Mining (crypto) Companies Valuation Model
During the last few weeks, all digital assets including bitcoin are under pressure for many reasons including being highly volatile and speculative since inception. But will the rising inflation and bitcoin with deflationary effect, can be a reason to use bitcoins as an inflation hedge, or bitcoin’s volatility, speculative characteristic, and not having a long enough history will prohibit it? All these discussions are important while we start looking at valuation models for bitcoin mining companies since pricing bitcoin is not only important from a revenue forecasting perspective but also from a power consumption perspective. Power or energy consumption is the major factor not only for the mining business’s sustenance but also for the further development of the ecosystem and new future use cases around blockchains.
But why I am analyzing only bitcoin mining companies since valuing Bitcoin as a blockchain and BTC as a cryptocurrency is very complex or not possible? The reason is, that the bitcoin network is the most transparent and open network with low ownership concentration. The network and pricing analysis is currently possible through open-source data (being a public blockchain) and various available data points can be leveraged such as network-related past data and near/long term future forecasts such as hashrate, difficulty, next halving time-frame, trading volume, circulating supply, number of transactions, unique active addresses, velocity, miner revenue, and fee, holder supply and position changes, holder net unrealized profit/loss, MVRV ratio (with adjusted realized value), etc.
While analyzing bitcoin mining companies, the first and critical step is to analyze the revenue of the bitcoin mining companies which is calculated from the bitcoins mined by a company. Therefore, the price dynamics of bitcoin are critical. If the price of bitcoin is high, then companies can continue to invest for future capacity expansion by adding more miners and increasing their hashrate achieving a higher ratio with respect to the overall network hashrate. In the past, reductions in bitcoin prices have resulted in the closure of mining facilities of non-profitable miners, and an increase in bitcoin prices has resulted in more large and industrial-scale mining farms being set up. The chart below shows that when the growth rate of bitcoin prices is down, they are followed by lowering of total network hashrate and the increase in prices are followed by an increase in total network hashrate growth rate. The lag for increasing network hashrate is affected due to supply-chain issues and we can see that post-2020 that there is a time-lag of close to 5–6 months due to delayed supply of new miners and the same was close to 2–3 months previously. Whereas the lag for the decrease in prices and the decrease in network hashrate is almost 1 month.
The network hashrate and difficulty (though there is a lag effect on difficulty also) are related to each other as the time to find one block remains almost equal at 10 mins (i.e. time needed to find a hash for a valid block). Each block currently has a subsidy of 6.25 coins and fee-reward. The block subsidy halves approximately every 4 years and due to the limited number of 21 million bitcoins that can be mined (until the year 2140), bitcoin has a deflationary effect. The next halving is estimated to happen around April 2024 when the subsidy will be 3.125 coins. It is estimated that transaction fees or fee rewards will continue to rise with each halving event.
Various analysts are forecasting bitcoin prices in 2024 to be from 1.5X to 5.9X compared to February 18, 2022, price excluding others who believe that CBDC (Central Bank Digital Currency) will force the bitcoin to eventually cease all its value over a short period of time. Federal Reserve’s paper of January 2022, Money and Payments: The U.S. Dollar in the Age of Digital Transformation is a good step taken for transparent public dialogue about CBDCs.
Stock-to-flow (S/F) ratio (metric introduced by PlanB in 2019) is a widely used model used to explain why gold and silver are different from other commodities as there is a scarcity that drives the value. Halving increases the scarcity and therefore the prices have increased after the previous three halving events. However, the effect of halving is not immediate and may take up to 12–15 months before they are reflected in the market prices.
Below is the S/F ratio chart from Glassnode.
I believe that bitcoin is here to stay and will remain an asset and many public bitcoin mining companies are “HODLing” mined bitcoins onto their balance sheets and some are buying at the same time as well.
We will use multiple scenarios of bitcoin price in the valuation model using the above analysis.
Valuation model
For valuing bitcoin mining companies, a different approach will be more appropriate since bitcoin is deflationary and most of the mining companies are going with ‘HODL’ing strategy thereby they are holding the acquired bitcoins as intangible digital assets. Valuing such companies can also be based on bitcoin being their base currency. Some researchers have talked about Net Coin Value (NCV) and Adjusted Coin Value (ACV) as a valuation model since the model gives the flexibility of assessing the value of the mining company based on the value of the intangible digital assets at a given point in time in the future and company’s ability to grow based on its investments. All cash outflows (for valuation-related expenses that are not made in bitcoins) will be valued at bitcoin price at the time they are incurred.
The two major costs that need to be analyzed are Capex or expenditure on miners to increase and stabilize (since miner useful life is approx. 3 years) the company’s mining hashrate and the second is the cost of power or energy.
In terms of miners, public companies have disclosed in their annual and quarterly filings the cost of miners for future deliveries, and they range from US$ 20 per TH/s to US$ 103 per TH/s. Added to these prices are phased delivery schedules and one can assume the time period of 6–15 months from procurement pre-pay to 100% operational state (depending on the size of the purchase order). We will need to adjust the number of miners procured and operational on a quarterly or half-yearly basis (average of the company’s mining hashrate) and similarly, we will adjust the overall network hashrate to arrive at a fairly calculated number of miners for each period. Difficulty (because has a lag effect) can be deduced from running a regression on the past data of network hashrate and difficulty. The regression has an R-square of 98% and takes care of the inflated forecast i.e. of a higher number of bitcoins being mined monthly/quarterly/yearly if we use standard 10 minutes for each new block.
The other major expense in bitcoin mining i.e. cost of power or energy can be deduced from the weighted average of the number of miners calculated above and their energy efficiency. Companies who have done agreements at attractive prices with power companies or companies which also use renewable energy will have the long-term advantage to face the bitcoin price volatility. Some mining companies are also using or planning liquid cooling technology to reduce their energy consumption and this will help them increase their gross margins.
Public companies in their quarterly and annual reports have stated their energy agreements ranging from US$ 0.022 to US$ 0.05. If we add renewable energy to the total energy consumption as well, we can arrive at the energy consumption calculations ranging from US$ 0.018 to US$ 0.05 for different companies. Many public mining companies which have long-term agreements with power companies also have the arrangement to resell the excess or unused capacity back to the power companies at agreed rates. Usually, the obligation is a minimum of 80% of contracted power must be paid for as a fixed cost. These arrangements become specifically helpful in the event of the reduced capacity of the company’s hashrate.
Costs such as real estate, cooling, installation, etc. are important but depending on the company’s hashrate capacity, these costs tend to become much smaller as compared to the power costs, to the extent that for large industrial-scale mining sites they can become insignificant while doing the valuations. However, they should not be ignored as they can affect future cash flows.
The best proxy to consider for forecasting direct mining costs and SG&A is the company’s hashrate forecasts, number of miners, and self-mining capacity.
Apart from the network and company hashrate forecasts, capital expenditure, SG&A expenses other important inputs that need to be used as adjustments are –
1. Pool fees (usually 2%, if a member of a mining pool)
2. Infrastructure uptime percentage assumption
3. Variance due to bitcoin price volatility
4. Miners price movement in future
5. Useful life of PPE
Many mining companies are also investing in projects which can help them in creating an ecosystem around their core business of mining. These investments need to be looked at individually as some may have a ‘cannibalization’ effect on the business however companies must invest in related and synergistic projects as the ecosystem will add to the company’s future growth rate.
I have modeled the valuation based on ‘Net Coin Value’ with companies looking to maximize bitcoin holdings as their core strategy. Following assumptions have been taken –
1. Network hashrate is expected to show some seasonality with the winter season showing slightly lower hashrate growth than the summer season. It is assumed that second half of 2021 average network hashrate will be approximately 282 EH/s
2. Bitcoin price CAGR is assumed to be 26% (based on assumption that bitcoin will double in 3 years)
3. The halving date is assumed to be April 1, 2024
4. No new debt and equity raise i.e. companies will be self-funded from the intangible assets held on the balance sheet (i.e. bitcoins)
The information presented herein is from the company’s SEC filings and MD&A, website, yahoo finance, and other public sources.
I shortlisted Core Scientific, Inc, (CORZ), Hut 8 Mining Corp. (HUT), Marathon Digital Holdings, Inc. (MARA), and Riot Blockchain, Inc [RIOT], for the valuation using the Net Coin Value model as described above.
The below chart gives the movement of bitcoin prices and stock prices of CORZ, HUT, MARA, and RIOT.
The power/energy contracts for these companies range from 2.4 cents to 4.2 cents (4.2 cents in case of MARA includes electricity and hosting costs)
One of the other key elements for any bitcoin mining company is the future capacity planning through miner purchases and pre-orders as prices of miners vary as per the demand including the delivery schedules. For different mining companies, in the last 12 months, there have been disclosures made on the miner purchase prices of different vendors and they have ranged from close to US$ 20 per TH/s to US$ 83 per TH/s. CORZ, MARA, and RIOT have announced very aggressive capacity expansion by end of 2022 i.e. 15 EH/s (CORZ), 13.3 EH/s (MARA by mid-2022), and 12.8 EH/s (RIOT) respectively. For calculation purposes, I have taken an approx. weighted average of $ per TH/s from the miner procurement disclosures by each company of new purchases for delivery in 2022.
For each company, I have taken the total number of miners, weighted average power efficiency deployed at a given point in time as a proxy for the total direct cost of mining as well as SG&A expenses.
The useful life of miners is assumed to be 3 years and while doing the valuation, future Capex planning (including expansion and replacing old miners) and 5% salvage value of old miners have been considered.
Based on the valuation model, see the figure below for the calculated stock prices.
The valuation model works well for RIOT, Hut 8 Mining Corp. (HUT), and Core Scientific, Inc, (CORZ) and stock prices have been within close range for the estimated average bitcoin price of US$ 35,000 in H1–2022 (and 26% CAGR of bitcoin price thereafter) but are valued lower at an estimated bitcoin price of US$ 40,000 (and 26% CAGR of bitcoin price thereafter). Marathon Digital Holdings, Inc. (MARA) seems to be overpriced based on the above model at the same estimated average bitcoin price of US$ 35,000 but it is in close range of the estimated average bitcoin price of US$ 40,000.
The above prices are based on financials and total outstanding shares as of February 18, 2022. Bitcoin prices used are possible average price scenarios for H1–2022 and 26% CAGR thereafter.
This model gives the ability to look at the intrinsic valuations and can help arrive at a fair value by comparing it to other valuation models such as using sales, forecasted hashrate multiples, or other ratios.
The prolonged stay of bitcoin price at below US$ 35,000 mark will add pressure for mining companies to raise more money either through equity or debt and at prices below US$ 30,000 mark will make it difficult for many mining companies to raise additional capital at an acceptable cost.
Assuming bitcoin price to be close to US$ 80,000 by Q1/Q2 of 2025, all the stocks covered in this valuation model are currently underpriced and are expected to provide a healthy return over a period based on the disclosures made by the management and the plan execution thereof.
As mentioned in this post previously, the management’s ability to invest in high-growth projects which have synergy with the mining company’s operations will provide a higher future growth rate and overall valuation of the company including adding stability to such growth rate.
Bitcoin will remain volatile until institutional investors start adding it to their portfolio for their treasury management and other strategic initiatives. Therefore, we will continue to witness swings in the returns whether it is bitcoin or associated stocks!
Disclosure: I do not own any stocks, options, or derivative positions in any of the companies mentioned in the article, and the views expressed are my own views and for information purposes only. As of the date of this article, I do not have a commercial relationship with any of the companies mentioned in this article. I own personal investments in cryptocurrencies and tokens.
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