Bitfarms: Higher Risk, Higher Reward (BITF)

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Bitfarms (NASDAQ:BITF) is now 80% off its all-time high, so should you buy the dip, or was the stock purely overvalued and is now falling in line with reality?

The fundamental answer using standard equity 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 companies overnight. As per my last article, Bitfarms is still a long-term buy if you are capable of withstanding the volatile nature of the underlying asset class.

Heightened Fiscal Risk, Strong Operations

Bitfarms surprisingly turned a profit of $5 million or 0.02 EPS, despite the collapsing cryptocurrency prices. But, standard accounting net income is not the greatest for analysis of Bitfarms’ (or crypto miners in general) underlying operations. A more meaningful metric is EBITDA or the adjusted EBITDA to evaluate operational performance.

Bitfarms EBITDA Bitcoin

Bitfarms EBITDA (Bitfarms)

The adjusted EBITDA gives a clearer view of the underlying operation. It removes the impact of the standard accounting depreciation and interest, eliminates the effects of share compensation and financing expenses, and perhaps most importantly, incorporates unrealized gains and losses.

We will still look at the impact of financing down further as it is generally vital but not necessary when looking at the underlying operations.

As holding Bitcoin is a core tenet of Bitfarms, incorporating the unrealized gains and losses, which are not included in accounting EPS, is extremely important.

So, year-over-year adjusted EBITDA grew 64% despite the polar opposite market conditions.

Energy Pressure

The decline in Bitcoin prices was primarily responsible for squishing the gross margin to 76% from 84% in Q4 2021. During Q1, prices ranged between $33K and $46K, so if the current price of roughly $30K stays for the remainder of Q2, expect a further compressed gross margin. At a $30K Bitcoin price and keeping the same variable costs of $8700, the next quarter’s margin would be 71%.

Along with a suppressed Bitcoin price, another external effect has been energy prices.

Some analysts are concerned about the costs of mining going up. Of course, rising energy costs will impact some miners, but not all miners, including Bitfarms, will be devastated. The variable costs to mine are now up to $8700/Bitcoin from $8400 in Q4. In fact, Bitfarms saw a higher variable cost per Bitcoin of $9000 in Q2 2021.

Bitfarms has some of its energy prices secured by contracts. Secured energy prices eliminates the risk of short-term energy fluctuations.

The major facility at risk is the Argentina facility, as it uses natural gas instead of hydro. Bitfarms has a $0.02 per KW hr rate for the next four years before shifting to market rates. So, if natural gas prices stay heightened after the contract fixed rate has surpassed, Bitfarms will feel the effects of increased costs at this facility.

However, most Bitfarms operations use hydroelectricity. As hydroelectric does not have the same mobility as natural gas or other fossil fuels, it does not see the same price increases even if long-term energy prices do rise. As far as Bitcoin miners go, Bitfarms is relatively well insulated.

The Importance of a Strong Balance Sheet

Now that we are actively seeing the downside risk of both the broad and crypto markets, it is crucial to see how companies react to their financing and cash management.

One of my main criticisms of a larger competitor Marathon Digital (MARA), is they took on debt, $600M of it in December 2021. Not to say debt does not have its place, but leveraging into an already volatile market increases risk substantially.

Since I last wrote on Bitfarms, it has taken on debt.

As of Q1 2022, Bitfarms has a $100M line of credit backed by Bitcoin, which charges roughly a 10.75% interest rate. The immediate risk here is needing to pledge additional Bitcoin if the price continues to fall.

For collateral, 133% of the credit value needs to be pledged, so $133M of Bitcoin. At the end of April, 5,646 Bitcoin is held, meaning if the price falls below ~23,500 can result in the disposition of the Bitcoin. If the credit value stays the same as Bitcoin is mined, the disposition price will fall. Collateral is the imperative short-term risk to watch.

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

Now, let us shift to the equity side of financing.

Bitfarms’ equity-driven financing strategy has its ups and downs. Shifting interest rate and default risk to dilutive risk, let us look at how dilutive it has been.

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

Bitfarms had 201.6M shares outstanding at the reporting date, so the at-the-market offering is responsible for 15% of the total shares issued. As the equity price has fallen below the average issue price by a significant amount, this is fundamentally beneficial to shareholders who have held through the program.

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

Once a company’s market value falls below its book value, it is commonly seen as a value opportunity.

Still Increasing Production

Q1 2022 has been the antithesis of the Q1 2021 bull run, as both the broad market and cryptocurrency markets have fallen dramatically since their similarly timed highs in Q4 2021. Unluckily Bitfarms (and other crypto equities) has taken a double whammy, having downward pressure from both relevant markets. But, looking past the drop in equity price and heightened risk, Bitfarms has been performing in its operations.

As of the Q1 earnings release on May 16th, Bitfarms’ hash rate has increased to 3.4 Exahash/s, roughly 1.5% of the 220 exahash/s for the total network hash rate.

Looking forward, electrical capacity and miner delivery allow for a 6.0Exahash/s by the end of 2022, short of the previous 8.0 goal. The lowered expectation is due to a delay in the Argentina facility. The original capacity is expected to be reached in the first quarter of 2023.

Bitcoin Hashrate Bitfarms

Author created using data from Glassnode, Bitfarms

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

Bitcoin Bitfarms Bitcoin

Author created using data from Glassnode, Bitfarms

There is a clear long-term uptrend in the percentage of the network once you remove short-term noise. The short-term fluctuations are primarily caused by the variance in the total network, which commonly ranges from +-10% within a day. The other factor is the step-wise function of receiving and installing new miners, which contributes to some of the choppiness of this metric.

A high hash rate does not matter unless it results in higher Bitcoin mined, so let’s look at that.

Bitfarms Bitcoin

Author created using data from Bitfarms

Bitfarms surpassed its temporary surge last Summer. The surge last Summer was due to the Chinese ban on cryptocurrency mining, which caused most miners to go offline and relocate, which took time. Since then, most of the previously Chinese miners have relocated to Kazakhstan or other countries with easily accessible cheap energy or have had the physical Bitcoin miners sold off and reintegrated into the network elsewhere. Yet, Bitfarms has still increased its production. The fact that the overall network has recovered and Bitfarms is putting in production highs is a sign of good things to come.

However, it should be remembered that we are halfway to the next Bitcoin halving, which will more-or-less cut the Bitcoin mined in half as the subsidy is cut in half. To retain the same dollar value mined, either the price of Bitcoin needs to double, the percentage of the network needs to double, or of course, a combination of both.

Operational Comparison

Let us compare Bitfarms to Marathon Digital and Riot Blockchain (RIOT), two of the more prominent players in the space.

Compared to the larger companies, BITF unsurprising falls behind on absolute terms.

Bitcoin BITF MARA RIOT

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

However, a different story appears once you account for the market capitalization or what you get 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 compared to other Bitcoin miners in the short term. That is not to say the other companies do now have room for price appreciation, as the price per hash rate is significantly cheaper even when including total network growth.

BITF is in the middle of forecast hash rates, as both competitors are forecasting greater hash rate growth. All the companies currently forecast into ‘early’ 2023.

Bitcoin Hashrate BITF RIOT MARA

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

Remember that these are management forecasts, and as far as BITF goes it has already been moved albeit slightly.

Concluding

With the emphasis on the long term, BITF is still undervalued. That is not to say risks haven’t risen, they have. The inclusion of debt into the broader capital structure increases leverage and therefore risk. But, the underlying operational performance is still strong. If Bitcoin does recover in the coming years, as I believe it will, the stock is considerably undervalued.

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