Riot Blockchain’s Middle Child Syndrome

Introduction

So far we’ve covered almost every major Bitcoin (BTC-USD) mining company listed in the US. We found that mining companies adopt different capital structures to sustain operations and growth. In our previous coverage of Riot Blockchain (NASDAQ:RIOT), we found that RIOT’s operation and growth are sustained through dilution, which saw RIOT increase its shares outstanding by 40% since 2021. We made a similar observation in Hut 8 Mining (HUT) as well, where HUT increased outstanding shares by 89% during the same period and will increase by 75% more in the coming quarters.

On the other hand, CLSK did not take on debt nor does it dilute shareholders, rather, it sells the Bitcoins mined to cover expenses. MARA is the opposite of HUT and RIOT where MARA takes on debt to fund operations and growth. Both MARA and CLSK have the highest targeted mining capacity by end of 2023 (23 EH/s and 22.4 EH/s, respectively). Since there is no dilution, as long as they remain solvent, a long-term investment time horizon can be justified.

Our eventual conclusion for HUT was timing the market is better than time in the market, despite trading well below book value. Given the similarities between RIOT and HUT, this article aims to examine the uniqueness of RIOT’s investment value proposition in the Bitcoin mining sector.

Varying Balance Sheet Policies

Although both HUT and RIOT dilute shareholders for operation and growth, the severity of the dilution varied due to balance sheet policies. HUT has committed to a 100% Bitcoin HODL strategy. It means that HUT will not sell the Bitcoins mined:

Keeping with our longstanding HODL strategy, 100% of the self-mined Bitcoin in September were deposited into custody

HUT hasn’t sold a single Bitcoin mined at least since 2021Q1. On the other hand, RIOT has started to sell the Bitcoins mined:

• 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
• 350 Bitcoins (out of 374 or 93%, to raise $7.7mil) sold in Aug
• 300 Bitcoins (out of 355 or 85%, to raise $6.1mil) sold in Sept

Naturally, RIOT does not need to dilute shareholders as much because of the cash flow generated from the sale. As a result, RIOT’s Bitcoin reserve grew only marginally compared to HUT (Table 1). Despite having 60% more mining capacity than HUT, HUT’s Bitcoin reserve has exceeded RIOT’s since 2022Q2 and its size is second only to MARA (10,670 BTC).

Table 1. Bitcoin Reserve Growth Over Time

QR	RIOT	HUT
2022Q3	6,775	8,388
2022Q2	6,653	7,406
2022Q1	6,320	6,460
2021Q4	4,884	5,518
2021Q3	3,995	5,053
2021Q2	2,687	4,240
2021Q1	1,771	3,522

Click to enlarge

Source: Author

RIOT’s Investment Value Proposition

We’ve previously established that HUT shareholder value will be very sensitive to the Bitcoin reserve value because its Bitcoin reserve alone is already worth 46% (= $20,000 per BTC * 8,388 BTC / $364mil market cap) of HUT’s entire market cap.

On the other hand, RIOT’s Bitcoin reserve value only represents 14% of its market cap. That being said RIOT is on par with HUT when considering other valuable assets. RIOT’s market cap ($982mil) to adjusted book value ($1.05bn = $270mil cash + $411mil PP&E + $20,000 x 6,775 BTC Bitcoin reserve + $376mil prepaid – $147mil total liability) ratio is 0.935, compared to HUT’s ratio of 0.9 ($364mil market cap / $404mil adjusted book value).

Therefore, RIOT has a similar value proposition to HUT in terms of equity.

In terms of mining profitability, RIOT outperforms HUT in every major aspect. RIOT’s current and near-future capacity are both higher than HUT by 82% and 260% respectively, while the cost of revenue (excl. Depreciation) per BTC and all-in business cost per BTC are lower than HUT by 35% and 30% respectively (Table 2).

Table 2. Profitability Metrics

	RIOT	HUT
Current Capacity	5.6	3.07
Near-term Capacity (2022Q4/2023Q1)	12.5	3.5
Cost of Revenue (CoR)(excl. Depreciation) per BTC	$13k = $18mil / 1,395 BTC	$20k = $19.1mil / 946 BTC
All-in Business Cost per BTC	$35k = $49.3mil / 1,395	$49.5k = $46.8mil / 946 BTC

Click to enlarge

Source: Author

What’s counterintuitive though, is that both RIOT and HUT offer the same upside potential. RIOT can justify a valuation of $3bn (200% upside) compared to HUT’s 1.1bn valuation (200% upside) based on the following assumptions:

• Q2 all-in business cost basis: RIOT $35k per BTC, HUT $49k per BTC
• Q2 asset and liability level
• Bitcoin reclaims all-time high (‘ATH’) at $70,000 per BTC
• P/E Ratio of 5
• 422 EH/s Bitcoin network hash rate by end of 2023 based on 2021 and 2022 growth rates.
• 12.5 EH/s / 3.5 EH/s near-future capacity will be fully realized.

Therefore, RIOT’s superior profitability could not provide it with additional upside.

These results suggest that there are no material differences in the investment value proposition between RIOT and HUT. What we can take away from these observations are:

• A major portion of RIOT’s 2.5x higher future capacity is already priced in. RIOT’s market cap is already 170% higher than HUT’s.
• RIOT’s upside potential was lost due to the sale of Bitcoins mined. As a result, RIOT’s smaller Bitcoin reserve has less to gain from the Bitcoin recovery.

Verdict

Investors are not short on alternatives when it comes to selecting a Bitcoin mining company: CLSK would be ideal if a smaller Bitcoin reserve in exchange for low dilution and low leverage is desirable; MARA would be ideal if higher leverage in exchange for a larger Bitcoin reserve and low dilution is desirable.

But when it comes to more severe dilution in exchange for a larger Bitcoin reserve and low leverage, both HUT and RIOT offer very similar propositions in terms of equity multiples and upsides. What will give HUT an edge is that HUT is not as volatile. Since risk is defined as volatility, HUT has a lower risk. Therefore, if severe dilution in exchange for a larger Bitcoin reserve and low leverage is desirable, HUT is ideal.

What about the near-term highest expected capacity? RIOT’s 12.5 EH/s still trails behind MARA’s 23 EH/s and CLSK’s 22.3 EH/s. What about mining efficiency? RIOT’s $13,000 CoR per BTC and $35k all-in business cost per BTC also trails MARA’s $6,240 CoR per BTC and $31,700 all-in business cost per BTC. Furthermore, RIOT recently sold Bitcoins mined as CLSK, yet continues to risk a similar level of dilution as HUT (e.g. RIOT’s recent filing for a $500mil equity offering in Q2).

In summary, RIOT fails to fit a particular profile exceptionally well. As a result, RIOT risks being excluded, ignored or neglected by investors.