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Introduction
A business can be funded in 2 ways: Equity or Debt. The notion of debt is a negative one because businesses risk insolvency when taking on debt. The late Peter Lynch once said:
When purchasing depressed stocks in troubled companies, seek out the ones with the superior financial positions and avoid the ones with loads of bank debt. • Companies that have no debt can’t go bankrupt.
Riot Blockchain (NASDAQ:RIOT) actually fits the description above. Firstly, RIOT is indeed depressed because Bitcoin and RIOT declined 70% and 90% from their respective highs. Secondly, RIOT has no debt. RIOT’s total liabilities are only 10% of its total assets.
Completed the first quarter of 2021 with record current assets and zero debt.
Given this context (a depressed yet debtless), we were prompted to dive deep into RIOT’s zero-debt policy. Therefore, this article aims to examine RIOT’s zero-debt policy going into its Q2 quarterly report release.
Identifying the source of RIOT’s growth
There is clear evidence that RIOT’s growth is sustained through dilution. RIOT’s shares outstanding grew from 84.12mil (2021Q1) to 117.3mil (2022Q1), or 40% in a year. $600mil was raised.
The significant increase in shares outstanding occurred in 2021Q4 which saw an influx of cash. In 2021Q4, RIOT’s cash position grew from only $57.8mil to $312mil, deposits for asset purchases grew from $94.4mil to $266.17, and properties and equipment grew from $200mil to $263mil. These changes amounted to 80% of the cash raised.
In the following quarter (2022Q1), the decrease in cash down to $113.5mil is reflected in the increase in deposits and properties, and equipment.
Since this growth (in mining capacity) took place without material changes in debt level, we can establish a thesis stating RIOT’s growth is sustained through dilution.
Dilution to cover operating expenses
In addition, we can also establish a thesis that RIOT is sustaining its business activities through dilution.
Since RIOT is a Bitcoin mining company, RIOT’s only source of income is Bitcoin mined. RIOT would need to sell Bitcoin mined to raise cash to cover expenses. The hosting segment is omitted here because it is loss-making (revenue $9.7mil vs cost of revenue $15mil). However, it doesn’t seem like RIOT is selling nearly enough Bitcoins to cover its business expenses.
During the period 2021Q1 to 2022Q1, RIOT produced (self-mined) 5,218 Bitcoins while RIOT’s Bitcoin reserve increased by 4,549 Bitcoins. This implies that 87% of mined Bitcoin was retained by RIOT. Could the 669 Bitcoins sold cover operating expenses? Unlikely, based on RIOT’s operating expenses during the period.
What does it mean to invest in RIOT then?
In order to maintain shareholders’ claim on the same amount of profit amidst 40% dilution, RIOT’s profit has to grow by 40%. Therefore, investing in RIOT means that investors believe Bitcoin can appreciate to increase RIOT’s profit by more than 40%.
40% dilution is by no means marginal. However, Bitcoin’s volatility could justify this 40% dilution. RIOT’s 2022Q1 all-in business cost per BTC is $30,800. Assume a $50,000 Bitcoin, RIOT’s profit per Bitcoin mined would be $19,200. Bitcoin only has to appreciate by 15.4% to increase profit by 40%, thus justifying the 40% dilution.
In fact, Bitcoin doesn’t need to increase by 15.4% to justify the 40% dilution. Since Bitcoin is an asset, RIOT’s valuation increases when Bitcoin appreciates. The more Bitcoin is in RIOT’s reserve, the less Bitcoin is required to appreciate to justify the 40% dilution.
Although our thesis sees Bitcoin bottoming out at $10,000 by the end of 2022, our thesis also sees Bitcoin reaching $100,000 in 2024.
Given that Bitcoin is in a bear market and is expected to remain in a bear market or sideways market until 2024, dilution is preferable in terms of the risk of insolvency. No debt, no bankruptcy.
What if RIOT can no longer dilute shareholders for capital?
It’s simple, RIOT will have to start selling more and more of its Bitcoins mined. However, herein lies the problem.
RIOT has already begun selling Bitcoin to raise cash to cover expenses amidst Bitcoin’s sharp decline since April 2022. For every passing month since April, RIOT has been selling more and more of its Bitcoins mined in both absolute amount and relative amount. But the cash raised from the sale is decreasing.
- 250 Bitcoins (out of 508 or 50%, to raise $10mil) sold in April
- 250 Bitcoins (out of 466 or 54%, to raise $7.5mil) sold in May
- 300 Bitcoins (out of 421 or 71%, to raise $6.2mil) sold in June
- 275 Bitcoins (out of 318 or 86%, to raise $5.6mil) sold in July
This trend is a worrying sign. Should Bitcoin decline further, sales from Bitcoins mined wouldn’t be sufficient to cover expenses. Then, RIOT would need to tap into its Bitcoin reserves to cover expenses.
Under such circumstances, share offerings (dilution) won’t be feasible as well. RIOT’s share price would tank further while more dilution will result in less cash raised. Assuming investors will subscribe to the shares offerings.
It is a vicious cycle indeed.
Upcoming Q2 performance expectations
RIOT mined 1,395 Bitcoins in Q2, a figure similar to its previous 3 quarters. Hence, RIOT’s all-in business cost per BTC (excluding stock-based compensations (SBC)) is expected to be around $29. RIOT’s stock-based compensation has historically fluctuated wildly (Table 1). But should SBC normalize, we expect RIOT’s all-in business cost to anchor around the $30k level. Should all-in business cost per BTC increase materially over $30k (not caused by SBC), RIOT should be devalued accordingly as it projects poorer profitability in the future, higher liquidity risk, and more severe dilution.
We also expect the cost of revenue per BTC to be at the low $10k level, which aligns with its consistency in 2022Q1 and 2021Q4. If the cost of revenue increases, this would imply that increase in energy cost or labor cost is creeping into RIOT’s costing. This would be devastating going into winter as demand for energy is expected to increase further.
We expect cash on hand to remain above $100mil. This is because the cash required to cover operating expenses was raised through sales of Bitcoins mined. Any decrease in cash on hand should be followed by an increase in deposits or properties and equipment. Should this expectation be violated, liquidity risk is material.
Table 1: RIOT’s Management SBC as a Percentage of Total Expenses
|
QR |
Cost of Revenue (mil) |
Depreciation (mil) |
Mgnt Comp (mil) |
Prof + Admin + consult (mil) |
Interest Exp (mil) |
Total Self Mining Cost (mil) |
Mngmt Comp % |
|
2022Q1 |
19 |
14.25 |
3 |
7 |
0 |
43.25 / 40.25 |
7 |
|
2021Q4 |
15.7 |
5.536 |
30.5 |
8.43 |
0 |
60.17 / 29.73 |
50.7 |
|
2021Q3 |
13 |
12.2 |
36 |
4 |
0 |
65.2 |
55 |
|
2021Q2 |
9.3 |
5.738 |
1 |
2.5 |
0 |
18.54 |
5.3 |
|
2021Q1 |
7.5 |
2.85 |
1 |
4.5 |
0 |
15.85 |
6.3 |
Source: Author, RIOT Form 10-Q
Valuation
RIOT’s cost structure aligns with industry averages. Hence, expected capacity (Table 2) should be the major factor in determining RIOT’s valuation relative to other Bitcoin miners. On this basis, RIOT’s market cap is justified. RIOT has a lower expected capacity than MARA and CORZ and a higher expected capacity than the rest.
CORZ may seem undervalued compared to RIOT, but CORZ is plagued by operating and business inefficiencies. CORZ’s cost of revenue is 2 times higher than RIOT’s. CORZ almost depleted its Bitcoins reservices by selling more than 7k Bitcoins in June to raise $160mil. We still need to wait for official SEC fillings to determine how the cash raised is utilized. Whether it is to cover its operating cost or for deposits and asset purchases (expansion).
Table 2: Bitcoin Mining Companies Market Cap Relative to Expected Capacity
| Company | Bitcoin Reserve (June 2022) | Built-up Mining Capacity | Near Future Expected Capacity | Market Cap Net of Bitcoin Reserve ($bn) |
| Marathon Digital (MARA) | 10,055 | 3.9 | 23.3 | 1.27 |
| Core Scientific (CORZ) | 1,959 | 8.3 | 16 | 0.875 |
| Riot Blockchain (RIOT) | 6,654 | 4.4 | 12.8 | 0.847 |
| Iris Energy (IREN) | -* | 1 | 10 | 0.29 |
| Bitfarms (BITF) | 3,144 | 3.6 | 8 | 0.246 |
| HIVE Blockchain (HIVE) | 3687 (3239 BTC + 7667 ETH) | 2.17 | 6 | 0.346 |
| Hut 8 Mining (HUT) | 7406 | 2.78 | 6 | 0.25 |
| Soluna Holdings (SLNH) | -* | 1.021 | 4 | 0.06 |
Source: Author
Verdict
In this article, we established our thesis that RIOT’s growth and operation are sustained through dilution. Given Bitcoin’s current bear market, RIOT could be entering a vicious cycle of selling more Bitcoins or shares to raise less cash.
Since production performance is already known before the Q2 report release, what we’re focusing on is the expenses. Should actual figures deviate from our expectations laid out in the previous section (for the worse), we’ll need to further downgrade RIOT accordingly.
Considering the vicious cycle, dilution, and other forms of business risks (e.g., inflation), we maintain our view that Bitcoin is the better investment than RIOT.
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