’s the price?

If you think US equities are fragmented, you should see private-company stock. If you think Singaporean small-caps are illiquid, you should see private-company stock. But in the absence of Reg NMS for private companies, the wisps of data from the second-market brokers are the best we’ve got in terms of establishing a market price for Ripple stock.

So here’s the most recent activity, from talking to private-company brokers:

• The series B preferred shares are currently being offered at a bit over $29;
• The class-A common stock was recently (within the last month) offered and paid at $28;
• The class-A common stock is actively bid at $27 in multiple brokers.

The spread between the preferred and common shares is covered in more detail below, but as a starting point, the series B preferred should be worth less than a dollar more than the common. So we have a relatively clean market, 27 bid 29 offered and it’s probably more bid than offered. But what should the shares be worth?

A side note: capital structure

Ripple has five classes of shares outstanding¹:

• Series A prefs and series B prefs: these are from the 2014 and 2016 funding rounds. They have fairly standard liquidation preferences (second in line behind the series C), but the prices for those liquidation preferences are so far out of the money (90 cents for the series A, and $1.91 for the series B) that they make basically no difference to the price. They’re the equivalent of a zero-delta option offered at a quarter of a tick.
• Series C prefs: these were mostly issued to Tetragon Financial, which led the late-2019 series C round; a couple of other early investors rolled some of their series A and B prefs into the C-round. The series C prefs have a first liquidation preference at $61/share, a 3.75% PIK dividend², and, most unusually, an embedded put option that allows them to be sold back to Ripple at their original $61/share price, if XRP is found to be a security on a going-forward basis³.
• Class B common stock: 10x voting power common stock, which converts to class A common stock on an IPO.
• Class A common stock: this is what gets handed out to employees (i.e. me). No liquidation prefs; no PIK divvies; you’re along for the ride and you’ll like it.

As of mid-2022, the fully-diluted share count across all the share classes is, very roughly, 165 million shares.

Valuing Ripple on a sum-of-the-parts basis

Sum-of-the-parts valuations are useless and nonsensical, but heyyooo we’re gonna do one anyway, because Ripple’s balance sheet is wildly different from what you’d expect to see at any other tech company. Unlike most tech companies, Ripple is flush with assets, and valuation is mostly driven by the marks applied to those assets.

There are four main parts to Ripple’s balance sheet:

• The enterprise payments-network business (aka RippleNet);
• Its investments in other companies;
• A billion dollars of cash⁴;
• …and, most importantly by literally an order of magnitude, its lump of XRP.

It’s surprisingly clarifying if you think of Ripple as an crypto closed-end fund with an enterprise software business attached to it, because the size of Ripple’s XRP lump dwarfs the value of anything else on their balance sheet⁵.

Going through each of these line items in order:

• RippleNet: Ripple doesn’t break out revenue for RippleNet, but the Q4 2021 report mentions that RippleNet’s volume run rate is now in excess of $10 billion annually. An order-of-magnitude comp would be Rapyd, which raised in mid-2021 at a price equivalent about 45% of its ARR transaction volume; even cutting that valuation by 75% to reflect the selloff in listed high-growth tech valuations since mid-2021 would value the RippleNet business alone at $1.1 billion;
• Investments:
  • Coil: Ripple owns a minority stake in Coil and granted it a billion XRP. There’s no public disclosure of the size of Ripple’s stake in Coil, though, so I’m not going to attempt to estimate its value;
  • Tranglo: Ripple owns 40% of Malaysian payments company Tranglo. Tranglo discloses transaction volumes of over $1.5bn USD/yr; using the Rapyd rule-of-thumb that a payments company could raise at a valuation of 11.25% of its annual payments volume, this would value Ripple’s Tranglo stake at about $65 million;
  • Bitso: Ripple led their 2019 round. Though the valuation and size of the transaction weren’t disclosed, if we guess that Ripple owns 4% of Bitso, apply that to the $2.2bn valuation of Bitso’s May 2021 funding round, and cut that by 50% (using Coinbase’s stock price since May 2021 as a benchmark), Ripple’s Bitso stake would be valued at about $40 million.
  • These are Ripple’s largest known investments in other companies. They’ve made other investments (for example, they participated in PDAX’s Series B round which closed in February 2022), but there’s no evidence to suggest any other large investments missing from this valuation. (Ripple did launch a $100mio fund in conjunction with Forte in 2019, but there wasn’t any evidence of this coming with an equity investment.)
• A billion dollars of cash, see above;
• And about 55 billion XRP.

Let’s Talk About The XRP

Mike Novogratz has tweeted about it. SBF has tweeted about it. What’s the deal with Ripple’s XRP holdings?

Here’s the deal.

Ripple owns, very roughly, about 55 billion XRP (as of April 2022). Contra SBF, it’s not “unissued”; it’s held in programmatic escrow on the XRP Ledger. The escrow was created in late 2017; before that, Ripple held its XRP in regular on-ledger wallets. Each month, one billion XRP is released from escrow, and each month, the vast majority is returned to programmatic escrow for another fifty-some months. (The escrow returns have never been less than 700 million XRP a month out of the 1 billion released each month; the average escrow return has been 827 million XRP per month.)

This is all publicly disclosed; it’s all visible on the XRP ledger. You can see the billions of XRP that Ripple owns, and you can value it however you like. But no matter which way you value it, it vastly outweighs any other asset on Ripple’s balance sheet.

At the time of writing, XRP’s trading at about 70 US cents per. Ripple carries the XRP on its balance sheet at near enough to zero, because it was gifted the XRP back when the company was created. So if and when it sells the XRP, it’s going to pay tax on those sales at the prevailing corporate tax rate. For the purposes of this piece, let’s say that’s 23%.

(Real ones will recognize this as the problem that stumped Yahoo when it tried to cash out of its low-basis stakes in Alibaba and Yahoo Japan. Yahoo couldn’t solve it, despite some delightfully creative solutioning from Matt Levine; Altaba, the rump CEF that held Yahoo’s legacy assets after the sale of the operating business to Verizon, ended up selling its stakes and handing out the cash to shareholders as a fully taxable return-of-capital.)

The easy way to go would be to assume that Ripple can sell all its XRP at the current price, without moving the market too much. (This wouldn’t be an unreasonable assertion! XRP is up over the last few years despite payments companies selling 100-200 million XRP a month into the market as part of their ODL sales.) Another option would be to apply an illiquidity discount, though this discount would be captured by the CEF discount described below.

Estimating a CEF discount

Call it a CEF discount, a conglomerate discount, whatever; it wouldn’t be surprising for Ripple to trade at a discount to the value of its assets. We’ve established that Ripple’s value is mostly driven by the value of the XRP on its balance sheet; so the closest comparable to estimate the discount would be Grayscale’s lineup of listed crypto CEFs.

The discount range of these funds is wide, and varies wildly based on sentiment. But at the moment:

• GXLM trades roughly flat to its NAV;
• GBTC, ETHE, and GDLC (the diversified fund) trade at a 23-28% discount to their NAV; and,
• LTCN trades at a 43% discount to its NAV.

The largest funds tend to cluster around a 25% discount to NAV, which would be a fair read-across to Ripple’s stock.

Adding It All Up

So we have:

• 55 billion XRP, valued at $38.5 billon (with XRPUSD at 70 cents);
• Minus $8.8 billion of tax liability when they do sell the XRP (23% of $38.5 billion);
• Plus about a billion dollars of cash;
• Plus the RippleNet business, valued at $1.1 billion;
• Plus the VC stakes that we know about, valued at roughly $100mio;
• And no debt (depending on how you count the series C prefs, which do have a coupon but have been mostly bought back)

Put it all together and it gets you to about 32 billion dollars of net asset value. Ripple has about 162 million shares outstanding across the whole capital structure, so a handy rule of thumb is that the after-tax net asset backing of each share is roughly 260 XRP, plus six dollars from RippleNet, plus six dollars of cash.

Value the XRP at 70 cents per, add a 25% CEF discount, and you get to a valuation for Ripple of around $145 per share.

(Alternatively: if you strip out the cash, buying Ripple stock at its current price of $28 is the equivalent of buying XRP at 8.5 cents and getting the RippleNet business thrown in for free.)

So why is the stock trading at 28?

Heck if I know.

Actually there’s a couple of decent reasons:

1. A risk premium and convenience-yield discount. The stock is illiquid once you’re in; and if you’re in, you’re probably going to be holding it through the outcome of SEC v Ripple. You’d quite rightly demand a discount to your estimated value in return for for taking that added risk.
2. The secondary market for the common is hugely lopsided: there’s axed sellers (ex-employees who need liquidity on what’s probably the biggest asset in their portfolios) and not a lot of natural buyers. The primary market for private company equity is extremely active (it’s venture capital!), but the secondary market is not (unless you count private equity, which almost never plays in the small ticket sizes that secondary-market brokers trade in.)

Ripple itself has been a buyer in the secondary markets (they’ve been exercising their right of first refusal recently on trades below about $20/share). In fact, Ripple’s shown strong capital and buyback discipline: since the 2017 crypto summer, Ripple has methodically bought back its stock and reduced the outstanding share count. The exception—the series C issuance—even helps to prove the rule: Ripple raised its Series C when XRP was twenty cents, and then bought it back two years later and 50% higher… but in that time, the value of the XRP on Ripple’s balance sheet had 3.5x-ed, making it economical for Ripple to buy back the series C.

Scenario analysis: what happens after SEC v Ripple?

Now that we have a framework for valuing Ripple’s equity, we can extend that framework to ask “what do we expect to happen to the equity given possible outcomes of the SEC v Ripple lawsuit?”. Setting up a framework for this valuation will let us make order-of-magnitude valuation estimates, and most importantly it’ll let us ask “what are the implied probabilities baked into the current price? Are those too high, too low, just right…?”.

You don’t need to have a view on the correctness or otherwise of each side’s arguments to use this framework; all that matters is the probability of each outcome. And while the range of possible outcomes is granular, there are four broad buckets that the outcome could fall into:

1. The court finds that XRP was and still is a security; and Ripple is forced to disgorge all its sale proceeds and stop using XRP globally;
2. The court finds that XRP was and still is a security under US law; Ripple has to disgorge the proceeds of its US-only sales, but can continue its business offshore;
3. The court finds that XRP was a security in the past, but isn’t a security now; Ripple has to disgorge the proceeds of its sales up to a certain time in the past, and can continue to use XRP in its business globally;
4. The court finds that XRP was never a security, or the fair notice defence holds; Ripple doesn’t have to disgorge, and can continue to use XRP in its business globally.

What would happen to the price of XRP, and the value of Ripple, in each of those situations? Our starting point would be the lawsuit filing: between December 18th and 27th of 2020 (the lawsuit was filed on December 20th), XRP dropped by around 60% (from 51 cents to 21 cents). A finding that XRP wasn’t a security going forward would in theory lead to that drop being unwound (a 2.5x spike in the price of XRP); an adverse finding is harder to estimate, but another 60% drop would be a good benchmark given that further exchanges worldwide would probably delist XRP.

Putting these valuations together for each scenario, and using our rule of thumb and CEF discount from above:

1. XRP drops by 60% to 0.28; Ripple has to pay over a billion dollars in disgorgement and can’t sell more XRP. The company is a zero;
2. XRP drops by 60% to 0.28; Ripple has to pay half a billion dollars in disgorgement, but can continue to sell XRP. Each share is worth 260 * 0.28 + 6 (from RippleNet) + 3 (from cash after disgorgement), minus a 25% CEF discount = $61
3. XRP rises by 2.5x to $1.75; Ripple has to pay $250mio in disgorgement. The RippleNet business doubles in valuation on higher client growth amid regulatory certainty. Each share is worth (260 * 1.75 + 12 + 4.5) * (1 - 25%) = $353
4. XRP rises by 2.5x to $1.75; Ripple pays no disgorgement; the RippleNet business triples; and thoughtful capital management by Ripple compresses the CEF discount to 10%. Each share is worth (260 * 1.75 + 18 + 6) * 0.9 = $430.

While it’s the wildest of wild guesses, equally weighting each of these four outcomes gives a probability-weighted value of $211/share.

Interestingly, even in Scenario 2—a Ripple that can no longer operate in the USA, has to pay an SEC-record half a billion dollars of disgorgement, and has its primary asset cut in half *again*—the company is still worth over $60/share. That means that even if we price in zero chance of Ripple getting a favorable finding on the non-security status of XRP, the current market price of Ripple stock implies a 55% chance that the company will be zeroed. The question for buyers is whether they think that market-implied probability—55% chance of a zero, 45% chance of an unfavourable outcome, zero chance of a favorable outcome—is right or wrong.

Catalysts

After asking “what should the stock be worth”, the next question is “is there some event that’ll make it re-rate from its current price to what it should be worth?”.

The most obvious driver for a re-rating of the stock would be a public offering, which would open the company up to a much broader base of buyers and analysts. Ripple has said in the past that they’re aiming to file for an IPO as soon as the SEC lawsuit is resolved—which, based on the recently-announced schedule, would happen in the first half of 2023 if the case is resolved at summary judgment.

An alternative, and faster, driver for a re-rating would be if Ripple becomes more aggressive in buying back its stock and exercising its right of first refusal on secondary-market sales. Brokers have indicated that Ripple is ROFR-ing trades below $20 in the common stock; this is far below the value of Ripple’s assets, and secondary-market volumes are low enough that Ripple could significantly raise its ROFR level without spending too much of its billion-dollar-plus cash holdings. Ripple’s buyback of the series C preferred shares at $92—spending over $200 million in the process—indicates that it has the capacity to conduct significant buybacks, and raise the price of its existing ROFRs, should it choose to do so.

In Conclusion, A Land Of Contrasts

A sum-of-parts Ripple valuation comes in at about $12 + 260 XRP per share, even including tax on the XRP; at today’s prices, and applying a 25% CEF discount, that’s about $145.

Scenario-analysis valuations are necessarily fuzzy because they involve estimating unobservable probabilities. But a scenario-analysis valuation of Ripple stock after the SEC v Ripple case is resolved gives a probability-weighted value of around $211/share.

But the stock is trading at 28—an 86-87% discount to both valuation estimates. The market is extremely pessimistic about Ripple’s odds of success, and even a partially successful resolution to the lawsuit would leave the stock significantly higher than it is today.