Bitmain's Assets: What's Wrong With Financial Situation Before IPO
01 October 2018 18:40, UTC
Previously, we wrote about the possible reasons that pushed the mining giant to consider holding an initial public offering (IPO). On September 26, the company finally submitted an official application to the Hong Kong Stock Exchange (HKEX). The underwriters will be Hong Kong Securities Limited, Maples and Calder (Hong Kong), KPMG and Frost&Sullivan.
In June the CEO at Bitmain Jihan WU shared his plans to attract funds through an IPO. However, then a number of large corporations, such as SoftBank, Temasek and Tencent, refuted participation in the pre-IPO. Despite the discouraging forecasts about the poor outcome of the Bitmain venture, the company seems to have serious intentions as the draft of the application, where the details can be still edited, is already under the HKEX consideration. Although the final evaluation of the company, the volume of shares to be offered and the date of the offer are still disguised, Bitmain shared the consolidated financial data for 2015, 2016, 2017 and separately for the first halves of 2017 and 2018, which we will compare and thereafter analyze the financial condition of the company conducting the IPO.
By selling mining hardware the company earned $2.684 bln, which takes 94.3% in the total income. Bitmain acknowledges there are production risks. Despite the fact that from 2013 to 2017 the mining industry grew by 195% generating revenue streams up to $3 bln, the market is highly affected by fluctuations of cryptocurrency rates, which all fell sharply after the winter boom. For example, on December 31, 2017 Bitcoin was $14,166, and on June 30, 2018 - $6,381 already.
The price drop performed by the most popular virtual currency as well as the increasing complexity of bitcoin mining caused by the declining number of coins not mined yet (3.707 mln out of 21 mln as of on September 28) led to a decrease in demand for mining hardware and, consequently, a fall in selling prices. The average selling price for Bitmain mining hardware diminished by 26% to $992. Thus, the net margin dropped from 27.9% to 26.1% which means that each dollar of Bitmain sales now generates less profit than it used to last year. Another reason behind the decline in demand for Bitmain products and necessary price adjustments is the fact that more and more potential rivals are entering the ASIC-processor market. "Bitmain seems to have suffered substantial losses lately. Mining hardware business is getting even more competitive due to other Chinese players emerging”, - says Christophe BOSQUILLON, founder at Crypto Economics Accelerator. It is important to note that after a very long lull, the company finally announced a new generation chip - 7nm processors which surpasses the old models in terms of hashrate and energy efficiency.
This time Bitmain held more inventory, the total value of which increased to $564.824 mln as of June 30. Inactive finished goods become technologically obsolete and lose its value. In addition, its maintenance as, for instance, warehouses decent operation requires resources.
Such expenses together with prepayments to suppliers for the company’s needs in the first half of 2018 costed Bitmain $317.144 mln. While for the next six months of 2018 the company has already paid advances to suppliers in the amount of $280.7 mln, where 59.2% of the Bitmain procurement accounted for TSMC. The semiconductor producer is the only third-party foundry Bitmain has as a partner, and strong reliance and dependence on it create additional risks for the business.
Bitmain explains the negative net operating cash flow by receiving part of the payments for their mining hardware in digital currencies as well as part of the revenue generated by mining pools and farms.
Consumers, who paid less advances by $884 mln, are also “guilty” for this state of affairs the company has with cash. Cryptocurrencies accounted for 28% of the total assets, which the company equates to $886.9 mln. It is worth noting that Bitmain assesses the value of its crypto holdings at the cost instead of revaluing them at a fair price. Their motivation behind this evaluation approach is to avoid distortion of the results of its operation and financial condition as substantial volatility takes place on the market.
The company admits that losses did occur and their digital assets lost $102.7 mln in value. But it seems that Bitmain is expecting an incredible level of naivety from investors who must blindly believe the company and agree with its assessment method. They note that “the cryptocurrencies we hold are highly liquid assets that can be sold in open market to satisfy our liquidity needs”. These assets include Bitcoin, Bitcoin Cash, Ether, Litecoin, and Dash. However, the most interesting and important information Bitmain does not disclose, namely the exact number of coins in the portfolio.
Skipping this part together with choosing the most secure approach of the asset evaluation, that would minimize losses on paper, only confirms that Bitmain has problems with their capital structure.
As we wrote earlier, the company since the beginning of the year sold a third of their bitcoin holdings, their most liquid digital assets, and acquired a pretty significant number of Bitcoin Cash coins at a price of $869, the total reserves of which exceeded 1 mln units on March 31. According to Coinmarketcap, the exchange rate on September 28 was $548, which is almost 40% less than the price at which the assets were purchased.
Given the bearish trend in the crypto space; huge volume of BCH reserves, that the company will not be able to dump on the market without the BCH price collapse due to the lack of a sufficient demand for it; the relatively small volume of transactions with BCH in the amount of $772 mln per day, which is 6 times less than the corresponding indicator of Bitcoin, BCH holdings cannot be qualified as highly liquid assets.
The press service of Bitmain refused to provide any comments on their IPO to our editorial team. So we had to go back to the information specified in the same application to HKEX, where the company makes a reservation that despite the fact that they sincerely believe in the liquidity of their digital assets, “there is no assurance that we would be able to dispose of our cryptocurrencies in open market at the price or in the amount we desire”.
Inventory is another category of illiquid assets held by the company, the volume of which has doubled since the end of last year and reached $1,278 bln, which is another 28% of the total assets. Pretty small cash holdings, which accounted for 10% of the total assets or $353 mln, in comparison with 56% of capital in illiquid assets create high risks for potential investors.
In our recent exclusive interview with ADDCAPITAL and AddVenture partner Alexei PROKOFIEV said that serious institutional investors choose such subjects for financing, the risks of investing in which do not exceed 2-5% of the total budget, so the refutations made by corporations about their participation in the Bitmain pre-IPO now appear to be quite reasonable. The return on assets of the mining company this year fell sharply by 20.3% comparing to the last year indicator and amounted to only 24.5%. Therefore, we can conclude that Bitmain began to generate less profit from each dollar invested in the formation of assets. This means that the corporation inefficiently distributes its resources and relies on assets that do not produce high results.
However, the list of risks an investor will face financing the Bitmain IPO is not complete yet. 37.2% of all Bitmain business operations take place in China, where the government strives for the entire control of the crypto industry, and there is no guarantee that regulators will not get to the mining manufacturers, whose activities may get banned or taken under very strict surveillance. The remaining 62.8% of business is run in the rest of the globe, where the market is also waiting for certainty in regulation on the legislative level. The company's income may be significantly reduced with the introduction of taxation in all countries where the company develops its business. In China alone, Bitmain paid $165 mln of income taxes in the first half of the year.
Such uncertainty scares not only investors, but it seems that Bitmain itself, which officially conducts an IPO in order to attract funding to develop a new business direction - AI hardware. Production of mining hardware is becoming less profitable and even the impressive at the first sight $2.8 bln for the first half of 2018 should not be misleading.
According to TechCrunch, in the first quarter, the revenue of the mining giant amounted to $2 bln, which makes the second quarter a total disaster as the company failed to generate more than $800 mln. Thus, the company intentionally provided only consolidated data for the first half of the year in order to hide the crisis in the second quarter.
But even if the first quarter's revenue was $1.1 bln, as Fortune wrote, there are still few reasons for Bitmain to be happy, as the gross margin fell from 48.2% to 36.2% compared to 2017. This negative trend shows that after paying all the production costs, the company has less financial resources to cover other liabilities, including dividend payments to shareholders, which should make potential investors think twice about the expediency of purchasing Bitmain shares.
Considering all this, we can conclude that the company's intentions may be as follows. Either Bitmain does seek to diversify its business so as not to be completely dependent on a highly volatile mining market that is closely correlated with prices of crypto assets. But in this case, the company should develop a capital restructure plan. Or the company just wants to use its last chance to raise a serious amount of money, taking advantage of their reputation of the market leader, before the collapse of the mining industry, associated with the fall in prices for digital assets, the increasing complexity of coin mining and the corresponding increase in the necessary computing power. Will the company be able to raise $18 bln and will the Bitmain IPO turn out to be the biggest scam in crypto history? Let’s follow together the developments of this story.