Core Scientific: Sell, Sell, Sell

Summary

• CORZ filed for bankruptcy protection.
• The company has a plan to potentially operate after debt restructuring.
• But the plan requires BTC spot pricing to never fall again, and is going to massively dilute current shareholders (at best).
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Vertigo3d

The sustained downturn in risk assets in 2022 has wreaked havoc on a wide variety of stocks and other financial instruments. One of those is certainly Bitcoin (BTC-USD), which is down 64% this year, and that has destroyed the share prices of the companies that (attempt to) make their living via mining the world’s largest digital currency. I’m not aware of a Bitcoin miner with a higher share price this year, but the declines of some have certainly been worse than others.

In what has become the poster child for the downfall of crypto mining, Core Scientific (CORZ) has filed for bankruptcy protection. Core is the largest crypto miner by capacity, so it theoretically should have had all the advantages over competitors. However, far too much leverage, combined with a downturn in Bitcoin prices, led to its demise and a share price of less than a dime.

The last time I covered Core, it was the “sell” portion of a Bitcoin miner pairs trade. The stock was $2.02 at the time, and has fallen 95% since then. I noted at the time that Core was far too leveraged, and the idea was that if there was going to be a prolonged bear market in Bitcoin (turns out that’s what we’ve gotten), those with too much leverage would suffer most. Here we are, and Core has now filed for bankruptcy protections.

So what do we do now? Before we take a look at Core’s situation, I want to stress that a stock with a $33 million market cap, a share price of 9 or 10 cents, and a recent bankruptcy filing is subject to extreme volatility. The very existence of Core is currently up for grabs, as we’ll see below, and that means there’s a high likelihood of the current equity value going to zero, or close to it.

The headline of what I’m about to show you is that I do not think it is prudent to take any positions in this stock given the volatility. If you’ve been shorting Core, you should congratulate yourself, take your profits, and move on. On the other side, I cannot see how this will work out for equity holders that pay even 10 cents per share. As far as I can tell, Core is either going to actually go out of business if Bitcoin continues to fall, or at best, current equity holders will be so diluted that even 10 cents will look expensive. With all of this in mind, I’ll reiterate my suggestion that you think long and hard before doing anything with this stock.

I always start my analysis with a chart, as I primarily use technical analysis for my own trading. However, with a bankruptcy filing in place, the chart is meaningless. We’ll therefore skip that and move right to the financing discussion, as that’s far more relevant in this case.

How did we get here?

The short answer is that Core financed itself as though the good times would never end in terms of Bitcoin pricing. The company wanted to become the largest Bitcoin miner, and it has done so. However, the cost of doing that has proven too much to bear, and we have a bankruptcy filing.

The economics of Bitcoin mining have deteriorated significantly in 2022, which I lay out in the linked article above from June. I won’t waste the space here to go through it again but suffice it to say that while the price of Bitcoin has fallen and fallen and fallen, the difficult of getting Bitcoin has gone higher and higher and higher. That’s a very bad combination, and it has led to the share prices of Bitcoin miners being decimated.

Core posted an investor update on its bankruptcy filing in the week before Christmas, which provides a fairly detailed roadmap of what the company believes is going to occur going forward.

Investor presentation

You can give this a read but basically, the company’s bankruptcy filing is because it can no longer make debt servicing payments to its lenders. That means it’s in default, and that means it needs a bankruptcy filing. There was far too much miner expansion (financed by debt) in the face of higher difficulty to mine and lower Bitcoin prices. Combine those factors for months on end, and you have an insolvent company.

Now, the company has a debtor-in-possession, or DIP, facility of $75 million in place. Existing holders of convertible notes will turn their debt into equity in the reorganized company, and holders of general unsecured claims will get common stock and warrants in the reorganized company. What that means is that creditors of various types are going to get “significant” portions of equity in the reorganized company. In practice, that means current equity holders will almost certainly be diluted to the point where even if one owned all outstanding shares of Core today, that investor would have a small minority stake in the company after reorganization. Let that sink in.

This is the risk of buying a company that is in the process of reorganizing; current shareholders are going to be diluted enormously as the company reorganizes its debt into equity. Management says the cash generated from operations, as well as the debt-for-equity swaps, should provide enough cash to emerge from bankruptcy some time in 2023. But in no way does that mean today’s share price is some sort of bargain; the company has said current investors are going to be diluted enormously to rid the company’s balance sheet of the unsustainable amount of debt it possesses.

Core says, for what it’s worth, that if it were debt-free, its miners would be “significantly” cash flow positive. That implies that if this plan works, Core could theoretically fund its own operations one day. We’ll see, but I’ll say again that this does not mean current equity holders would see a benefit by riding out the bankruptcy process.

Capital structure woes

Obviously, the company’s bankruptcy filing means its capital structure was, let’s say, suboptimal. Let’s take a look at the updated capital structure from the company’s filing.

Investor presentation

There is just $30 million of cash and equivalents on the balance sheet, and $908 million of debt of various types. One thing for those looking to “bargain hunt” with the current equity to notice, is that there is $552 million of convertible notes that the company has told us are going to be converted into new equity. The current market cap is $33 million, so you can do the math on what equity holders are likely to have at the end of this. The ultimate amount of equity these convertible note holders receives is up for grabs, but it’s unlikely to be the full face value. Even so, a 50% discount would still be $226 million, or about seven times the current market cap. This is why I was urging extreme caution when trying to buy this stock; people that buy today are likely to be left with little to nothing after the restructuring.

For what it’s worth, Core says it will not sell any more equipment, and that it should be virtually debt-free after the restructuring. Those things should allow it to operate itself with cash generated from mining and selling Bitcoins. That argues that the company could survive in some form after the restructuring. That’s good news for employees that want to keep their jobs, but that does not change the outlook for buying the stock today.

As I see it, buyers of the stock today have two possible outcomes. Either the restructuring doesn’t work and the company goes out of business, or the restructuring works and equity holders are diluted six or eight or 12 times the current float. The net outcome for the current stock is almost the same in either case, and that is extremely poor returns from the current share price.

The company provided a handy 13-week cash flow forecast, the assumptions of which you can see below.

Investor presentation

Now, with those in mind, we can look at the actual cash inflows and outlays to get a sense of what Core thinks is on the near-term horizon. Apologies for the eye chart; you can click to make it larger.

Investor presentation

The company expects ~$10 million in monthly hosting revenues, and ~$25 million in monthly Bitcoin revenue from coins mined and sold. The assumed price is $15k per coin, so there’s upside and downside risk to this forecast depending upon what happens with spot prices.

Importantly, net cash flow is still expected to be negative, so this is why Core filed for bankruptcy. Power and operating costs alone eat up essentially all of its revenue.

Looking further out, here’s what Core thinks it can achieve after restructuring.

Investor presentation

It expects something like 65 BTC mined each day, which would equate to about $1.1 million of daily revenue. It also expects a flat number of miners deployed, as well as essentially flat earnings for the foreseeable future. Now, just like the cash flow forecast, these numbers have upside and downside risk from BTC spot prices. If the bear market persists and BTC goes to $10k or something like that, we’ll see huge risk to these numbers. If it goes back to $30k or $40k, Core stands to do very well with its reorganized structure. Regardless, keep in mind that current equity holders will have very little (if any) participation in any of this under the terms of the restructuring deal.

Finally, let’s take a look at the liquidity schedule going forward. Again, click to enlarge, or go to page 34 in the investor presentation to view for yourself.

Investor presentation

The bottom line here is that at $16.5k in Bitcoin price, Core believes it can just scrape by in terms of operating sustainably going forward. It expects it can produce a run rate of $50 million to $55 million in total monthly revenue longer term, but that operating costs will be roughly the same. I’ll invite those looking to buy this stock to zoom in on the stock-based compensation line as well; the company is forecasting ~$5 million per month in SBC going forward indefinitely. Remember the current market cap is $33 million.

The bottom line

If you’re still with me, it means you’ve seen loud and clear that I do not think buying this stock is in any form a good idea. Based upon what I see, it is my belief that it is quite likely that this stock is going to trade very close to zero once the restructuring plan comes to fruition, or potentially even before that. I simply don’t see a path forward for current buyers of the stock, and I certainly recommend that if you own this for some reason, you take the money today, as quickly as you can, and never look back.

I DO NOT condone trying to short this stock, even though I’m saying it is likely to lose most or all of its current value. If you could even find someone to lend you shares, the costs of doing so, and the risk of a short-term squeeze higher are far too great for the reward.

Core has the chance to emerge from this as a company that can actually fund itself going forward. This is particularly true if BTC spot pricing rises significantly. The opposite is true as well, if BTC spot pricing falls further, Core may go out of business even after restructuring.

If you’re looking to own a piece of the new company, I strongly suggest you wait until the reorganization is done, and look to purchase the “new” company. Buyers today are going to be diluted into oblivion, according to the plan, and I therefore think it’s best to just stay away.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.