Summary Riot Platforms' shares have surged nearly 20% since July due to Bitcoin's rise, but I remain bearish, citing overvaluation and risky debt-financed Bitcoin purchases. Riot's core Bitcoin mining operation is unprofitable, and their new debt strategy to buy Bitcoin mirrors MicroStrategy but lacks a sustainable business model. Post-halving, Riot's gross margins have declined, and their valuation metrics are significantly higher than sector medians, signaling potential 68.73% downside. Despite Bitcoin's bullish outlook, Riot's continued losses and expensive valuation make it a strong sell; their business model is unsustainable. Co-Authored by Noah Cox and Brock Heilig Investment Thesis While Riot Platforms ( RIOT )’s shares are up nearly 20% since the last time I wrote on the stock, this doesn’t mean I have turned bullish on the crypto miner. The stock is nearing $12.50 per share after being as low as $6.36 earlier this year and $10.80 as of just a few days ago (December 10). A big driver behind the increase in the company’s shares has been the rise of Bitcoin. While Bitcoin has gone up in price, I continue to believe that shares are overvalued on multiple metrics. The company recently appears to have embarked on a risky strategy of borrowing money (via convertible senior notes ) to purchase more Bitcoin. While I already was bearish on the company, I certainly believe this is not a good idea (for both shareholders and for corporate operations). I do not believe that the MicroStrategy-esque plan of borrowing to buy Bitcoin will work out for them in the long run. Their core bitcoin mining operation loses money (in dollars) and erodes any long run Bitcoin potential. This is a huge drag on the capital structure (in my opinion). Borrowing more money makes the company more levered. I don’t like it. With this, I think shares continue to be a strong sell. Why I'm Doing Follow Up Coverage A big reason why I was bearish over the summer during my previous coverage was due to Riot’s operating performance since the Bitcoin halving from April. At the time, this had not resulted in a strong, bullish outcome for Riot mining. For those who do not know what the halving event is, this is a periodic event (every 4 years) where the amount of reward (Bitcoin) miners receive is cut in half. This halving happens every time 210,000 Bitcoin blocks are mined. When Bitcoin miners’ pay is cut in half, it typically results in a major shift in Bitcoin pricing, which many times later ends up marking a new all-time high for the crypto currency. In the recent halving that took place in April, the reward for mining a block fell from 6.25 Bitcoin down to just 3.125 Bitcoin. In 2009 (right as the cryptocurrency was launched), the reward for mining a block was 50 Bitcoin. Basically, what made me so skeptical during my last coverage in July was that each Bitcoin miner Riot owns now has to work twice as hard to produce the same amount of Bitcoin. Or, for the same effort as before, they now only receive half as much payment. Ultimately, this halving led to (at the time) a 45% year-over-year decrease in Riot Platforms’ Bitcoin production. I just don’t believe investing in a Bitcoin miner is nearly as lucrative as simply investing in Bitcoin itself. With losses continuing in their mining division, a big driver for the run up in shares for Riot Platforms has been the price of Bitcoin itself. Bitcoin is up roughly 60% since the summer. Riot Platforms is only up ~20%. In essence, the market does not see the company that is adding more Bitcoin to its balance sheet daily (thanks to mining) as a more superior investment than the underlying asset. I think that’s telling. Now that Riot Platforms is employing a MicroStrategy-esque debt financing strategy, I wanted to go in-depth and explain why I don’t believe this will work for them. Why Their Plan Won’t Work A big reason why this won’t work for Riot Platforms has to be because of the core analysis of the business. Last quarter alone, Riot lost $154.4 million , with a big part of this coming from the depreciation of GPUs that are mining Bitcoin. The biggest reason for Riot’s struggles is this: Riot’s gross margin is declining post-halving. Riot Platforms Gross Margins (Seeking Alpha) To offset this, Riot is hoping to employ Microstrategy ( MSTR )’s strategy or borrowing funds to put Bitcoin on the company’s balance sheet. Riot’s hope is that these financing projects will allow them to purchase Bitcoin and drive shares to trade at a premium to their net asset value. Shares currently trade for less than 1x book on a forward basis. However, the main difference between MicroStrategy and Riot’s business is that MicroStrategy’s core business is a software business. This core business was actually profitable last quarter (albeit slightly). MicroStrategy Q3 Earnings (Seeking Alpha) Riot’s core business is the actual mining of Bitcoin. So the main issue for Riot is that when the company borrows money in the open market to invest in Bitcoin, you’re buying Bitcoin right at the spot price. However, they are net-losing money in this situation because the total cost of mining Bitcoin (including overhead for Riot) is higher than the proceeds they could receive for selling these mined Bitcoin right now. What this means is that, over the long run, investors who are buying shares in hope of Bitcoin bull run a need to realize that the shares are still denominated in dollars. And in dollars, the company is losing money. So, for the company’s shares to make sense, the price of each Bitcoin would need to rise in the first year faster than the corresponding loss of mining the Bitcoin. I am bullish in the long run on Bitcoin, but every asset has its down year. For Riot, this could be a major issue. Valuation When looking at Riot’s valuation metrics, there are multiple categories where shares are significantly more expensive than the sector median. For example, when looking at Riot’s TTM GAAP P/E, Seeking Alpha gives the company a grade of a D- in this metric. The reason for the poor grade is simple. Riot’s TTM GAAP P/E is incredibly high at 232.35. This is a concerning 629.61% higher than the sector median of just 31.85. On a forward price-to-sales basis, Riot is also very expensive. The company has a forward price-to-sales ratio of 10.65, which is more than 220.09% higher than the sector median of 3.33. Seeking Alpha gives Riot a grade of a D on this metric. The company is projected to see losses per share more than double over the next 12 months and will likely have to issue more stock/debt just to operate their mining business versus directly expanding their Bitcoin holdings. In my opinion, this is an inefficient way to acquire Bitcoin. I think shares should trade at the sector median price-to-sales ratio. If we saw shares converge on a price-to-sales basis of 3.33, down from 10.65, this would represent 68.73% downside for the company. Bull Thesis I think the biggest bull thesis for Riot relies on the Bitcoin miner figuring out how to get their core Bitcoin mining business profitable. What I mean by this is not that they get profitable just by mining Bitcoin directly. What I mean is that they should get creative with their GPU assets to control costs. There are a couple ways to do this. Some steel mil l and sauna bathhouses are trying to put a focus on Bitcoin mining, helping them capture their excess heat. Repurposing heat is not a new practice. According to the US Environmental Protection Agency , it's common for companies to use excess heat to repurpose for generating electricity. Energyintensive processes—such as those occurring at refineries, steel mills, glass furnaces, and cement kilns—all release hot exhaust gases and waste streams that can be harnessed with well-established technologies to generate electricity... This electricity can mine Bitcoin. The problem for Riot in this case is the obvious one: they don’t own any steel mills or sauna bathhouses. They would likely need to partner, and this messes with what little economies of scale the firm has that allows them to be profitable (on a gross profit basis). For Riot, they’ve built their entire business around mining for Bitcoin. Now, some activist investors (like Starboard Value who took a stake as I was writing this) think the company can repurpose some of their GPUs and mining facilities towards AI data centers. On the surface, this doesn’t feel like a bad idea. The issue with running a datacenter (as opposed to crypto mining) is that the datacenter industry is a two sided market place. Here, Riot will have to supply computers and match it with customers. For Bitcoin? The demand for computers in the form of proof of work is already there. It's not as easy as building datacenter capacity and expecting clients to come. Takeaway While being a pro Bitcoin company should be a boost to Riot, the Bitcoin miner is incredibly expensive on a series of valuation metrics, and continues to lose money with guidance showing losses should continue next year. Now, the company is issuing debt to buy Bitcoin. I just don’t think this is sustainable. While some may want to compare Riot’s business model to a similar, but different, plan run by MicroStrategy, I’m just not confident this will work. Riot’s core business just loses too much money in my opinion. I think this is why shares have underperformed the overall Bitcoin rally. With this, while the stock is in an overall space I like, I continue to believe that shares are a strong sell.
