Bitfarms: higher risk, higher reward (BITF)

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Bit Farms (NASDAQ: BITF) is now 80% off its all-time high, so should you buy the dip, or was the stock purely overvalued and now lining up with reality?

The basic answer using standard stock valuation methods is that Bitfarms is undervalued. But, as you surely know, the underlying asset Bitcoin (BTC-USD) has a mind of its own, and short-term fluctuations can make and break individuals or businesses overnight. Like according to my last postBitfarms is always a long-term buy if you are able to withstand the volatile nature of the underlying asset class.

Heightened fiscal risk, strong operations

Bitfarms surprisingly made a profit of $5 million or 0.02 EPS, despite the collapse in cryptocurrency prices. But the standard accounting net income is not the best for analyzing the underlying operations of Bitfarms (or crypto miners in general). A more meaningful measure is EBITDA or Adjusted EBITDA to assess operational performance.

Bitfarms Bitcoin EBITDA

Bitfarms EBITDA (Bitfarms)

Adjusted EBITDA gives a clearer view of the underlying operation. It removes the impact of standard book depreciation and interest, eliminates the effects of equity compensation and financing costs, and perhaps most importantly, incorporates unrealized gains and losses.

We will continue to review the impact of downside funding as it is generally vital but not necessary when looking at the underlying trades.

Since owning Bitcoin is a fundamental principle of Bitfarms, the incorporation of unrealized gains and losses, which are not included in accounting EPS, is extremely important.

As a result, year-over-year adjusted EBITDA increased by 64% despite opposing market conditions.

Energy pressure

Lower Bitcoin prices were primarily responsible for gross margin crashing to 76% from 84% in Q4 2021. During the first quarter, prices ranged between $33,000 and $46,000, so if the current price of about $30,000 remaining for the remainder of Q2, expect further compressed gross margin. At a Bitcoin price of $30,000 and keeping the same variable costs of $8,700, the margin for the next quarter would be 71%.

In addition to a suppressed Bitcoin price, another external effect has been energy prices.

Some analysts are concerned about rising mining costs. Sure, rising energy costs will impact some miners, but not all miners, including Bitfarms, will be devastated. Mining variable costs are now at $8,700/Bitcoin, up from $8,400 in Q4. In fact, Bitfarms saw a higher variable cost per bitcoin of $9,000 in Q2 2021.

Bitfarms has some of its energy prices guaranteed by contracts. Secure energy prices eliminate the risk of short-term energy fluctuations.

The main installation at risk is the Argentinian installation, because it uses natural gas instead of hydroelectricity. Bitfarms has a rate of $0.02 per KWh for the next four years before moving to market rates. So, if natural gas prices remain high after the contract fixed rate is exceeded, Bitfarms will feel the effects of increased costs in that facility.

However, most Bitfarms operations use hydroelectricity. Since hydroelectricity does not have the same mobility as natural gas or other fossil fuels, it does not experience the same price increases even if long-term energy prices increase. When it comes to bitcoin miners, Bitfarms is relatively well insulated.

The importance of a strong balance sheet

Now that we are actively seeing downside risk in the broader markets and in crypto, it is crucial to see how companies are reacting to their funding and cash management.

One of my main criticisms of a larger competitor, Marathon Digital (MARA), is that it went into debt, $600 million in December 2021. Not to say that the debt doesn’t has no place, but taking advantage of an already volatile market increases the risk considerably.

Since I last wrote about Bitfarms it has gone into debt.

As of Q1 2022, Bitfarms has a $100 million line of credit backed by Bitcoin, which charges an interest rate of around 10.75%. The immediate risk here is having to commit additional Bitcoins if the price continues to fall.

For collateral, 133% of the credit value must be pledged, or $133 million worth of Bitcoin. At the end of April, 5,646 Bitcoins are held, which means that if the price falls below ~23,500, it may cause the Bitcoin to be disposed of. If the credit value stays the same as bitcoin is mined, the disposal price will drop. Collateral is the imperative short-term risk to monitor.

The advantage of using a line of credit is that it is less expensive compared to financing equipment.

Now let’s move on to the crucial aspect of financing.

Bitfarms equity financing strategy has its ups and downs. By turning interest rate and default risk into dilutive risk, let’s look at how dilutive it was.

Since the program’s implementation at market in August 2021, 30.7 million shares have been issued at an average of $5.77/share, significantly higher than the current price. The most recent quarter had 6.8 million shares issued at an average of $3.99/share.

Bitfarms had 201.6 million shares outstanding as of the closing date, so the market offering is responsible for 15% of the total issued shares. Since the share price has fallen below the average issue price by a significant amount, this is fundamentally beneficial to shareholders who have held shares under the program.

The benefit of this can be seen in the book value, which is $2.28/share. When combined with the price of the shares, the price-to-book ratio is 0.83, which means that the book value of the underlying exceeds the valuation of the shares. Adjusting for $30,000 Bitcoin, the book value per share drops to $1.93 and, in reality, will likely be higher as more Bitcoin has been mined since March 30.

Once the market value of a business falls below its book value, it is generally considered an opportunity for value.

Still increasing production

The first quarter of 2022 was the antithesis of the first quarter of 2021 bull run, as the broader market and cryptocurrency markets fell dramatically from their highs at the same time in the fourth quarter of 2021. Unfortunately, Bitfarms (and other crypto stocks) took a double whammy, having downward pressure from both affected markets. But, beyond the lower share price and increased risk, Bitfarms has made its trades.

Since the first quarter earnings release on May 16, Bitfarms’ hash rate has risen to 3.4 exahash/s, or about 1.5% of the 220 exahash/s for the network’s total hash rate.

Going forward, electrical capacity and miner delivery allow for 6.0Exahash/s by the end of 2022, below the previous target of 8.0. The drop in expectations is due to a delay in the installation in Argentina. Initial capacity is expected to be reached in the first quarter of 2023.

Bitcoin hashrate bitfarms

Author created using data from Glassnode, Bitfarms

Bitfarms and the network hash rate have grown steadily since the Chinese exodus in Q2-Q3 2021. Bitfarms has outpaced network growth; at the end of May 2021, Bitfarms was only responsible for 0.88% of the network and is now at 1.5%. This network overrun results in the mining of more Bitcoins.

Bitcoin Bitfarms Bitcoin

Author created using data from Glassnode, Bitfarms

There is a clear long-term upward trend in the percentage of the network once you remove the short-term noise. Short-term fluctuations are mainly caused by the variance of the total network, which typically varies by +-10% within a day. The other factor is the staged function of receiving and installing new miners, which partly contributes to the instability of this metric.

A high hash rate doesn’t matter unless it leads to higher bitcoin mining, so let’s look at that.

Bitfarms Bitcoin

Author created using data from Bitfarms

Bitfarms surpassed its temporary surge last summer. Last summer’s surge was due to China’s ban on cryptocurrency mining, which forced most miners to go offline and move, which took time. Since then, most former Chinese miners have moved to Kazakhstan or other countries with easily accessible cheap energy or have seen the physical Bitcoin miners sold off and reintegrated into the network elsewhere. Yet Bitfarms has further increased its production. The fact that the entire network has recovered and Bitfarms is hitting production highs is a sign of good things to come.

However, it should be kept in mind that we are halfway through the next Bitcoin halving, which will more or less halve the bitcoin mined while the subsidy is halved. To keep the same minted dollar value, either the price of Bitcoin must double, or the percentage of the network must double, or of course, a combination of both.

Operational comparison

Let’s compare Bitfarms to Marathon Digital and Riot Blockchain (RIOT), two of the biggest players in the space.

Compared to larger companies, BITF unsurprisingly lags behind in absolute terms.

Bitcoin BITF MARA RIOT

Author created using data from Bitfarms, Marathon Digital, Riot Blockchain

However, a different story emerges once you consider market capitalization or what you are getting for your money.

Bitcoin BITF MARA RIOT

Author created using data from Bitfarms, Marathon Digital, Riot Blockchain

Bitfarms is clearly in the lead when comparing operations relatively. This metric is why I am more bullish than other Bitcoin miners in the short term. That’s not to say that other companies now have room for price appreciation, as the price per hash rate is significantly cheaper, even including total network growth.

BITF sits in the middle of predicted hash rates, as both competitors predict greater hash rate growth. All companies are currently planning until “early” 2023.

Bitcoin Hashrate BITF RIOT MARA

Author created using data from Bitfarms, Marathon Digital, Riot Blockchain

Remember, these are management forecasts and as far as BITF is concerned, they have already been edited, albeit slightly.

Final

With the focus on the long term, BITF is still undervalued. That’s not to say the risks haven’t increased, they have. Including debt in the overall capital structure increases leverage and therefore risk. But the underlying operational performance is still solid. If Bitcoin recovers in the coming years, as I expect, the stock is significantly undervalued.

About Catherine Wilson

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