More Red Flags For Bitmain IPO

After reviewing the leaked CICC pre-IPO Investor deck and latest Bitmain prospectus filing one can clearly see 4 major discrepancies that misled Preferred B and Preferred B+ investors to invest at pumped valuation levels of US$12-$14bn during June — August 2018. No wonder the investors are so angry and rumoured to be preparing for a major lawsuit in Hong Kong courts against the company.

First misrepresentation relates to Net Profit Level for Year 2017. CICC investor deck (slide #30) states Net Income at US$1.25bn vs Bitmain Prospectus KPMG audit at US$701mn (page 307 of prospectus). This massive US$550mn Net Income “miss” translates into implied PE multiples being significantly inflated. Many investors relied on this essential figure for doing the analysis, and misrepresenting this and to such a degree is nothing short of financial fraud. Interesting to see that four prominent Chinese Private Equity Funds: Sequoia China, New Horizon, IDG, and Sinovation had Board Observer seats. It’s hard to believe they also were not aware that actual Net Income for 2017 was far less than stated in CICC investor deck. Particularly it’s interesting to see that largely only Sequoia China participated in Pref B round, while others stayed on the sidelines. Sequoia China Partners Neil Shen and Steve Ji have been major promoters and backers of the story. It’s interesting to see how they will recover now that it’s clear its investee company has misled investors and withheld information from them. Will there be some sort of settlement to give investors more shares or warrants ? Will investors be returned their funds back? In any case Pref B and B+ rounds have left a very sour taste in investors’ mouths.

Second misrepresentation relates to Net Profit Target for Year 2018. CICC investor deck (slide #30) states Net Profit Target for 2018 at US$1.8bn which we now know is a complete sham . But did Jihan and Directors know of this while fund-raising for Pref B and B+ rounds during summer? This is the key question Hong Kong courts will be asking. And the answer is undoubtedly yes!

Sure enough if one looks at page 20 of prospectus in Recent Development Section it clearly states: “ Following June 30, 2018 there has been significant volatility of the market price of cryptocurrencies. As a result of such volatility, the expected economic return from cryptocurrency mining has been adversely affected, which in turn may require us to make significant provisions with respect to our inventories, and the cryptocurrencies we held and lower the selling prices of our mining hardware, and our profitability, business, results of operations and financial conditions may be materially adversely affected.

What is now shocking to investors (Pavillion, NewEgg, Lioness Capital, Breyer Capital, Palace Investments and others) that none of the above, so obvious to industry insiders, was disclosed to them by the Company during summer road-shows. And bear in mind both company founders gave personal warranties to the accuracy and timely disclosure of information in investor agreements. Surely lawyers will use this to their advantage.

Third misrepresentation relates to Bitmain and KPMG skillfully bundling Q1 and Q2 numbers into an overall 1H number, without breaking them out. If one reads the prospectus, one gets the feeling that business is doing great as overall 1H 2017 to 1H 2018 growth numbers are impressive. However, we now know as Bitmain amassed massive profits last year and Q1 of this year, it has also started amassing massive losses starting Q2 onwards. And the reason for this is simple, being a dominant player (some 75% of market) Bitmain went all-in with TSMC at the top of market ordering huge amounts of wafers. Unfortunately for Bitmain as the market turned south it got stuck with massive amounts of highly perishable outdated 16nm inventory — i.e. Bitcoin ASICs that it had to dump at any cost, amassing huge losses. For the 1H Bitmain already disclosed inventory impairment of some US$252mn, alongside a massive $240mn in 2017 for failed chip wafers (page 199 of prospectus) We believe there is much more to come.

Fourth misrepresentation relates to Bitmain not breaking down its actual inventory of cryptocurrency and recording it at cost vs true market value. It’s very odd that for something that constitutes 28% of Assets is a complete “black box” to investors. As per page 185 of prospectus : “ We account for cryptocurrency assets at cost, instead of revaluing cryptocurrencies at their fair value on each accounting reference date. In addition, we only recognize impairment from cryptocurrency assets, if any, and do not recognize any increase in value from the appreciation of cryptocurrency assets over the original cost prior to our disposal of cryptocurrencies. “ Table from CICC presentation shows as off Q1 Bitmain’s primary cryptocurrency holding is in Bitcoin Cash — an illiquid, highly vulnerable protocol whose value almost collapsed to zero had it not been for the discovery and altruistic saving efforts of MIT researcher Cory Fields .

Bitmain holding close to a US$1billion in a “black box” that can at any time plummet to zero, is surely not something the Hong Kong regulator will take lightly .

To summarize, Bitmain’s prospectus filing has confirmed that although company made massive profits in the past, it is presently on a trajectory of making massive losses. Investors in the recent pre-IPO round were misled as to the accuracy of the data, and considering complexity and opacity of Bitmain’s business (compared for example to its competitors Canaan and EBang), Hong Kong Regulators will be taking a very close look at the business model, requiring more clarity and explanation. All of that will require more time, and that will coincide with Bitmain having to disclose even more disastrous Q3 results, which will even further damage investors’ appetite for the IPO. There is an old German proverb: “Lies have short legs. They cannot go too far.” Bitmain’s IPO is a clear case study of the above.

Ken Lu, Crypto Muddy Waters