Canaan Begins Process For Large U.S. IPO Attempt

Summary

• Canaan has filed to raise $400 million in a U.S. IPO, although the final figure may differ.
• The firm designs ASIC chips for cryptocurrency and AI applications.
• CAN has suffered from the severe fluctuations in the crypto industry and is seeking to diversify into AI chips.
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Quick Take

Canaan (NASDAQ:CAN) has filed to raise gross proceeds of up to $400 million from a U.S. IPO, according to an F-1 registration statement.

The firm provides cryptocurrency mining hardware and an edge computing AI chip.

CAN has been subject to the severe ups and downs of the cryptocurrency industry and doesn't have significant sales for its AI chips. Management says its AI development program is 'crucial' to its ability to diversify its revenue sources.

I'll provide an update when we learn more about the IPO's pricing and valuation assumptions.

Company & Technology

Huangzhou, China-based Canaan was founded in 2013 with an initial focus on developing ASIC applications for Bitcoin mining under the brand Avalon Miner and has since expanded its portfolio with the Kendryte K210 chip.

Management is headed by founder and CEO Nangeng Zhang, who was previously an assistant researcher at the Beijing Remote Sensing and Communication Technology Institution.

The company is the second-largest designer and manufacturer of Bitcoin mining hardware globally in terms of total computing power sold in H1 2019, accounting for 21.9% of the combined computing power of all the Bitcoin mining machines sold globally, as per data from Frost & Sullivan.

Kendryte K210, also referred to as 'Kendryte AI' is an Artificial Intelligence [AI] edge computing chip based on the Risk-V open-source hardware instruction set architecture that has been backed by companies like Alibaba (BABA), Google (GOOG) (GOOGL), Samsung (KRX:005930), Qualcomm (QCOM), and Antmicro.

Investors in Canaan have included Tunlan Investments, Jinjiang International, and Baopu Asset Management. Source: Crunchbase

Customer Acquisition

The company has an 'AI marketing' team and participates in industry associations, including Zhejiang Software Industry Association, the Zhejiang Blockchain Technology Application Association, the Chinese Private Technology Entrepreneur Association, the Hangzhou Association of Enterprises with Foreign Investment, and the China Communications Industry Association (IoT Application Branch)

Sales and marketing expenses as a percentage of revenue have been variable and more than doubled in the most recent reporting period, per the table below:

Selling	Expenses vs. Revenue
Period	Percentage
To June 30, 2019	2.9%
2018	1.4%
2017	1.6%

Click to enlarge

Source: Company registration statement

The sales & marketing efficiency rate, defined as how many dollars of additional new revenue generated by each dollar of sales & marketing spend, has fluctuated widely, as shown in the table below:

Selling	Efficiency Rate
Period	Multiple
To June 30, 2019	-202.9
2018	36.0

Click to enlarge

Source: Company registration statement

Market

According to a 2018 market research report by Technavio, the global cryptocurrency mining hardware market is projected to grow over $2.2 billion by 2022, representing a CAGR of 10% between 2018 and 2022.

The main factor driving forecast market growth is the profitability of cryptocurrency mining ventures.

Management says that in 2017, the ASIC hardware segment held the largest market share of 74% of the market and is projected to dominate the industry during the period, decreasing by only 3% through 2022, according to a Frost & Sullivan report.

Due to rapid IoT and 5G technology development, it is expected that the combined edge AI chips and cloud AI chips markets will grow at a CAGR of about 45.1% between 2018 and 2023.

The edge AI chip segment alone will register CAGR of about 62.1% as compared to a CAGR of approximately 22.3% for the cloud edge AI chip segment from 2018 to 2023.

Edge AI chips and cloud AI chips accounted for 43.9% and 56.1%, respectively, of the total AI chips market in 2018.

Financial Performance

CAN's recent financial results can be summarized as follows:

• Highly variable top-line revenue

• A sharp drop in gross profit and gross margin

• A swing to operating losses

• Fluctuating cash flow from operations

Below are relevant financial metrics derived from the firm's registration statement:

Total Revenue
Period	Total Revenue	% Variance vs. Prior
To June 30, 2019	$ 42,100,000	-85.3%
2018	$ 394,100,000	104.9%
2017	$ 192,367,647
Gross Profit (Loss)
Period	Gross Profit (Loss)	% Variance vs. Prior
To June 30, 2019	$ 1,600,000	-97.6%
2018	$ 74,000,000	-16.7%
2017	$ 88,882,353
Gross Margin
Period	Gross Margin
To June 30, 2019	3.80%
2018	18.78%
2017	46.20%
Operating Profit (Loss)
Period	Operating Profit (Loss)	Operating Margin
To June 30, 2019	$ (47,700,000)	-113.3%
2018	$ 19,400,000	4.9%
2017	$ 52,735,294	27.4%
Comprehensive Income (Loss)
Period	Comprehensive Income (Loss)
To June 30, 2019	$ (45,800,000)
2018	$ 8,300,000
2017	$ 55,264,706
Cash Flow From Operations
Period	Cash Flow From Operations
To June 30, 2019	$ 931,000
2018	$ (1,856,000)
2017	$ 13,411,618

Click to enlarge

Source: Company registration statement

As of June 30, 2019, the company had $55.5 million in cash and $91.4 million in total liabilities. (Unaudited, interim)

Free cash flow during the twelve months ended June 30, 2019, was a negative ($28.6 million).

IPO Details

CAN has filed to raise $400 million in gross proceeds from an IPO of ADSs representing underlying Class A shares.

Class B shareholders, who will be the Chairman and Chief Executive Officer, will be entitled to fifteen votes per share versus one vote per Class A share.

The S&P 500 Index no longer admits firms with multiple classes of stock into its index.

Per the firm's latest filing, the firm plans to use the net proceeds from the IPO as follows:

for research and development for ASICs related to AI algorithms and applications;

for research and development for ASICs related to blockchain algorithms and applications;

for expansion of our AI and blockchain business globally by making strategic investments and establishing overseas offices;

for supply chain optimization and repayment of debts incurred by us in connection with our reorganization; and

the balance of the net proceeds for general corporate purposes.

Management's presentation of the company roadshow is not yet available.

Listed underwriters of the IPO are Credit Suisse, Citigroup, China Renaissance, CMBI, Galaxy Digital Advisors, Huatai Securities, and Tiger Brokers.

Commentary

CAN is attempting to tap U.S. public markets for a large capital raise.

The firm's financials show the ravages of the widely fluctuating cryptocurrency mining markets in recent years.

In response to the highly variable crypto mining industry, management is pursuing a diversification strategy, trying to capitalize on its ASIC chip designing expertise to extend into AI chip making.

The market opportunity for AI (deep learning) chips is likely about the same as the crypto market, but enticing due to its smoother revenue prospects, at least in the short term.

The Canaan IPO is a risky proposition for two reasons: one, the crypto industry is highly volatile and two, the firm has limited experience or history in successfully designing and selling AI ASICs.

I'll provide an update when we learn more IPO details from management.

Expected IPO Pricing Date: To be announced.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.