• Riot Platforms’ shares have surged nearly 20% since July due to Bitcoin’s rise, but I remain bearish, citing overvaluation and risky debt-financed Bitcoin purchases.
• Riot’s core Bitcoin mining operation is unprofitable, and their new debt strategy to buy Bitcoin mirrors MicroStrategy but lacks a sustainable business model.
• Post-halving, Riot’s gross margins have declined, and their valuation metrics are significantly higher than sector medians, signaling potential 68.73% downside.
• Despite Bitcoin’s bullish outlook, Riot’s continued losses and expensive valuation make it a strong sell; their business model is unsustainable.

Co-Authored by Noah Cox and Brock Heilig

Investment Thesis

While Riot Platforms (NASDAQ:RIOT)’s shares are up nearly 20% since the last time I wrote on the stock, this doesn’t mean I have turned bullish on the crypto miner. The stock is nearing $12.50 per share after being as low as $6.36 earlier this year and $10.80 as of just a few days ago (December 10).

A big driver behind the increase in the company’s shares has been the rise of Bitcoin.

While Bitcoin has gone up in price, I continue to believe that shares are overvalued on multiple metrics. The company recently appears to have embarked on a risky strategy of borrowing money (via convertible senior notes) to purchase more Bitcoin. While I already was bearish on the company, I certainly believe this is not a good idea (for both shareholders and for corporate operations).

I do not believe that the MicroStrategy-esque plan of borrowing to buy Bitcoin will work out for them in the long run. Their core bitcoin mining operation loses money (in dollars) and erodes any long run Bitcoin potential. This is a huge drag on the capital structure (in my opinion). Borrowing more money makes the company more levered. I don’t like it.

With this, I think shares continue to be a strong sell.

Why I’m Doing Follow Up Coverage

A big reason why I was bearish over the summer during my previous coverage was due to Riot’s operating performance since the Bitcoin halving from April. At the time, this had not resulted in a strong, bullish outcome for Riot mining.

For those who do not know what the halving event is, this is a periodic event (every 4 years) where the amount of reward (Bitcoin) miners receive is cut in half.

This halving happens every time 210,000 Bitcoin blocks are mined. When Bitcoin miners’ pay is cut in half, it typically results in a major shift in Bitcoin pricing, which many times later ends up marking a new all-time high for the crypto currency.

In the recent halving that took place in April, the reward for mining a block fell from 6.25 Bitcoin down to just 3.125 Bitcoin. In 2009 (right as the cryptocurrency was launched), the reward for mining a block was 50 Bitcoin.

Basically, what made me so skeptical during my last coverage in July was that each Bitcoin miner Riot owns now has to work twice as hard to produce the same amount of Bitcoin. Or, for the same effort as before, they now only receive half as much payment.

Ultimately, this halving led to (at the time) a 45% year-over-year decrease in Riot Platforms’ Bitcoin production. I just don’t believe investing in a Bitcoin miner is nearly as lucrative as simply investing in Bitcoin itself.

With losses continuing in their mining division, a big driver for the run up in shares for Riot Platforms has been the price of Bitcoin itself. Bitcoin is up roughly 60% since the summer. Riot Platforms is only up ~20%. In essence, the market does not see the company that is adding more Bitcoin to its balance sheet daily (thanks to mining) as a more superior investment than the underlying asset. I think that’s telling.

Now that Riot Platforms is employing a MicroStrategy-esque debt financing strategy, I wanted to go in-depth and explain why I don’t believe this will work for them.

Why Their Plan Won’t Work

A big reason why this won’t work for Riot Platforms has to be because of the core analysis of the business. Last quarter alone, Riot lost $154.4 million, with a big part of this coming from the depreciation of GPUs that are mining Bitcoin.

The biggest reason for Riot’s struggles is this: Riot’s gross margin is declining post-halving.

To offset this, Riot is hoping to employ Microstrategy (MSTR)’s strategy or borrowing funds to put Bitcoin on the company’s balance sheet. Riot’s hope is that these financing projects will allow them to purchase Bitcoin and drive shares to trade at a premium to their net asset value. Shares currently trade for less than 1x book on a forward basis.

However, the main difference between MicroStrategy and Riot’s business is that MicroStrategy’s core business is a software business. This core business was actually profitable last quarter (albeit slightly).

Riot’s core business is the actual mining of Bitcoin.

So the main issue for Riot is that when the company borrows money in the open market to invest in Bitcoin, you’re buying Bitcoin right at the spot price.

However, they are net-losing money in this situation because the total cost of mining Bitcoin (including overhead for Riot) is higher than the proceeds they could receive for selling these mined Bitcoin right now.

What this means is that, over the long run, investors who are buying shares in hope of Bitcoin bull run a need to realize that the shares are still denominated in dollars. And in dollars, the company is losing money. So, for the company’s shares to make sense, the price of each Bitcoin would need to rise in the first year faster than the corresponding loss of mining the Bitcoin. I am bullish in the long run on Bitcoin, but every asset has its down year. For Riot, this could be a major issue.

Valuation

When looking at Riot’s valuation metrics, there are multiple categories where shares are significantly more expensive than the sector median.

For example, when looking at Riot’s TTM GAAP P/E, Seeking Alpha gives the company a grade of a D- in this metric.

The reason for the poor grade is simple. Riot’s TTM GAAP P/E is incredibly high at 232.35. This is a concerning 629.61% higher than the sector median of just 31.85.

On a forward price-to-sales basis, Riot is also very expensive. The company has a forward price-to-sales ratio of 10.65, which is more than 220.09% higher than the sector median of 3.33. Seeking Alpha gives Riot a grade of a D on this metric.

The company is projected to see losses per share more than double over the next 12 months and will likely have to issue more stock/debt just to operate their mining business versus directly expanding their Bitcoin holdings. In my opinion, this is an inefficient way to acquire Bitcoin.

I think shares should trade at the sector median price-to-sales ratio. If we saw shares converge on a price-to-sales basis of 3.33, down from 10.65, this would represent 68.73% downside for the company.

Bull Thesis

I think the biggest bull thesis for Riot relies on the Bitcoin miner figuring out how to get their core Bitcoin mining business profitable. What I mean by this is not that they get profitable just by mining Bitcoin directly. What I mean is that they should get creative with their GPU assets to control costs. There are a couple ways to do this.

Some steel mill and sauna bathhouses are trying to put a focus on Bitcoin mining, helping them capture their excess heat.

Repurposing heat is not a new practice. According to the US Environmental Protection Agency, it’s common for companies to use excess heat to repurpose for generating electricity.

Energyintensive processes—such as those occurring at refineries, steel mills, glass furnaces, and cement kilns—all release hot exhaust gases and waste streams that can be harnessed with well-established technologies to generate electricity…

This electricity can mine Bitcoin.

The problem for Riot in this case is the obvious one: they don’t own any steel mills or sauna bathhouses. They would likely need to partner, and this messes with what little economies of scale the firm has that allows them to be profitable (on a gross profit basis).

For Riot, they’ve built their entire business around mining for Bitcoin. Now, some activist investors (like Starboard Value who took a stake as I was writing this) think the company can repurpose some of their GPUs and mining facilities towards AI data centers.

On the surface, this doesn’t feel like a bad idea. The issue with running a datacenter (as opposed to crypto mining) is that the datacenter industry is a two sided market place. Here, Riot will have to supply computers and match it with customers. For Bitcoin? The demand for computers in the form of proof of work is already there. It’s not as easy as building datacenter capacity and expecting clients to come.

Takeaway

While being a pro Bitcoin company should be a boost to Riot, the Bitcoin miner is incredibly expensive on a series of valuation metrics, and continues to lose money with guidance showing losses should continue next year. Now, the company is issuing debt to buy Bitcoin. I just don’t think this is sustainable.

While some may want to compare Riot’s business model to a similar, but different, plan run by MicroStrategy, I’m just not confident this will work. Riot’s core business just loses too much money in my opinion. I think this is why shares have underperformed the overall Bitcoin rally. With this, while the stock is in an overall space I like, I continue to believe that shares are a strong sell.

Analyst’s 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.

Noah Cox (main account author) is the managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Riot Platforms: MicroStrategy Plan May Not Work appeared first on Up2info.com.

• I believe the recent share price rally is mainly driven by speculation tied to Bitcoin’s price increase, rather than strong fundamentals or earnings results.
• I find the company’s rising mining costs concerning, especially with an increase in the average cost per Bitcoin mined, now at $35,376.
• I remain concerned about Riot’s diminishing power credits from the ERCOT market due to grid stabilization, with the integration of large-scale batteries supporting renewables penetration.
• I foresee delays in the company’s expansion plans and lowered hash rate projections hurting long-term growth, making its 2024-2025 targets hard to achieve.
• Despite a low P/B ratio, I believe the recent Bitcoin rally may be short-lived, while structural challenges continue to undermine the company’s outlook. I maintain a sell rating for this stock.

Riot Platforms, Inc. (NASDAQ:RIOT) has seen its share price jump by over 40% since November 6, recovering from this year’s downward trend.

However, this increase doesn’t appear to be due to the Q3 earnings, which came out on October 30.

In my view, the recent rally is tied to the increase in Bitcoin’s share price, likely driven by Donald Trump’s expected win.

It seems that shareholder excitement is at all-time highs, with promises from the new administration to make the US the crypto capital of the planet.

However, in this article, I will do something that (probably) most investors during the bull run haven’t done: analyze the fundamentals and the different strategic initiatives of the company.

I will advance here that my sell rating is not based on a pullback following the recent rally (although this event is likely to happen). My bear thesis revolves around the company’s cost structure and delayed expansion plans, which led management to issue a lower guidance in Q3 this year.

Let’s start with what, I believe, is the most pressing factor for the future growth of the company.

Rising Cost of Mining Bitcoin

Let’s start with dessert.

The average cost to mine Bitcoin in Q3 2023 was negative $22,741. Just to be clear, this cost was negative due to the net gain generated by not mining during peak power demand and selling their pre-contracted power back to the grid.

As a matter of fact, in Q3 last year, Riot received $49.6 million in power credits, which exceeded the total mining costs, resulting in a net gain.

Well, in the last quarter, mining costs were (positive) $35,376.

Let’s now understand the contributing factors behind this increase, starting with the Bitcoin halving event in April this year.

As we all know, the block reward was cut from 6.25 BTC to 3.125 BTC per block. Therefore, to achieve the same Bitcoin revenue as in 2023, miners now need to secure rewards from more blocks, which naturally increases the average cost per Bitcoin.

In my view, the halving event was not the main contributing factor. If we look closer at the last 10-Q published, we can see a significant decline in power curtailment credits, from $49.6 million in Q3 last year, down to $12.4 million.

As I mentioned before, these credits are earned when Riot curtails mining during high electricity price periods and sells power back to the grid.

Back in 2023, electricity prices were highly volatile, particularly in the Texas ERCOT market. However, in the past quarter, ERCOT experienced less frequent and less severe price spikes, leading to a 75% decline YoY in power credits for the company.

So, what is the outlook for ERCOT?

Well, it seems that the introduction of large-scale battery storage is expected to stabilize the grid as renewables penetration increases. This year, Texas is projected to install 12.7 gigawatts of utility-scale solar power. To put things in perspective, this accounts for 35% of the total US additions.

Therefore, the outlook for the ERCOT market doesn’t seem very promising for Riot Platforms, since the energy grid is expected to stabilize with the integration of large-scale battery systems.

Another headwind comes from the increase in network difficulty.

To put it simply, network difficulty measures how tough it is for miners to solve the cryptographic puzzles needed to add a new block to the Bitcoin blockchain. The Bitcoin network adjusts this difficulty approximately every two weeks to ensure that blocks are mined on average every 10 minutes, regardless of changes in the hash rate on the network.

In the last quarter, the network difficulty increased by 59% YoY, with the hash rate rising by 4% QoQ.

It seems that the rise in Bitcoin’s price during 2024 attracted more miners, with more powerful and efficient mining equipment. An example is Riot’s MicroBT miners. As a result, the network difficulty rose to maintain the block time at 10 minutes.

Another challenge is the rise in electricity prices, coupled with a shift at the Rockdale facility from fixed contracts to variable. Additionally, the new Corsicana facility has been procuring more electricity at spot market rates.

The latest earnings report shows that the average power cost increased to 3.1 cents per kWh in the last quarter, up from 2.7 cents per kWh in Q2 this year.

SG&A and Litigation Expenses

A closer look at the income statement shows a sharp increase of 130% in SG&A.

In my view, the drivers for this increase are quite concerning. Let’s start with the first one.

Stock-based compensation increased by $13.5 million YoY, sitting at $30.6 million in the last quarter.

If we consider the nine months ended September 30, 2024, stock-based compensation was $94.7 million, compared to just $14.7 million in the same period in 2023.

It seems that this increase is driven by the long-term incentive program implemented by the company in July 2023.

Look, I don’t blame the company for rewarding and motivating employees, officers, and directors by offering performance-based and service-based equity awards.

However, if the share price hasn’t been moving, these rewards are not justified, in my view.

A quick look at the chart below shows a decline of close to 20% since July last year.

Therefore, a 5x increase in stock-based compensation doesn’t make the slightest sense to me (aside from retaining your employees / directors / officers).

Another factor that contributed to the increase in SG&A was $4.2 million in advisory fees and $3 million in litigation expenses.

One of the legal cases the company is dealing with involves a dispute with Rhodium, which has since filed for bankruptcy. In Q1 2023, Whinstone, a Riot’s subsidiary, filed claims against Rhodium for breaches of hosting agreements, seeking recovery exceeding $26 million.

I considered including an excerpt from the Q1 2023 earnings report with more details about this claim:

In the amended petition, Whinstone asserts breach of contract claims for Rhodium’s failure to pay certain hosting and service fees under certain hosting agreements and seeks a declaration that certain hosting agreements with Rhodium are terminated and that no power credits are owed to Rhodium under any agreement. Riot seeks recovery of more than $26 million, plus reasonable attorneys’ fees and costs…

Since then, in September 2023, the District Court ruled that Whinstone’s claims against Rhodium must be resolved through arbitration.

However, as I mentioned before, Rhodium went bankrupt in August this year, which paused the arbitration process.

Below, I’ve included some paragraphs from the last 10-Q published with additional information that I found relevant for this case:

On September 13, 2023, the District Court compelled Whinstone’s claims against Defendants to arbitration over Whinstone’s objection and stayed the lawsuit pending such arbitration.

On December 11, 2023, Rhodium submitted an arbitration demand to the American Arbitration Association (“AAA”), seeking damages and specific performance of unspecified contracts. Rhodium amended its demand on June 4, 2024 to include additional claims and disclosed it seeks at least $67 million in damages.

After a permanent arbitrator was appointed and written discovery commenced, Rhodium filed for bankruptcy protection on August 24, 2024 and August 29, 2024 in a now jointly administered proceeding styled In re: Rhodium Encore LLC, et al., Case No. 24-90448 (ARP), in the United States Bankruptcy Court for the Southern District of Texas—Houston Division. Therein, Rhodium filed a motion to assume the Hosting Agreements, and the court set a contested hearing on the matter commencing November 12, 2024.

Another legal case involves GMO Gamecenter USA, initially seeking over $150 million in damages for alleged breaches of a colocation services agreement. However, this amount was later amended to $496 million in October last year.

Again, I considered including some quotes from the most recent 10-Q to provide more context:

On June 13, 2022, GMO Gamecenter USA, Inc. and its parent, GMO Internet Group, Inc. (collectively “GMO”), filed a complaint against Whinstone alleging breach of a colocation services agreement between GMO and Whinstone, which has since been terminated, seeking damages in excess of $150.0 million for lost profit and profit-sharing payments GMO alleges it was owed from Whinstone.

On October 19, 2023, GMO filed its fourth amended complaint claiming an additional $496.0 million in damages, for loss of future profits and future profit-sharing payments GMO alleges would have been received through the term of the agreement, based on Whinstone’s allegedly wrongful termination of the colocation services agreement as of June 29, 2023.

Delayed Expansion Plans

Riot has lowered its hash rate growth projections for 2024 and 2025 due to delays in expansion projects at its Kentucky and Corsicana facilities.

Riot initially projected a year-end hash rate of 36.3 EH/s for 2024. The revised guidance is 1.4 EH/s lower than its prior guidance.

By the end of 2025, the company’s goal is to reach 46.7 EH/s, down from their previous estimation of 56.6 EH/s.

Considering that the company has pushed the Kentucky expansion into 2025, with design modifications and new equipment required, and one of the three new buildings at Corsicana is now delayed into 2026, I believe the company might struggle to reach the 2025 hash rate target.

The New Administration

The Guardian mentions in one of their articles a so-called “Trump pump”.

Since November 6th, Bitcoin’s share price increased by over 20%.

It seems that Donald Trump’s re-election as US President has sparked a bull run in Bitcoin due to expectations that his administration will implement policies favorable to cryptocurrencies.

These include promises to reduce regulatory hurdles, including potential changes in leadership at the Securities and Exchange Commission.

Additionally, in a keynote address at the Bitcoin 2024 conference in Nashville, he stated his intent to make the US the “crypto capital of the planet” and proposed the creation of a strategic Bitcoin reserve.

How Can I Be Wrong?

Let’s start with valuation.

In my view, paying 1.8x the book value of the company seems to be quite cheap.

As a matter of fact, if we compare the company with its industry peers (notice not all are direct competitors) using P/B as the comparison metric, Riot Platforms is the cheapest in the group.

Additionally, a closer look at the chart below shows the P/B of the company trading in the middle of the 2-year historical range.

Therefore, I believe the company is relatively cheap compared to its book value.

Another factor that could break my bear thesis (at least, in the short run) is the recent increase in Bitcoin mining revenue of 116% YoY, mainly driven by higher Bitcoin prices in the last year, and expanded operational capacity.

If the current Bitcoin excitement persists, I anticipate a further increase in Bitcoin prices, at least, until the end of the year.

Considering that the company holds 10,427 Bitcoin on its balance sheet, this bull run could be quite favorable in the short term.

Finally, there is a chance that the engineering division (managed through Riot’s subsidiary ESSMetron) could recover in 2025, as Riot announced that the delayed government contract was finally shipped by the end of last quarter.

This means that one-third of ESSMetron’s warehouse capacity is now available for higher-margin projects, like data center development and power distribution for growing industries like AI and HPC.

Conclusion

In my view, the challenges and headwinds the company is facing outweigh the limited upside, which, I believe, is mainly driven by shareholder excitement following changes in the US administration.

If we look at the cost structure of the company, things don’t look particularly favorable, with the average mining costs skyrocketing to $35,376 per Bitcoin.

With ERCOT grid stabilization from large-scale battery storage, Riot’s ability to capitalize on power credits has diminished significantly, dropping 75% YoY.

In my view, this structural shift in ERCOT’s grid stabilization likely marks the end of Riot’s previously lucrative power strategy.

Operational delays further erode my conviction in this stock. Management has already revised its hash rate projections downward for 2024 and 2025 due to setbacks at its Kentucky and Corsicana facilities.

Additionally, the 130% increase in SG&A expenses makes me sweat, especially with a 5x in stock-based compensation. In my view, this compensation is unjustifiable given the company’s declining stock performance since the all-time highs in early 2021. Legal disputes only compound this problem.

The main risk to my bear thesis is the recent Bitcoin rally. However, I believe that the nature of this bull run is temporary and speculative, as with many other Bitcoin bull runs.

Another risk is the attractive P/B ratio of the company, which could attract “deep value investors” in the crypto world with a high risk – high reward appetite.

Overall, I believe the risks outweigh the potential benefits, which is why I’m giving this company a sell rating.

Analyst’s 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.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Riot Platforms: Why This Could Be The Best Time To Sell This Stock appeared first on Up2info.com.

• For quarter ended September 2024, Riot Platforms reported top line revenue of $84.8 million – a year over year increase of 63%.
• The company lost 54 cents per share in the quarter. From both net income and earnings per share standpoints, this was Riot’s worst quarter since ‘crypto winter.’
• Riot’s energy curtailment strategy lacks consistency and SG&A is enormous relative to industry peers.

When I last covered Riot Platforms (NASDAQ:RIOT) for Seeking Alpha, I was actively holding the company’s stock as a trade idea. The thesis behind that trade wasn’t technical in nature, but there was a shelf-life on the viability of the thesis. My argument back in June was that Riot could benefit from a hot Texas summer:

Between now and likely the end of September, Riot should be able to benefit from power credit optionality. If it’s hot and Bitcoin’s price returns are lackluster, Riot can instead go the energy route for monetizing power. This is not something that every public miner is able to do, so it gives Riot Platforms an advantage in the event Bitcoin’s summer month price languishes.

At that time of that publication of that article, the price of Bitcoin (BTC-USD) was topping out before a multi-week selloff that took the coin from $72k down to $53.5k by early-July.

As fate would have, the price of BTC is right back where it was in early June. The BTC pricing angle to my power credit thesis generally held up. The other half of my thesis did not. In this article, we’ll look at Riot’s Q3 earnings and assess whether RIOT is still a good trade with BTC now breaking out of multi-month resistance.

Riot’s Q3 Results

For quarter ended September 2024, Riot Platforms reported top line revenue of $84.8 million. This was a year over year increase of 63% and a sequential increase of 21%. 80% of that headline number came from Bitcoin mining with the rest coming from ‘engineering’ and ‘other.’ Importantly, Riot didn’t sell any BTC during the quarter.

Despite the block reward halving back in April, the company managed to mine 1,104 BTC. This was almost an identical number of Bitcoin compared with the 1,106 mined during the same period from the prior year. However, that post-halving BTC production has come at a considerably higher ‘all-in cost’ when adjusting for the company’s growth in installed exahash capacity.

Riot has simply made up for declines in gross margin by scaling mining capacity up over 28 EH/s. Notably, quarter ending hash rate capacity is more than double the 10.9 EH/s figure from the end of Q3-23. I think this really highlights the problem with long term reliance on the block reward subsidy as the primary incentive for transaction validation. The company’s self-reported cost to mine one Bitcoin including both power costs and hardware depreciation was $75.5k per coin during the quarter – nearly three times the figure from a year ago. And this doesn’t even factor in other opex costs.

SG&A came in at $66.9 million. For the full quarter, the company reported a net loss of $154.4 million and a loss of 54 cents per share. From both net income and earnings per share standpoints, this was Riot’s worst quarter since ‘crypto winter’ even though Bitcoin spent most of the quarter between $58-65k per coin.

Power Credits

What has saved Riot’s bottom line in the past is the curtailment strategy that the company was able to execute during much of 2023. Riot’s curtailment strategy paid off so well last year, that the company actually reported a negative net power cost for the three months ended September:

The company never sniffed curtailment credits to that degree this time around. Compared with 2023, the relative lack of energy and demand response credits during the Texas summer months has resulted in much less of an impact on the company’s net power cost. In the chart below, we can get a good visual sense for how the company’s power credit segment performed relative to last year and compared with BTC sales:

What complicates things for Riot now financially is the company’s pivot from selling part of its BTC production to a 100% HODL approach. When combining BTC sales, power credits, and DR: 70% of Riot’s monthly monetary production came from BTC sales in 2023. That is no longer the case. So long as Riot is HODLing mined BTC and generating very little in the way of DR/Energy credits, I don’t see how the company can sustain a positive net income under this current strategy without significantly higher BTC prices. But even that doesn’t address the long term asset volatility problem.

Consider that mined BTC that isn’t sold is an unrealized gain rather than an actual sale of goods. If we’re simply leaving the company’s quarterly results to FASB accounting adjustments, I don’t see much of a reason to long RIOT over simply buying a spot ETF. The latter is certainly a lot less expensive to shareholders.

Bitfarms Fiasco

Something that I believe has weighed on RIOT’s stock price is the failed hostile takeover of mining peer Bitfarms (BITF). The result of Riot’s attempted takeover is a temporary truce between the two companies. As part of this agreement, Riot and Bitfarms will table merger talks through Bitfarms’ 2026 annual meeting. Thus, Riot is now the largest holder of BITF stock without a clear path toward full ownership of the company at this point in time.

Click to enlarge

Source: Whale Wisdom

Riot’s Bitfarms position represents 19.9% of outstanding BITF common shares and is about four times the daily trading volume for the month of October. This means that even if Riot wanted to unwind its BITF position, it is unlikely to be able to do so without having a fairly significant impact on the share price. One could argue this makes Riot sort of a captive holder of BITF shares. For full disclosure, I actually happen to like BITF as a trade at the moment so I don’t think immediate share price declines in BITF will be an immediate risk to RIOT for the time being. But I do think longer term the BITF shares take away balance sheet optionality from Riot management.

Closing Summary

I’ve maintained for quite some time through my previous Seeking Alpha work that I don’t think Bitcoin miners are great long term investments without a meaningful rise in transaction fees on the primary blockchain layer. That being said, I think there are some miners that are better suited for speculative wagers than others. Yet, I’m struggling to see the bull case for RIOT relative to other opportunities. Perhaps the best thing RIOT has going for it is balance sheet strength with a large cash position and no debt. But the company now seems pot-committed to holding Bitfarms stock, which is eating up a considerable portion of Riot’s capital.

From an operational standpoint, Riot Platforms isn’t historically the most efficient miner measured by BTC per EH/s. The energy/DR credit strategy doesn’t seem to be a reliable way to mitigate energy costs. Riot Platforms has the highest SG&A cost as a percentage of revenue of any mining company with a top ten market cap – and by a wide margin. And for that expense, investors are getting a Bitcoin HODL play and 20% of Bitfarms. At this point, I think there are better opportunities elsewhere in both the industry and in the broad market overall.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BTC-USD, BITF either through stock ownership, options, or other derivatives. 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.

I'm not an investment advisor.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Q3 Earnings: An Ugly Quarter For Riot Platforms appeared first on Up2info.com.

• RIOT’s current valuation is likely to attract significant attention as the sector’s valuation is undergoing mean reversion which presents a potential 2x upside.
• The pessimism surrounding RIOT could derived from its underperformance in operating cost efficiency; if this is true, the prospect of RIOT operating at full capacity will positively change its outlook.
• RIOT’s acquisition of BITF makes sense as BITF helps RIOT diversify its operations away from curtailment-prone Texas, but limited benefits can be derived due to BITF’s scale and % ownership.
• We think that the likelihood of RIOT operating at full capacity is low given it is systematic to Texas, putting our thesis into question: Will RIOT ever operate at full capacity?

Introduction

At the time of writing, RIOT’s valuation is likely attracting significant attention. Not only is it trading below book value, but it is priced at half the sector average Price-to-book value (‘PBR’) (Fig A). Riot Platforms is currently trading at $1.9bn, while its liquidation value (based on our terms: tangible assets + deposits – total liability) is worth $2.16bn. That’s ~10% below the liquidation price.

This excites us because instances of a Bitcoin miner trading below liquidation value are rare when the crypto market is expecting a bull run anytime soon. We found several deals like this during the bear market or the recovery phase, such as Iris Energy Limited (IREN) back then, but rarely in a bull market.

In this article, we identified a situation where RIOT could rank high on our watch list as we prepare for a potential Bitcoin USD (BTC-USD) bull run in about 1 month.

RIOT At Full Throttle

We have always found it difficult to justify an investment in RIOT because of its cost basis, making it very unprofitable. Referring to Fig 1, it is observable that RIOT spends the majority of the time having the highest all-in cost basis per Bitcoin mined. Note that even the historic amount of curtailment credits received isn’t enough to revert it back to the sector mean.

Our previous thesis, based on 2023Q3, concluded that RIOT could mirror Core Scientific, Inc. (CORZ) as it aims to expand ambitiously to 100 EH/s despite being unprofitable (due to a high all-in cost basis). However, the recent 2024Q2 earnings report changed our perspective on RIOT’s operating efficiency, and thus, the entire outlook of RIOT.

Firstly, a portion of RIOT’s high-cost basis can be explained by its aggressive depreciation of Bitcoin mining fleets. Since our early coverage, we’ve assumed a 5-year useful life for the mining fleet, whereas RIOT had assumed only 2 years. Recently, RIOT extended the expected useful life of its fleets from 2 to 3 years which helped minimize the accounting depreciation cost. This cost can further be reduced if RIOT adopts the same 5-year useful life.

Effective January 1, 2024, the Company changed the estimated useful life of its miners and mining equipment from 2 years to 3 years.

Depreciation and amortization for the three months ended March 31, 2024 and 2023, were $32.3 million and $59.3 million, respectively, a decrease of approximately $27.0 million. The decrease was primarily due to the change in the estimated lives of our Bitcoin miners from 2 years to 3 years.

Since depreciation is subject to different accounting methods, and we’re unable to adjust them for a fair comparison, we’ll omit depreciation cost during comps. This is justifiable because the total depreciable costs are generally similar across Bitcoin mining companies. For instance, RIOT and CLSK‘s purchase costs are $16 million per 1 EH/s. Hence, the depreciable cost is also capped at $16mil per 1 EH/s. Hence, only the rate of depreciation should differ.

Secondly, we observed that RIOT’s variable cost component (cost of revenue per Bitcoin) closely tracks the sector average. In contrast, its fixed cost components-such as SG&A, SBCs, and professional fees-remain elevated. This suggests that RIOT may not suffer from operational cost inefficiencies, and its challenges likely lie elsewhere.

SG&A typically consists of human capital-related expenses. Since Bitcoin mining companies are like factories, higher-than-sector SG&A suggests 2 potential causes: either RIOT’s team is oversized for its operational capacity, or RIOT is not operating at full capacity. Our findings point to the latter.

Fig 6 illustrates major Bitcoin miners’ capacity utility rate (the ratio between the monthly average operating and deployed hash rates). By referring to it, we can see that RIOT is operating below its full capacity. This implies that RIOT has to incur the fixed costs (such as more human resources, depreciation costs, etc.) of having a higher capacity (23.3 EH/s) but produce Bitcoin with 15.5 EH/s capacity. Knowing this, when assuming RIOT’s full capacity, RIOT’s fixed cost component (SG&A) now falls to the sector average (Fig 7). This also caused RIOT’s total all-in cost basis to fall to the sector average cost basis (Fig 8).

Therefore, it is reasonable to expect RIOT’s cost basis to recover when it operates at full capacity.

How Acquisition of BITF Helps RIOT’s Cost Basis

Given the context we provided throughout the article, RIOT’s acquisition of BITF makes sense. RIOT disclosed how the acquisition of BITF is compelling for both parties. Among the key benefits, we think “geographical diversification” ranks at the top because it can help RIOT improve the capacity utility rate.

A large portion of RIOT’s operations is in Texas, which is prone to curtailment. We think it is a ‘systematic risk’ (unavoidable) because MARA also faces curtailment issues (We covered it in detail here). Although RIOT receives curtailment credits, we think that it is more profitable to operate at full capacity than to rely on curtailment credits. For instance, in July, RIOT averaged an operating hash rate of 15.5 EH/s, short of 8 EH/s from its full capacity. At that capacity, RIOT produced 370 Bitcoins, which implies 23.9 Bitcoins per 1 EH/s. At full capacity, RIOT could’ve earned 191 more Bitcoins, which are worth $11 million at $60k per Bitcoin, which is 3x more of the credits it received.

Considering BITF mining sites are diversified and outside of Texas and Kentucky, BITF’s stable uptime can improve RIOT’s overall capacity utility rate, which improves cost basis and overall profitability.

Not to mention, BITF’s valuation (based on Implied Bitcoin Price (‘IBP’) without depreciation) is also the lowest, making this acquisition strategic from both an operational and valuation standpoint.

Click to enlarge

Verdict

We speculate that the pessimism surrounding RIOT is related to its all-in cost basis being the worst in the sector by a margin (Fig 1). While the actual reasons for RIOT’s falling out of favor with the market remain unclear to us, we are reasonably confident that RIOT offers significant upside potential if it can operate at full capacity, especially at its current valuations. This is because the profitability outlook of RIOT operating at full capacity is very attractive, rivalling even CLSK (Fig 8).

Currently, there’s also an ongoing mean reversion in the Bitcoin mining sector, where the PBRs of Bitcoin mining companies are converging around the 2.3 PBR level. RIOT is the only remaining Bitcoin mining company yet to revert. If RIOT reverts, it could present investors with a 2x return (assuming constant book value and sector-average PBR).

Combining the prospects of RIOT achieving profitability (at full capacity), RIOT’s current valuation (below book value and half the sector’s PBR), and the ongoing mean reversion, RIOT looks really attractive.

That being said, we lack confidence that RIOT can improve its capacity utilization rate in a short period of time, even after the acquisition of BITF. Recently, RIOT experienced another decline in its average operating hash rate in August, highlighting a significant challenge. Furthermore, RIOT currently only owns 20% of BITF while BITF’s capacity is half that of RIOT. Therefore, the positive impact that can be derived from the acquisition is expected to be limited.

If our speculation holds, it implies that RIOT may not even return to the sector mean. This uncertainty calls our entire investment thesis for RIOT into question: Will RIOT ever operate at full capacity?

As we prepare for a potential Bitcoin bull run by October 17th, we believe it’s unlikely that RIOT can make significant operational improvements within a short, one-month period. For now, RIOT will remain on our watch list, with potential catalysts to monitor.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BTC-USD, BITO either through stock ownership, options, or other derivatives. 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.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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• Riot Platforms faces significant challenges, including Bitcoin halving, equity dilution, and EBITDA level losses, leading to a 60% stock decline year-to-date.
• Despite a strong balance sheet and aggressive expansion plans, Riot’s profitability remains uncertain due to the halving event, increasing network difficulty, and volatile Bitcoin prices.
• The company’s recent financial performance has been poor, with substantial operating losses and minimal operating cash flow, raising concerns about future profitability.
• Given the current market conditions and operational challenges, I recommend staying away from RIOT stock, although there may be short-term trading opportunities.

Investment Overview

After a strong rally in the first quarter of 2024, Bitcoin USD (BTC-USD) has been sideways to lower. However, the digital asset is still higher by 24% for year-to-date. In comparison, it’s been a challenging year for Bitcoin miners. Riot Platforms, Inc. (NASDAQ:RIOT) stock has plunged by almost 60% year-to-date.

This coverage on Riot stock will discuss the reasons for the sharp correction and evaluate if the miner is worth considering. At a forward P/E of 24.4, Riot stock seems attractive. The company has ambitious growth plans through 2027.

However, it’s not enough to look at the growth ambitions. This thesis discusses the major concerns along with the positives. Overall, my view is that it makes sense to remain on the sidelines. However, for traders, there are likely to be opportunities for quick gains from oversold levels.

As a quick overview, Riot Platforms is a North American Bitcoin miner. As of August 2024, the company reported deployed and operational hash rates of 23.5EH/s and 14.5EH/s respectively.

Why Riot Stock Corrected?

The starting point of discussion is the reason for a deep correction in Riot stock even as Bitcoin has trended higher. In my view, there are four reasons for the downside.

First, Bitcoin’s halving might be good for investors in the long term. However, the halving event implies difficulty in mining and a significant increase in cost. Omid Malekan, an adjunct professor at Columbia Business School opines that “some miners will no longer be profitable, and they will stop mining.” This is likely with block rewards essentially cut into half and significant energy costs will impact margins. Riot is therefore in an uncertain zone and the coming quarters will provide further insight into the profit potential.

Second, in the second week of August, Riot filed for a $750 million controlled equity offering. This implies potential dilution in the coming months and has negatively impacted Riot’s stock. Earlier in February 2024, the company had entered a $750 million ATM offering. I must add here that in 2022, Riot pursued a $500 million at-the-market equity offering. Also, in 2023, the company had a $750 million ATM offering. It would be a different story if significant dilution translated into growth and robust cash flows. That has not been the case in the last few years.

Third, Bitcoin traded at a high of $73,800 on March 12, 2024. The cryptocurrency has, however, remained sideways to lower in the last few months and currently trades near $55,000. Even with the prospects of expansionary monetary policies, Bitcoin has not witnessed a sharp rally as seen in gold. After the halving event, Bitcoin needs to trade significantly higher from current levels for mining operations to deliver robust cash flows. Considering the volatility in digital assets, investors have been jittery about considering exposure to Riot stock.

Fourth, at the beginning of September, Riot announced a stake of 19.9% in Bitfarms Ltd. (BITF). The company has gradually increased its stake in Bitfarms. However, according to Riot, there has been a lack of engagement from Bitfarms. With the latter announcing the acquisition of Stronghold Digital Mining, Inc. (SDIG), it seems clear that the objective is to fend off Riot’s plans for a potential merger or acquisition. An open letter to Bitfarms shareholders is an indication of the point that Riot is in an awkward position. The acquisition of a 19.9% stake might not end well for Riot and its shareholders.

The key point I want to make here is that all these factors have contributed to the correction in Riot stock. However, the first three factors are an ongoing risk and are not limited to a few quarters. It remains to be seen if the positives outweigh these risks. In my view, the possibility is low.

Strong Fundamentals and Aggressive Expansion

Among the positive factors, the first point to note is strong fundamentals. As of Q2 2024, Riot reported cash and marketable securities of $639 million. Further, the company held 9,334 Bitcoins that were valued at $585 million. This implies a total cash buffer of $1.2 billion. I must add that Riot has a zero-debt balance sheet and financial flexibility is therefore high.

Having said that, the source of cash is not robust operating cash flows. Last year, Riot reported an OCF of $33 million, and the OCF in 2022 was less than a million. The cash buffer has therefore been built through dilution of equity. It’s not necessarily bad if the dilution provides a revenue and cash flow bump-up. That’s the key challenge with Bitcoin halving.

In terms of expansion plans, Riot reported a deployed hash rate of 23.5EH/s as of August 2024. As the chart below shows, the plan is to pursue aggressive hash rate capacity expansion in the next few years.

By the end of 2025, the capacity deployed will more than double to 56.6EH/s. I don’t see any financial challenges on the expansion front. Riot has a strong balance sheet and the controlled ATM will add to the cash buffer.

The big question, however, remains: Will hash rate capacity addition translate into EBITDA margin expansion and cash flow upside?

Let’s look at Q2 2024 numbers for some insight. For the quarter, Riot reported operating level loss of $117 million. This includes changes in the fair value of Bitcoin and derivative assets. Further, EBITDA and adjusted EBITDA loss for the quarter were $55 million and $75 million respectively. If I had a add a fifth reason for Riot stock correcting, it would be dismal numbers for Q2 2024. Of course, these numbers reflect the impact of difficulty in Bitcoin mining after the halving event.

There is a case for profitable operations if Bitcoin doubles from current levels. However, that’s the only assumption that makes a case for investing in Riot stock. When it comes to hash rate capacity expansion, MARA Holdings, Inc. (MARA), and Bitfarms, among others, have been aggressive. Therefore, it’s not just Riot that’s positioned to benefit from incremental capacity.

Also, an increase in hash rate does not necessarily imply an increase in the number of Bitcoin mined. Between June 2023 and June 2024, Riot increased its hash rate by 105.6%. However, the number of Bitcoin mined declined by 43.2%. Besides halving, an increase in network difficulty impacted growth. With the hash rate (global) likely to increase in the coming quarters, network difficulty will increase. This will negatively impact the mining numbers. To counter this challenge, the market share of the hash rate needs to increase. It’s not surprising that Riot has been pursuing acquisitions. In July 2024, Riot acquired Block Mining for a consideration of $92.5 million. This transaction has the potential to add 16EH/s of self-mining hash rate by the end of 2025.

Breakeven and Power Cost Challenges

In April 2024, Marathon CEO Fred Thiel opined that the firm’s breakeven rate would be $46,000 after the halving event. While it’s likely to differ for companies, it would be safe to assume that the breakeven would be in the range of $45,000 to $55,000 per Bitcoin.

With Bitcoin trading at $55,000, the operations would be hardly profitable. The first point therefore is that Riot is likely to report sluggish numbers for Q3 2024. This will ensure that Riot stock remains sideways to lower.

It’s important to note that Riot reported a direct cost to mine one Bitcoin of $25,327 for Q2 2024. For the same period, the Bitcoin mining gross margin was 62%. However, this non-GAAP gross margin includes $13.9 million in power curtailment credits. I would also look at the EBITDA margin rather than the gross margin to determine operating level profitability.

For Q2 2024, the average Bitcoin price was $66,071. Even at this price, Riot reported an adjusted EBITDA loss of $75.2 million. Having said that, the losses are exaggerated due to a change in the fair value of Bitcoin by $76.4 million. If this factor is eliminated, Riot Platforms would have an EBITDA level profit of $1.2 million. Riot was barely profitable at the EBITDA level with Bitcoin above $60,000. This underscores the view that EBITDA breakeven is likely above $50,000 even if we assume operating efficiency going forward.

Another interesting point to note is that securing cheap electricity for mining operations will be a bigger challenge. It’s estimated that the AI sector pays 3x to 4x more for electricity than U.S. Bitcoin miners. It’s expected that U.S. Data Centers will consume 9% of the country’s electricity generation by 2030. Considering the AI boom, I expect the breakeven for miners will continue to increase on the back of higher power costs.

Of course, Bitcoin has skyrocketed after each halving event. Between the halving of 2020 and 2024, the cryptocurrency has delivered 8x returns. However, hoping for an upside in Bitcoin would be a weak thesis for exposure to miners. It would make more sense to invest in Bitcoin or a Bitcoin ETF and consider miners if there is a significant rally from current levels for the digital asset.

Concluding Views

Riot Platforms has a strong balance sheet and is pursuing aggressive hash rate capacity expansion. However, beyond this, the thesis is dominated by concerns related to cost. I don’t see Riot delivering strong numbers in the coming quarters. That’s likely to keep sentiments bearish. Further, Bitcoin needs to surge higher for mining activity to be profitable. For now, the company is diluting equity for expansion, but it’s unlikely that operating cash flows will be robust.

If we look at the valuations, Riot stock trades at a forward EV/EBITDA of 5.4. There seems to be a valuation gap as compared to the industry metrics. It’s however important to note that a relatively low enterprise value is on the back of a debt-free balance sheet and solid cash buffer. Further, if Bitcoin trades around current levels, it’s likely that EBITDA estimates will be revised on the downside. While valuation metrics are important, I believe that the forward EV/EBITDA metric will change significantly in the next few quarters.

Amidst the concerns discussed, I would stay away from Riot stock. I believe that further downside is likely in the coming months. Of course, there can be trading opportunities from deeply oversold levels, but Riot is far from being a long-term investment idea.

Analyst’s 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.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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• Riot Platforms rated as hold in April, now downgraded to strong sell due to 17.26% share decrease post Bitcoin halving.
• Bitcoin halving has increased operational challenges for miners like Riot, leading to financial losses and potential share dilution for funding.
• Despite potential leverage to Bitcoin price movements, Riot’s operational inefficiencies and financial struggles make direct Bitcoin investment a more profitable strategy.

Investment Thesis

Back in April, I covered Riot Platforms (NASDAQ:RIOT), and rated the company as a hold. Since then, shares have fallen roughly 17.26%, while the market has increased by 10.74%.

The recent Bitcoin halving has introduced considerable challenges for miners, including Riot. Post-halving, each ASIC miner now needs to work twice as hard to mine the same amount of Bitcoin, yet the anticipated price increase for Bitcoin has not materialized to offset this increased difficulty. In June 2024, Riot’s Bitcoin production fell 45% year-over-year, highlighting the operational inefficiencies and heightened challenges the company faces due to this halving. ​

As a result of this, Riot Platforms is now losing money (estimated for the upcoming quarterly report). I am concerned the company is going to have to reach for even more share dilution to fund the business, which would result in further shareholder losses. With this, I’m now downgrading my belief on the stock to a strong sell.

Why I Am Doing Follow-Up Coverage

As I mentioned above, when I covered Riot last in April, I marked the company as a hold. My reasoning for this was that miners were banking on Bitcoin (Bitcoin)’s prices doubling in order to sustain the competitive nature and costs. If Bitcoin’s prices had moved higher post halving, I would have been more bullish.

However, this did not seem to be the case. Bitcoin prices have fallen, partly caused by miners needing to sell their stashed Bitcoin in order to support their valuation.

Some miners have taken the approach of attaching Bitcoin miners to saunas to subsidize the cost of operating them, also known as selling the heat. While this has been helpful for some miners, I just don’t see Riot doing this, and I am skeptical of the company’s ability to find a long run sustainable way to augment mining costs (I will talk about the ERCOT grid program in the valuation section). Historically, they have not had a long run sustainable cost basis.

With this, I believe updated coverage is warranted. The purpose of this article is to demonstrate the effects this halving has had on their valuation.

Bitcoin Miner Economics

In the wake of the Bitcoin halving on April 19th of 2024, the core economics of the Bitcoin market are undergoing significant shifts. In the long run, the market is expected to absorb the increased supply of Bitcoin as struggling miners are forced to sell their reserves and eventually exit the business. This will occur because it is becoming increasingly difficult for miners to operate profitably under the new, more challenging conditions. As these less efficient miners leave the market, the remaining miners, who can sustain operations, will only mine Bitcoin at prices that are economically viable over the long term.

This selective survival of the fittest should gradually lead to a higher equilibrium price for Bitcoin. The process works through the gradual reduction of Bitcoin supply as miners capitulate, leading to reduced sell pressure in the market. As a result, Bitcoin’s price is likely to move higher over time, driven by the reduced supply and the sustained demand from investors and users.

This increase in price is actually good for miners who are built for longevity and have a sustainable operational model. These miners can weather the tough periods and emerge stronger, receiving the rewards of higher Bitcoin prices in the future. However, Riot does not appear to be built for longevity. Despite their efforts to increase their hash rate and improve operational efficiency, Riot’s financial health and operational sustainability are of concern for me. The company has faced significant production declines and financial losses​.

In addition to the pressures placed on Riot from the Bitcoin halving, they seem to just be struggling overall with mining efforts. For example, during the latest earnings call, Colin Yee, Riot CFO, stated:

During the first quarter of 2024, we mined 1,364 Bitcoin, which represents a decrease of 36% from the 2,115 Bitcoin we mined during the first quarter of 2023. This was primarily due to the significant increase in the Bitcoin network difficulty, which has more than doubled since January 2023 -Q1 2024 earnings call.

Keep in mind, this was before the halving, which occurred in April.

While the company mentioned during the call that they expect this number to move back up due to their increased hash rate capacity, I am unsure if they will be achievable due (we saw their mining yields drop significantly in June). While they saw an increase in Bitcoin mining from May to June (they produced 255 Bitcoin), up 19% from May, they still year-over-year saw a 45% drop.

Valuation & Financials

On the surface, Riot’s forward P/E ratio may appear to make the stock attractive. While the company is forecasted to report GAAP profitability over the next 12 months, a big portion of what management is focusing on is their ERCOT program, buying power from the grid at low demand times to help the grid load balance.

In essence, ERCOT’s program works by providing companies (like Riot) incentives and credits to purchase power at non-peak hours of grid operation. Management has praised this program as a way to help them keep their average costs per Bitcoin mined low (this is their answer to the Sauna heat capture business model).

Unfortunately, I am highly skeptical this will be enough for Riot. Management in their Q1 earnings presentation highlighted the benefit. $5.1 million (and up 67% year over year). This is promising growth, but a small part compared to total revenue in Q1 ($79 million).

With this, Riots business appears highly commoditized to me. They are primarily mining Bitcoin and selling it on the open market. They took a 45% production hit when the halving occurred, and were down 36% in mining volume before this as well, which tells me they are not succeeding in grabbing market share (% of Bitcoins mined per day).

This leaves me still at a strong sell. Their forward price to sales ratio stands at 6.96, 130.56% above the sector median (3.02). I am not confident at all in their ability to hit production targets for Bitcoin mining, given they saw a mining volume collapse even before the halving.

With this, I think the stock should be valued at just the sector median price to sales. If the stock converged at this multiple, it would represent 56.7% downside in shares, assuming no dilution.

Bull Thesis

Despite what I believe to be core challenges Riot Platforms faces in their business model, there remains (what I believe to be) a single, solid bull thesis that should be considered.

This lies in the price of Bitcoin.

I believe the price of Bitcoin is likely to move higher in the long run due to its deflationary nature, increasing scarcity, and growing adoption. If Riot can survive the current operational and financial difficulties, they could benefit significantly from the long-term increase of Bitcoin prices. They do have 9,334 Bitcoins as of the end of June.

This Bitcoin reserve effectively provides Riot with significant leverage to Bitcoin’s price movements. As Bitcoin prices rise, the value of Riot’s holdings increases, potentially offsetting some of the operational losses and enhancing the company’s overall valuation. This could be a huge levered Bitcoin investment,​ much like MicroStrategy (MSTR).

With this, many Bitcoin bulls argue that issuing stock in dollars to mine Bitcoin is a smart move. The logic here is that Riot is raising capital in an inflationary currency (USD) to invest in a deflationary asset (Bitcoin). Over time, assuming the value of Bitcoin continues to appreciate relative to the dollar, this strategy could pay off. This approach could be particularly advantageous if Bitcoin experiences significant price increases, allowing Riot to convert their mining operations and reserves into substantial profits.

Despite the potential upside here, there are considerable risks. I believe Riot’s operational inefficiencies and financial struggles raise doubts about their ability to capitalize on long-term Bitcoin price increases. I think that investing in straight Bitcoin is a much better way to play Bitcoin, therefore potentially a more profitable strategy than investing in Riot’s future. Direct Bitcoin investment eliminates the operational risks associated with mining companies such as Riot and provides direct exposure to Bitcoin’s price movements.

To be clear, I am long run bullish on Bitcoin itself, just not Riot Platforms. If you’re curious on my thoughts on Bitcoin itself, I wrote a piece on BlackRock iShares Bitcoin Trust (IBIT) in April.

Takeaway

Since the Bitcoin halving in mid-April, Riot has been facing significant operating challenges that have led me to adjust my past hold rating from April to a strong sell. This halving has caused each ASIC miner to now need to work twice as hard to mine the same amount of Bitcoin without a corresponding doubling in Bitcoin’s price. This has led to a notable decline in Riot’s Bitcoin production, down 45% year-over-year in June 2024. Despite the bullish long-term outlook on Bitcoin, Riot’s financial health and operational inefficiencies present considerable risks to investors. I believe this strategy of investing in a Bitcoin miner that consistently issues will not be as lucrative for investors as investing in straight Bitcoin. The company’s valuation metrics, particularly their high price-to-sales ratio, suggest that the stock is significantly overvalued compared to their peers.

I believe that with the company’s recent performance, I do not think they are well positioned to recover in the long run (I do not see what part of their strategy will lead them to be long run profitable). Given the lack of a clear path to profitability, the ongoing dilution risks, and the operational challenges post-halving, I now believe Riot is a strong sell.

Analyst’s 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.

Noah Cox (account author) is the managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Riot Platforms: Miner Capitulation (Rating Downgrade) appeared first on Up2info.com.

• Riot Platforms has failed to consistently show profitability in its mining operations, even after the recent Bitcoin bull market.
• The company’s profits are attributed to Bitcoin’s fair value changes, which may become negative given its recent declines.
• Riot Platforms has raised over $1B in investor cash on a TTM basis, which is nearly half of its current market value. This suggests significant and potentially fruitless equity dilution.
• The company may have some support from its tangible book value. To me, that depends on whether or not its physical investments can be used for non-Bitcoin activities.
• RIOT’s political risk appears high as more voters and politicians question its voracious power needs, which can be argued to provide limited general economic benefit, particularly given ERCOT’s grid difficulties.

In December of 2021, I published a bearish view regarding the blockchain mining company Riot Platforms (NASDAQ:RIOT) in “Why Riot Blockchain May Never Generate Consistent Profits.” The stock has declined by ~64% despite a significant Bitcoin rally over the past year. RIOT is also down 28% YoY despite an 86% increase in Bitcoin’s value. Analyst sentiment remains very mixed, with many bullish and bearish outlooks.

Given Bitcoin is back at a high level and facing some stagnation to its rally, I believe it is another excellent time to analyze Riot Platforms. The company has changed over the past two and a half years, and the cryptocurrency market has shifted even more, going through a full negative and positive cycle since.

With Bitcoin at a high, we should imagine Riot’s current profit level may be in the higher range of its forward potential. Thus, it may be headed for even greater financial pressures if it cannot earn a consistent profit after years of development and higher cryptocurrency prices. Further, with Bitcoin crashing by over 5% on Thursday, we must consider RIOT’s exposure to a potential reversal in Bitcoin’s value.

Bitcoin May Have No Value in the Long Run

Over a decade ago, Riot’s business model likely would have sounded nonsensical to most people. The company owns massive Bitcoin “mining” facilities through data centers. This requires Gigawatts of power, enough energy to power hundreds of thousands of homes. Mind you, its operations are focused in Texas, which has had notorious difficulty with the ERCOT grid in recent years due to rising demand. As such, Texas has paid Riot Platforms through energy credits to avoid consuming power during peak demand periods. The company has reported this as “providing power,” but it is more than not using it during high-demand periods and getting paid for that.

All of this power is used to make more Bitcoins. Those who have read my work know that I do not believe Bitcoin is a viable currency, given its poor transaction efficiency “scalability problem.” What I understand is not necessarily important in the short-term, as if people believe in Bitcoin, it will have value. However, in the long run, I think it will likely be other cryptocurrencies that do not have scalability issues and extremely excessive power demand requirements that prove viable. Riot may adapt to this by shifting toward other cryptocurrencies.

Of course, potentially viable alternatives like Ripple cannot be mined. I argue that “mining” is a crucial issue with many cryptocurrencies. Riot’s servers are dedicated to solving “complex cryptographic puzzles” that become more difficult once Bitcoins are mined, artificially limiting supply growth. This validates transactions, but in a highly inefficient manner where the transaction ledger must be updated across a comprehensive decentralized platform of miners. Cryptocurrencies like XRP that do not use this inefficient method can do transactions in seconds (as opposed to ~30 minutes) at much lower power costs.

For me, Riot Platform is far too dependent on Bitcoin, a Dinosaur in the cryptocurrency market—the vast majority like Bitcoin for its speculative volatility. Most people think of Bitcoin in terms of its dollar value, directly implying that its value compared to fiat currency is more important than its value as a replacement of fiat currency. This is to say that Bitcoin has value only because people think it has value – not because it can replace fiat currency.

Rising Power Retail Prices Signal Political Risk

The most significant issue with its profitability is the cost of power. Including all of its facilities, its power cost was 2.6c/kWh last month. Due to seasonal fluctuations, its annual average power cost should be above that level. Its power costs are far below retail levels due to long-term power contracts and its effort to buy at low-cost periods and avoid consumption during peak demand. Since it has contracts to buy, it has earned sales by selling this pre-contracted power during expensive periods. It could be argued that its most profitable business segment is these gains from not operating.

Still, there is a generally positive trend in Texas’ power costs, likely partially driven by rising demand from industrial sources like Riot. See below:

Given Texas ‘ power grid issues, it is unclear if Riot will manage very low power costs indefinitely. Key figures in the Texas state government sought to survey its power consumption in an “emergency survey.” However, Riot, with aid from the Texas Blockchain Council, blocked this through a lawsuit, leading to the destruction of all relevant data. From this, I conclude that Riot’s exposure to political strains will likely grow, as people and politicians may see it as an enormous drain of scarce power that is not going to a clear economic purpose. Of course, I am confident that Riot would argue that mining Bitcoin serves some purpose, but politicians and voters struggling with rising electricity bills may disagree.

Unprofitable In Good Times and Bad

Most cryptocurrency-centric stocks are highly correlated to Bitcoin and other major cryptocurrencies. RIOT has partially lost its correlation to Bitcoin, given its operating income has collapsed to terribly negative levels despite an increase in revenue. See below:

Critical differences exist between how YCharts accounts for Riot’s operating income and how the company does. Per its annual report, we can see that it counts changes to Bitcoin’s value as an operating factor, whereas such (changes to fair value) are more typically viewed as non-operating, which is how YCharts accounts. Riot’s operating income is very negative, attributable to its relatively low profit margins after its power costs and other overhead. Of course, if we add back depreciation and amortization, or “net operating income,” we can see it closer to breakeven but still generally below that threshold. Further, by looking at the difference between its operating income and net income (per YCharts’ accounting), we can see its exposure to Bitcoin’s price. See below:

Riot Platform holds around 9.33K in BTC, which is worth around $538M at today’s price. As the price of Bitcoin rose in 2023, the company reported a positive change in the fair value of Bitcoin of $184.7M (10-K pg. 42). That figure is the primary driver of its positive net income on a TTM basis. However, even if we deduct all depreciation (some of which will be realized as its assets age), the company does not earn a consistent profit on its core operations, primarily mining.

The Bottom Line

I am skeptical of Riot Platform’s current business model. Not only is the premise of Bitcoin mining likely flawed (in my opinion), as well as the concept of Bitcoin-as-a-currency, but it has also failed to earn a positive net operating income even during a period of high Bitcoin prices. Of course, that point can be debated based on how we account for changes to Bitcoin’s fair value. Its income is positive due to unrealzied gains on higher BTC prices. Now that we’re seeing negative pressure in BTC, it seems that those gains could become losses.

From an operational standpoint, its most profitable activity is not using the power it bought at a lower cost. That is interesting, but I do not believe it will be an avenue for long-term consistent profitability. Today, its Bitcoin production is down dramatically YoY as it continues to shift toward lower production at greater Hash Rate efficiency.

While Riot’s strategy has failed to earn consistent profits in a would-be-strong period, it has some value. The company owns electronic assets, some of which could theoretically be converted into a traditional data center if it shifted away from Bitcoin. The critical issue with this is that most of its computational power comes from Application-Specific Integrated Circuits instead of CPUs and GPUs. These “ASIC” chips are specifically designed for cryptocurrency mining and use more power to do so more efficiently. If the cryptocurrency mining market fails due to a prolonged decline in cryptocurrency prices or higher power costs, these components may be of little value.

Still, Riot has no material financial debt and other valuable assets. Its tangible book value per share is $9.15, which is near its current share price of $9.6. Its cash position is historically high at $688M. That said, its value is at high dilution risk. The company is likely losing cash on an operational basis today and is instead utilizing tremendous cash from financing via very aggressive share sales. See below:

On a TTM basis, the company raised ~$1.09B from financing (primarily equity sales). However, its market capitalization is only $2.76B, so continued dilution at this pace could rapidly deteriorate equity holders’ value. In other words, the company is raising a lot of cash from investors and has failed to show a positive ROI from these investments. While its tangible book is near its market capitalization, I estimate that its liquidation value would be below its book value as I do not believe its chips are worth what they’ve paid for them, given I also think the Bitcoin mining industry is inherently unsustainable.

Compared to its peers, Riot does have a lower valuation based on price-to-sales and price-to-book. See below:

It is larger and more established within its industry but has a weakened reputation due to low returns on equity-dilutive investments. Consistently positive operating profits are unseen in the industry, so it isn’t easy to distinguish between their valuations.

I feel that companies can bring in a great deal of money from retail investors interested in popular trends or capitalizing on “FOMO.” In my experience, genuinely profitable growth industries usually focus on private capital markets with access to “smart money.” Those firms who can garner media attention with popular media buzzwords like “Bitcoin,” “AI,” and similar may find public markets a better avenue to raise capital, given institutional investors are more likely to be skeptical of its profitability potential. This is not to say that Riot or its peers are dishonest, only that retail investors should understand that companies can earn a lot of money from retail investors through equity sales if investors are willing to overlook profitability potential consistently.

In my opinion, retail investors in RIOT are overlooking its failure to earn a positive income despite massive projects that have required immense equity investor capital dilution. Again, if it cannot earn a solid operating profit during high Bitcoin periods, I do not see how it can thrive in the long term. My view is based on my belief that Bitcoin’s feasibility as a currency is very low. I am sure some may disagree with my opinion. However, even if we assume Bitcoin maintains the $50K to $100K range, it is unclear if Riot will see consistent positive operating cash flows.

For these reasons, I am bearish on RIOT and expect it will decline due to equity dilution, negative operating income, and potentially significant losses, given recent declines in BTC-USD. That said, I would not short-sell RIOT. RIOT’s short interest is 20%, giving it some risk of a positive breakout in a short squeeze. Although I am bearish on Bitcoin, it could continue to rise where Riot may temporarily see improved profits.

Lastly, and most importantly, if we assume Riot ends its equity dilution habit, its tangible net asset value may not be dramatically below its market capitalization. The company has a strong cash position and physical assets likely have some value even if it ended its mining focus. That said, I cannot provide a feasible value estimate for its physical assets because we’re not seeing a positive net operating income. Still, I think RIOT is overvalued broadly due to dilutions (and generally negative returns on investment) and not necessarily due to a significant premium to its theoretical net asset value.

Analyst’s 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.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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• Riot Platforms has underperformed compared to other Bitcoin mining peers, down 12% over the last year.
• Riot Platforms has made a bid to takeover smaller mining peer Bitfarms. Following rejection, RIOT has begun a hostile takeover attempt by acquiring 12% of BITF.
• Given the recent block reward halving, I suspect Riot Platforms will benefit from power credit optionality. This is not an advantage shared by peers.

One of the Bitcoin (BTC-USD) miners that has lagged the peer group year to date and over the last 12 months is Riot Platforms (NASDAQ:RIOT). Down 12% over the last year while other mining peers have doubled and in some cases even quadrupled, RIOT has been a disappointing ticker for mining stockholders at down almost 10%:

Riot is a company that I’ve covered for Seeking Alpha in the past. I’ve previously been bullish the name last year due to the company’s mix of EH/s capacity, debt-free balance sheet, and large unencumbered BTC stack. However, in my most recent article covering the company in February, I was less enthusiastic about the name and downgraded the stock to a “hold” due to what I viewed as efficiency concerns from the underlying business. A lot has happened in the four months since that coverage.

In this update, we’ll look at the company’s recent bid to takeover smaller mining peer Bitfarms (BITF), early post-halving production figures, and revenue trends to consider as Texas enters what could be yet another hot summer.

Bitfarms Takeover Bid

Less than two years ago, Riot Platforms was the second-largest Bitcoin miner by exahash capacity after only Core Scientific (CORZ). Marathon Digital (MARA) has impressively scaled to the top spot over the last 12 months. But today, Riot finds itself behind even CleanSpark (CLSK) which has quickly catapulted to a top tier miner. Given Riot’s nearly $1.3 billion in balance sheet liquidity between cash and Bitcoin, it’s not surprising to see the company already being active as Bitcoin mining faces consolidation.

On June 5th, Riot Platforms disclosed owning 12% of the outstanding common shares in Bitfarms stock. This is after reporting 10% ownership about a week prior. Riot’s disclosure of its beneficial ownership in Bitfarms comes about a month after making a buyout offer directly to the company at $2.30 per share. Per a prior disclosure:

In particular, on April 22, 2024, Riot sent a letter to the Board that set out Riot’s non-binding proposal to acquire all of the outstanding Common Shares of the Company (the “Proposal“) for consideration of US$2.30 per Common Share, to be paid with a combination of cash and shares of Riot’s common stock (the “Purchase Price“).

The Board of Directors for Bitfarms rejected Riot’s offer and recently announced a strategic review as the company attempts to figure out a path forward with buyout sharks apparently in the water. It should be noted that Bitfarms disclosed additional unsolicited expressions of interest in the company, though no specific names of additional suitors have been made public. It also bears mentioning that Bitfarms doesn’t have an acting CEO and is being sued by its last CEO for alleged wrongful dismissal and breach of contract.

Per Riot’s June 5th disclosure, the company is seeking presence on the company’s board of directors:

Riot currently intends to requisition a special meeting of the Company’s shareholders, at which Riot intends to nominate several well-qualified and independent directors to join the Company’s board of directors (the “Board“), which follows from Riot’s serious concerns regarding the Board’s track record of poor corporate governance.

Given Riot Platforms’ increased position in BITF stock, we appear to have a hostile takeover attempt happening in real time. As of article submission, Bitfarms shares are 8% above Riot’s original buyout offer price. But at 7.5 operational EH/s for the month of May, Bitfarms’ post-halving Bitcoin production isn’t terribly far off from what Riot averaged in the month when accounting for curtailment.

From Riot’s vantage, taking over Bitfarms’ operations is a fast way to grow operations in line with tier 1 peers without having to ship or energize machines. If Bitfarms does indeed have additional suitors who are willing to pay a higher price, it works to Riot’s advantage since it’s now such a large shareholder in the company.

Post-Halving Production & Power Credit Strategy

Riot Platforms has been slower to scale than other companies in the space. The latest production data from May shows a production figure that has predictably cratered following the block reward halving in late-April:

At just 215 BTC mined in May on 8.8 average operating EH/s, Riot’s BTC per EH/s figure in the month was 24.4. Bitfarm’s May figure was virtually the same. May is an important signal to the market because it’s our first indication of the viability of many of these companies in a post-halving environment. For Riot, May shows the fourth consecutive month of what amounts to a HODL strategy for the company, as it has kept all BTC produced.

Between June and September 2023, Riot Platforms reported $63.1 million in total power credits. This was against $40.3 million in BTC sales at an average price of just under $28k. As of article submission, the price of BTC is near $71k. Thus, even with the reduced block reward following the halving, the price of Bitcoin is more than double what it was last year when Riot Platforms found energy credits to be the better strategy.

Yet despite what is few as terrific gains in the price of BTC over the last year, we can already observe Riot’s willingness to curtail as May 2024 resulted in $7.3 million in energy credits – a 160% increase over May 2023. And again, May was the fourth consecutive month that Riot didn’t sell any of its BTC production. Acquisitions aside, Riot’s revenue path over the next four months boils down to something that is largely out of the company’s control:

June and July have both been previously forecasted to be hotter than average months for the state of Texas, with August and September being closer to normal. A more time sensitive update from NOAA (graph above) shows a high probability of above normal temperatures for nearly the entire state. While the company endured negative press because of its energy credits last year, RIOT’s stock responded very well to the strategy:

Risks

As I see it, the worst case scenario for Riot Platforms from an unapologetic business standpoint would be Bitcoin’s price declines and Texas simultaneously has a moderate to cool summer. If these things were to happen together, Riot’s power credit revenue would likely disappoint and the reality of operating mining machines in a post-halving world would impact the company’s bottom line. I would say that each of these factors are out of the control of the company.

Summary

From where I sit, Riot Platforms is an interesting trade idea, but probably not a great long term investment. Between now and likely the end of September, Riot should be able to benefit from power credit optionality. If it’s hot and Bitcoin’s price returns are lackluster, Riot can instead go the energy route for monetizing power. This is not something that every public miner is able to do, so it gives Riot Platforms and advantage in the event Bitcoin’s summer month price languishes. Alternatively, if Bitcoin’s price rockets higher, and it’s more economical to keep the machines running, Riot will benefit from its pivot to a HODL strategy and its Bitfarms equity will likely appreciate. There’s admittedly a lot of “ifs” and guesses here, but that’s the nature of the speculation game.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BTC-USD, RIOT, MARA either through stock ownership, options, or other derivatives. 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.

I'm not an investment advisor. I have a small speculative long in RIOT that I envision exiting later this summer.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Riot Platforms: A Summer Of Hostility And Energy Credits? appeared first on Up2info.com.

• Riot Platforms’ bid to buy Bitfarms signals potential consolidation in the competitive Bitcoin mining industry.
• Riot is reducing costs by purchasing power plans from utilities in Texas and using a flexible approach to mining.
• Scaling production capacity is crucial to overcome the effects of difficulty and sustain production levels in the face of halving rewards.
• However, comparison with peer Marathon Digital shows that Riot may not have increased hashrate fast enough to avoid a YoY revenue shortfall compared to last year, when it will report second-quarter revenues in July.
• Therefore, there are volatility risks which explain my Hold position, but, with a focus on maximizing self-mining operations, the company could represent a long-term opportunity.

I covered Riot Platforms (NASDAQ:RIOT) with a Hold thesis in June 2021 highlighting the way it was scaling, and since it has lost 71.5% in value and is trading at around $10. Its growth strategy saw it recently make a takeover bid for Bitfarms (NASDAQ:BITF) for about $950 million. This, I believe should be followed by other deals in a highly competitive crypto-mining industry where it is getting more difficult to produce Bitcoins.

This difficulty was exacerbated by the Bitcoin (BTC-USD) halving event last month, which marked a drastic reduction in the rewards perceived by miners for each block they add to the blockchain as operating costs remain on the high side in a market where prices may be pressurized.

Against such a backdrop, this thesis shows that despite a 35% year-to-date downside, Riot is not a buy.

Instead, this could represent an opportunity given the way it is managing direct costs to mine while also scaling operations.

Reducing Costs to Address The Issue of Lower Rewards

First, energy remains the largest cost item for Bitcoin miners, as it limits the ability to bring the hashrate online or increase production capacity.

Thus, for Riot, power costs were $16,764 in the first quarter of 2024 (Q1) and represented 73% of the total direct cost to mine. The remaining 27% includes labor, insurance, network maintenance, equipment repairs, land lease and taxes, network costs, and other utility expenses.

Looking across this highly competitive industry, miners like Bitfarms normally target low-cost, stranded, and renewable electricity. However, Riot has a different strategy, one consisting of purchasing power plans from utilities in Texas. Moreover, instead of just using all of them to maximize crypto output, these are used on an economically efficient basis. In other words, Riot only uses part of the energy purchased for business operations and sells the rest to utilities in exchange for credits to apply to future energy bills.

Second, in addition to energy, the efficiency of mining operations also depends on the Bitcoin mining machines and the type of cooling used. In this respect, to compensate for the drop in revenue, miners improve the average energy efficiency of their fleet by replacing older, less efficient miners with newer, more efficient miners.

As for Riot, it has chosen MicroBT M66S machines for its Rockdale facility and one of the particularity of this machine is its ability to use immersive liquid cooling, a technology the miner is deploying for its Corsicana facility purchased in 2022. For investors, immersion cooling is more efficient than air cooling and data centers equipped with this technology can consume as much as 50% less energy.

Overall, flexible power plans, a more efficient mining fleet, and cooling technology are ways to improve margin profiles, but, equally pressing, is the need to increase production capacity since the reward earned for adding each block on the blockchain was divided by two, or from 6.25 BTC to 3.125 BTC after halving. This entails a reduction in mining revenues unless additional hashrate is added.

Mining Difficulty and How Bitfarms Could Have Boosted Riot’s Position

To complicate matters further, there is also mining difficulty. Thus, looking at production, only 1,364 BTC were mined in Q1 representing a substantial 36% YoY drop. This is explained by a doubling in average difficulty, from around 40 in the first quarter of 2023 to 80 in the same period this year, as shown in the chart below. This was caused by an increase in global hash rate, making it more difficult to mine the next block as miners boosted production in the pre-halving period to profit from higher rewards.

Now, unless a miner diversifies into AI or another industry verticals, the only way to overcome the effects of difficulty and sustain production levels is to increase the hash rate. For Riot, this means more than doubling the 12.4 exahash deployed at the end of Q1 to 31 exahash by end-2024. Now, while the company is executing plans to add capacity organically, acquiring Bitfarms which intends to boast 12 exahash by the end of this year would have greatly accelerated its endeavor.

However, the takeover was rejected on the basis that it undervalued Bitfarms which initiated a strategic review or a re-assessment of a company’s strategy and finances to achieve optimum shareholder value through a merger, sale, or other transaction.

Moreover, from the competitive standpoint, the 43 (31 + 12) exahash would have placed Riot closer to Marathon Digital (MARA) which plans to increase capacity to 50 exahash by the end of 2024. To achieve such a feat, the world’s largest Bitcoin miner has been aggressively acquiring mining sites and was able to boost the hash rate from 11 exahash to 27 exahash at the end of Q1.

Thus, by scaling, miners increase their hash rates to obtain more block rewards while at the same time, it provides them with a larger base of operations on which to spread fixed costs, resulting in better gross margins. In addition, it also entitles them to more influence regarding network changes, as voting power is proportional to a miner’s hash power.

Thus, with 27 exahash compared to only 12.4 exahash for Riot, Marathon is in advance. From this perspective, Riot seems to be playing catch up with the Bitfarms acquisition.

Riot Has Increased Hash Rates Organically but This Could Not Be Enough

Moreover, in addition to the absolute number of Bitcoins mined, investors are likely to focus on the degree to which miners can avoid revenue shortfalls. In this respect, a comparison of the realized Bitcoin hashrate, which is the hashrate actually achieved over the installed operational capacity shows that Marathon has increased its production capacity faster in Q1, indicated by the steeper gradient of the yellow line below, while the pace has been slower for Riot.

In these circumstances, given that mining difficulty remains above 80, likely Riot will again suffer from lower mining revenues for Q2 compared to the same period last year. This is further justified by its BTC production for April being 41% lower YoY.

As a result, it may have to sell more Bitcoin to offset this shortfall and not suffer a dent in revenues. However, prices will likely be under pressure as other miners who have not been able to boost production capacity in time to offset the effects of mining difficulty may be constrained to sell some of the coins they have HODLed, possibly as much as $5 billion in total as per analysts at 10x Research.

As a result, Riot could see a further decline in its revenue growth relative to its five-year average of nearly 282% as pictured below, which could in turn prove volatile for the stock.

Riot is a Hold with its Power Credit Differentiator

This means potential volatility risks when the company reports Q2 results at the end of July. Volatility also grappled Riot’s stock when its takeover bid was rejected, and may again impact the stock in case another miner merges with Bitfarms. This is the reason why with a trailing price-to-sales of 6.91x three times lower than its five-year average of 22.96x as tabled below, it is not the right time to invest, but I am not bearish.

The reason is analysts estimate revenue growth to pick up at 54% YoY for 2024. This is explained by the miner deployed a hashrate of 12.4 exahash at the end of Q1 resulting in an 18% YoY increase in production capacity. At the same time, the energization (powering up) of its Corsicana facility as part of the first phase deployment puts it on a clear path to achieve 31 exahash by the end of 2024.

Thus, for those who want to position themselves, the support level has been in the $8 to $8.8 range during the last year as pictured below, yielding a median of $8.4, which would be a reasonable entry price.

Furthermore, looking at finances, the miner had 8,490 coins entering into Q1 which is worth about $594.3 million considering a unit price of $70K. When added to the $688.5 million of cash in its balance sheet totals $1.28 billion. This signifies it has sufficient money to cover operating expenses which averaged $216 million in the last three years, in case the halving/difficulty combination takes a bite at its revenue. Also, after terminating hosting contracts or leasing data center space to miners, at its Rockdale facility, the focus is on maximizing self-mining operations.

Therefore, the stock is a Hold while it delivers on increasing hashrate efficiently. It could again benefit this summer ahead of what’s predicted to be one more record-hot summer in Texas. For this purpose, as part of its long-term power agreements, it already received power credits totaling $71.2 million for the twelve months that ended in December last year, compared to only $27.3 million during the same period in 2022. This equates to approximately 1,017 BTC considering a unit price of $70K per coin, or 12% of its actual Bitcoin reserves, which is significant.

Equally important, had the power curtailment credits been applied to the cost of sales, the gross margins would have increased by 2% on a non-GAAP basis, or from 45% to 47%.

Volatility Risks are not excluded as the Industry Consolidates

However, its energy strategy could induce volatility risks to the stock in case the United States were to face an energy crunch as a result of higher activity for AI and Bitcoin. In this respect, Riot has already been criticized by Greenpeace, as the “largest and most energy-intensive Bitcoin mine” causing pollution and climate change. In response, the miner put forward its flexible approach to Bitcoin mining which contributes to grid stability, especially in the summer when there is more demand for power.

Finally, Bitfarms has received additional expressions of interest implying other parties could be interested in its assets, triggering a wave of consolidation in the mining industry. Potential bidders could include miners who instead of, or in addition to, investing to build or expand mining capacity opt to acquire or merge with existing ones. However, after having accumulated a 9.25% stake, Riot could be its largest shareholder and plans to request a special shareholder meeting to add independent directors to Bitfarms’ board. Therefore, chances are it could eventually gain the upper hand.

Analyst’s 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.

This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post Riot Platforms: Potential Long-Term Opportunity In A Consolidating Industry appeared first on Up2info.com.

• Riot Platforms’ aggressive expansion and investments in advanced mining infrastructure position them as a major player in the Bitcoin market.
• Shareholders face heavy dilution due to frequent public offerings of stock to raise necessary capital.
• The post-halving landscape presents challenges for miners, and Riot Platforms’ profitability remains uncertain.

Investment Thesis

I believe as Riot Platforms (NASDAQ:RIOT) navigates the post-halving landscape of Bitcoin now that the halving occurred last weekend, their aggressive expansion and significant investments in advanced mining infrastructure position them as a major player poised to capitalize on potential market upturns. However, I think this expansion is turning out to be expensive and shareholders have to contend with heavy dilution.

Key to Riot’s growth strategy is their ability to manage the strong financial pressures from their increased depreciation costs due to its rapid asset expansion. This is being compounded by frequent public offerings of stock that raise necessary capital but risk shareholder dilution. While some analysts are not as concerned, as evidenced by the recent upgrade from “Neutral” to “Strong Buy” by J.P. Morgan, I am more reserved. I absolutely believe in the long run potential of Bitcoin, as I wrote about in my recent Blackrock iShares IBIT ETF analysis, but I am more concerned about the pressure that miners are facing, Riot Platforms included.

Given the critical need for price increases from here to sustain profitability post-halving, I believe Riot’s stock remains a hold. However, if Bitcoin continues to appreciate rapidly and aligns favorably with Riot’s operational advancements, I definitely think there could be a strong case for an upgrade to buy.

Background: Understanding The Impact of The Halving

The Bitcoin ecosystem recently underwent its quadrennial halving event, a significant occurrence that slashed the mining reward from 6.25 to 3.125 BTC per block. The per block reward reduction has big implications for miners, with some projecting that about 15% of Bitcoin miners may shut down due to unsustainable profits, as the cost of mining remains high while the rewards have halved.

With this, the impact of the halving is particularly severe for miners with less efficient setups or those facing higher electricity costs. Only the most efficient miners, equipped with the latest technology and accessing the cheapest power, are likely to endure the new economic realities of the Bitcoin network. Post-halving, I believe the industry is seeing a shift where only well-capitalized and technologically advanced miners can maintain profitability. This scenario may lead to further centralization of mining operations, as smaller players could be forced out of the market​. This is definitely a market where Riot can outperform their competitors. My concern is that this may not be enough on its own for them to be profitable.

The decreased reward per block fundamentally changes the economic landscape for Riot Platforms. Going into the halving (last month) Riot, BTC mining yield wasn’t quite increasing even before the halving. So my concern is that the new reward structure exacerbates the challenge.

Earlier this month, Riot reported a 39% decrease in Bitcoin production year-over-year for the month of March, highlighting the problems with mining rate stability even pre-halving. While the firm has ordered more mining rigs to bring on more capacity, I don’t believe the efficiency of the ones they currently have was maximized.

What I find notable is that the average operating hash rate was below the deployed in both March 2023, February 2023, and last month. While the proportion has stayed roughly the same, it means the company is likely not operating at peak efficiency.

Historically, halving events have led to increased Bitcoin prices over the long term, driven by reduced supply and increased scarcity. However, the period right after (the immediate aftermath) can be turbulent for miners if the price of Bitcoin does not increase proportionally to offset the reduced block rewards​, Riot included.

Depreciation Is A Problem

Over the last few years, Riot shareholders have had to deal with dilution, partially caused by strong depreciation expenses, driven by their accelerated mining rig upgrade cycles.

The depreciation and amortization expenses alone totaled approximately $246.5 million for 2023, up substantially from $105.9 million in 2022 and $26.1 million in 2021​​. This surge in depreciation costs is attributed to the company’s aggressive expansion and mining rigs (partially in anticipation of this most recent halving_. As noted from their 10K:

Depreciation and amortization expense during the years ended December 31, 2023 and 2022 totaled $252.4 million and $108.0 million, respectively. The increase of $144.4 million was primarily due to higher depreciation expense recognized for the Rockdale Facility and the significant increase in the number of recently acquired and deployed miners. -RIOT 2023 10K

The company’s strategy to handle these soaring costs largely consisted of issuing additional shares to raise capital. In 2023 alone, Riot conducted large at-the-market (ATM) equity offerings, receiving net proceeds of approximately $761.773 million from the sale of 62.2 million shares (10K). Keep in mind that at the time of this writing, their total market cap now is only $2.3 billion.

While these offerings provided what I believe to be necessary capital, they also led to strong shareholder dilution. I think this really needs to change for investors (including myself) to get more bullish on the stock. I personally like Bitcoin because the quantity of coins is capped. It does not appear the same is true for Riot Platform shares.

While this has been fairly necessary for funding the substantial capital expenditures required to stay competitive in the Bitcoin mining industry, it introduces a significant forward dilutive risk. This is one of the main reasons why I am a hold on the stock. Since I am a hold I’m not going to attempt what I think the current fair value of the stock is (the dilution factor adds too much uncertainty).

Bull Thesis (What Could I Be Missing?)

In a recent update from J.P. Morgan, Riot got an upgrade from “Neutral” to “Overweight” with a price target of $15. As of the time of this writing, JPM reiterated their rating this morning.

The bullish outlook by J.P. Morgan’s analyst was influenced by Riot’s initiatives aimed at expanding its mining capacity and improving fleet efficiency, particularly with its plans to boost its hash rate at the new Corsicana facility to nearly 20 EH/s throughout 2024.

The bank’s endorsement comes amidst a broader adjustment of price targets for Bitcoin mining stocks by J.P. Morgan, reflecting recent positive movements in Bitcoin prices and overall network hash rate, which supports a more optimistic financial outlook for companies like Riot Platforms.

To be clear, I think there is a good chance even with the decline in Bitcoin mining yields in Q1 that the company made ~some~ sort of profit. In the 10K, they note:

A 10% increase or decrease in both the price of Bitcoin produced during the year ended December 31, 2023 and the fair value of Bitcoin as of December 31, 2023, would have increased or decreased net income by approximately $48.9 million -10K.

Since December 31st, Bitcoin is up over 50%. Extrapolated to one quarter of 50% gains and this would result in about $61 million in net income adjustments in Q1. This doesn’t mean this is sustainable however (we all know how volatile Bitcoin is). Rather, this is the firm benefiting from securities on their balance sheet going up in value. This does not indicate the viability of the underlying mining business.

Conclusion

I believe Riot Platforms, one of the major players in the U.S. Bitcoin mining landscape, finds themselves at a juncture following the 2024 Bitcoin halving event.

The halving on April 19th has drastically reduced block rewards, likely extending the financial strain due to the company’s aggressive expansion of mining rigs and the rising costs of technological upgrades. These challenges are reflected in Riot’s significant increase in depreciation expenses and the substantial capital raised through share offerings to fund its operations, which, while necessary, dilutes shareholder value.

While I am long run bullish on Bitcoin itself, I think the company’s mining strategy may face headwinds due to their strong at-the-market offerings to fund capital upgrade cycles. After a while, the market may balk at these equity demands and not provide a share price high enough to support future share offerings.

For now, I am a hold. If the price of Bitcoin appreciates exponentially, or the company is able to sustainably mine Bitcoin (and generate net income after depreciation expenses) then I could be convinced to upgrade the stock.

Analyst’s 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.

Noah Cox (account author) is the Managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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