Silvergate Capital (NYSE:SI) may be a stock that appears to be undervalued and offer a great opportunity for investors. However, a closer examination of the company and its recent activities suggest that it may be a stock best avoided by investors.
The company is a bank, regulated as such, and deals primarily in debt securities such as Treasury bonds and municipal bonds. However, it has also become a popular destination for deposits from companies in the crypto industry. As the crypto industry has suffered in recent months, Silvergate has seen a reduction in deposits, from $11 billion in September 2022 to $9.8 billion in mid-November. This has had a direct impact on the company’s balance sheet and income, as it has had to return the deposits to customers and sell the accompanying assets.
Silvergate has also been subject to legal risks and class action lawsuits due to its involvement with FTX, a crypto firm that has since gone bankrupt. There is a possibility that Silvergate could be subject to fines, legal costs and reputational damage from this case. On top of this, Silvergate also has the potential to see loan losses if the crypto industry continues to suffer, as it only lends against Bitcoin and does so conservatively.
The company has a market cap of $530 million and is trading at 2.9x estimated earnings and a broadly similar PE on trailing earnings of 3.0x. It is also trading at 0.39x book, which is incredibly cheap for a bank. However, it is not unreasonable to expect the shares to trade at 3x-4x their current value, if valuations were to normalize.
Silvergate has additional upside potential through the Silvergate Exchange Network, which allows their clients to easily move money to other clients at the bank, and Diem, a crypto payment solution that it has acquired for around $200 million. However, these potential sources of further upside depend on the survival of the crypto industry, which is looking increasingly unlikely.
The company also has two ways to play: investing in the equity of Silvergate or owning the preferred shares, which yield around 11% today and trade at around half their liquidation value of $25.
In conclusion, Silvergate Capital appears to be a stock that should be avoided by investors. The company is facing numerous legal and financial risks that could lead to further losses and shareholder value being dumped. On top of this, the company’s future prospects are dependent on the survival of the crypto industry, which looks increasingly unlikely. For these reasons, Silvergate may be a stock best avoided by investors.