- Riot makes use of blockchain technology to mine bitcoins.
- The company has invested heavily in mining equipment.
- However, one of its competitors has invested more aggressively for growth.
- Still, given its higher productive efficiency, amid favorable demand-supply dynamics, Riot deserves higher valuations.
- Most importantly, investors require some insights into the bitcoin ecosystem including the mining part, in view of high volatility.
After bitcoin's hugely successful performance in recent months, which saw the cryptocurrency cross the $57K level on February 23, 2021, there are questions whether the upside can continue, after the dip. There is also an interrogation mark as to whether all the good news have already been priced in, or there may be a fallback as observed at the end of 2017, when there was a 100% drop in the value of the digital currency in a matter of just two months.
Figure 1: Bitcoin value evolution
Closely associated with bitcoin's value are the stock prices of miners which produce it, just like those extracting gold from the earth's crust. Riot Blockchain (NASDAQ:RIOT) is one of several bitcoin miners, but in contrast to those which have to dig out gold from the earth's crust, it uses computing power together with blockchain technology to produce cryptos.
Bitcoin mining financials
Just like for gold, bitcoin mining remains a highly capital-intensive enterprise. Thus, Riot disbursed $35 million to purchase 15,000 Antminers of the S19j Pro model from Bitmain at the end of 2020. The ultimate goal of this heavy investment, combined with the company's prior mining equipment purchases, is to significantly increase its estimated bitcoin mining hash rate from 2.3 EH/s to 3.8 EH/s or by 65%.
The mining hash rate is the computational power that is used to mine and process blockchain transactions and these are on the high side compared to more commonly used software applications.
Figure 2: The growth path
Continued growth through expanding mining hash rate is key to make its presence in the mining community significant, namely by being the first to solve "blocks of transactions", but operating on a cost-effective basis is another important parameter too. This is possible through the Antminer 19 series which offers outstanding hash rates and power efficiency.
Diving into financials, mining gear purchases continue to be funded using available working capital with Riot bearing no long-term debt as depicted in the balance sheet. However, the company's aggregate revenues for the last three quarters remain low, at only $6.8 million, in view of the high capital expenditures totaling $17.7 million.
To address the shortfall and at the same time benefit from investment opportunities in bitcoin mining, Riot has various options, "including selling common stock, preferred stock, warrants, units or a combination of these securities for an aggregate initial offering price of up to $200,000,000."
Figure 3: Balance sheet and income statement
Source: Seeking Alpha
Apart from the investment required to purchase the mining machines, other expenses relate to energy costs. Indeed, to operate the 37,640 Antminers that Riot will have at its disposal, the electricity bill will have to cover 120 megawatts, for all devices. In comparison, the NSA's newest datacenter in Utah consumes only about 90 megawatts of energy with its four separate 25,000 square foot data halls capable of holding thousands of servers.
Thus, mining giants need to have enough space for the installation of equipment too. To prevent space from becoming a concern, Riot has managed to clinch a co-location agreement with Coinmint. This agreement should improve Riot's productive efficiency and mining output as Coinmint operates one of the largest digital currency data centers in the world, signifying better BTC production costs compared to the miner's own Oklahoma City operations.
Additionally, Riot now has a clear path forward to continue expanding its total hashing capacity, especially at a time when supply of mining hardware has become increasingly scarce.
Competition and volatility
Looking at the bitcoin mining industry, most miners choose to sell mined assets in order to reinvest further to increase production capacity. Hence, along the same lines as Riot, Marathon Digital Holdings (MARA), which I covered last month as part of my thesis on the Amplify Transformational Data Sharing ETF (BLOK), has also ordered mining equipment last December through entering into a contract with Bitmain to purchase 70,000 Antminer S-19 devices.
Once all miners are fully deployed, the company's mining fleet will consist of more than 103,000 miners capable of producing 10.36 EH/s, or about 2.5 times Riot's 3.8 EH/s hash rate.
However, in addition to growth, there is also the efficiency metric to consider.
In this respect, there are some indications that Riot has been working more aggressively on this metric since the May 2020 halving event, when the mining reward (revenue for producing one block) was reduced from 12.5 bitcoins per block to 6.25. The event directly affected mining revenues with operators becoming under pressure to upgrade to more efficient equipment and cheaper power.
By advancing on these two fronts with the most energy-efficient miners available, Riot has established a more strategically advantageous position relative to the competition.
Consequently, while Marathon exhibits much better growth than Riot, it is the latter's gross margins which are superior, highlighting significantly better productive efficiency.
Figure 4: Comparison with a peer
Source: Seeking Alpha
While some may opt for higher growth, I would prefer a miner which is more focused on profitability, especially when considering that the crypto market tends to be very volatile and the next halving event will be in 2024.
In this case, there is no shortage of publicly traded cryptocurrency stocks that rode bitcoin's astronomical rise, translating into big gains of their own. Also, Tesla's (TSLA) Elon Musk has just added to the volatility with its purchase of $1.5 billion worth of bitcoins.
This means that those who are new to digital currencies should be prepared for an even higher level of volatility, this time caused by the Tesla's CEO's emotions and whims.
On a positive note, to counteract feelings, there is the cool efficiency of ARK's Cathie Wood, with significant investments in blockchain and Tesla itself.
Valuations and key takeaways
Now, the fact that ARK Fintech Innovative ETF (ARKF) holds bitcoin plays is significant and this brings us to the main differentiator between 2017-2018 and 2020-2021: the fact that the virtual currency is supported by large investment funds and some of the world's largest companies. For this matter, institutional investors' interest marked a turning point for cryptos in 2020.
Before this, IT companies like publicly listed MicroStrategy (NASDAQ: MSTR) and other less known names invested large sums of money in bitcoin, mainly to shore up their balance sheets. This investment move was followed by Square (SQ), a provider of payment solutions. More importantly, both these companies have incremented their original bitcoin investments, demonstrating trust in digital currency.
Pursuing further, bitcoin's vertiginous rise on October 21, 2020, coincided with online payment giant PayPal (PYPL) announcing a service to buy, hold and sell cryptocurrencies. This move is really important as unlike MicroStrategy and Square, which focus on storing bitcoin for its value, PayPal's intent is more on the exchange side. Thus, it launched a service in October enabling customers to buy, hold and sell cryptocurrency directly from their PayPal accounts.
Equally important, from the transaction perspective, PayPal plans to increase cryptocurrency's utility by making it available as a funding source for purchases at all of its merchants' locations worldwide, which number 26 million.
Thinking aloud, wider adoption of the digital currency as a medium of exchange and for carrying out transactions, are both helping those which apply blockchain technology to produce bitcoins, like Riot.
Thus, Riot's shares have soared over 4K% in the past year, bestowing a $2.9 billion valuation on the company, up from $1.7 billion at the end of January. But digging a bit deeper, one finds that this is even higher than bitcoin's own appreciation of over 450%.
Figure 5: Price performance comparison: Riot, Bitcoin index and Marathon
Strikingly, the market is pricing miners much higher than the value of bitcoin itself.
In order to gain further insight into the reason for this, I consider a parallel with gold miners whose business model is based on using the assets buried in the ground, but with no precise idea as to how much of the metal lies in a given deposit, until extraction. As a result, the value of a mining stock generally trends the market value of its reserves.
In the case of bitcoin, speaking in relative terms, the deposit or reserve size is more limited than gold, as there will never be more than 21 million bitcoins which can be mined, with the number of new ones created being halved every four years until 2140. Moreover, Riot's business model does more than just rely on sustained bitcoin euphoria. It is also driven by efficient product creation.
Hence, looking at profitability and revenue per share metrics, the trailing EV/Sales metric at 366 (figure 4) is on the low side compared to Marathon's 1,413 even if the latter is growing seven times faster. Thus, a share price of $75-80 can be targeted for Riot by conservatively raising valuations to the 550 level (366 x 1.5).
Also, Riot's current revenue levels are 4 times higher.
Finally, further bitcoin ascension should be fueled by increasing demand driven by more widespread usage not being able to be met by the supply side, simply due to limited availability of mining gear.
This article was written by
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