Riot Platforms: My Levered BTC Bet

Summary Riot Platforms is one of the larger Bitcoin mining companies by both exahash capacity and BTC treasury. Fundamentally, the company has been a cash burner that raises capital through dilution. RIOT shares have worked well in the past as a Bitcoin proxy. But breakeven prices are eye-popping. In the world of Bitcoin (BTC-USD) miners there are three that stand above the rest in terms of exahash capacity; Riot Platforms (RIOT), Marathon Digital (MARA), and Core Scientific (CORZQ). Core is going through bankruptcy while Marathon Digital and Riot Platforms have seemingly weathered the storm of "Crypto Winter." Data by YCharts When it comes to 12 month performance, RIOT has done better than Marathon digital though they are roughly in line with each other year to date. What's important to consider is the difference in mining models. MARA has an asset-light model that utilizes third party hosting providers for infrastructure while RIOT is a vertically integrated business. In the latest Crypto Roundtable article published on Seeking Alpha in early July, I noted RIOT was my largest bitcoin miner position and provided some bird's eye rationale for why: I think Riot has the right mix of large Bitcoin stack, low debt load, and the high EH/s capacity. But to be clear, I'm not really sold any of these companies are great long-term investments unless transaction fees permanently become a meaningful portion of the block reward. In this article, I'm going to go a bit deeper into how I view Riot and how I'm personally playing my allocation to the company's shares. June Production In the company's June update, there was a noticeable decline in month over month BTC production. One of the major catalysts for the decline that was shared by the entire industry was reduction in transaction fees on the Bitcoin network. Miner Rewards (IntoTheBlock) In May, transaction fees spiked due to the surge in Ordinals inscriptions and BRC-20 tokens. By June, transaction fees had returned to previous levels. Compared to other miners, RIOT's month over month decline in production by percentage was the worst in the industry: May 2023 June 2023 Change RIOT 676 460 -32.0% Cipher Mining ( CIFR ) 493 360 -27.0% CORZ 1,314 1,030 -21.6% MARA 1,245 979 -21.4% CleanSpark ( CLSK ) 609 491 -19.4% Sources: Company filings, sorted by change In the table above, I'm showing the bottom five moves from a larger sample of 12 publicly listed miners. The average decline for those 12 miners was -15.8%. What's interesting though is the company generated $10 million in power sales and demand response revenue. June Operations (Riot Platforms) The reason behind this was record temperatures in Texas that resulted in a surge in energy demand. Riot Platforms was essentially getting paid to turn off machines to help stabilize the grid. This is interesting for a couple of reasons: It shows the company can be strategic with its resources when the environment demands it But it also shows the potential problem with the company's business model In the update, Riot noted the revenue from selling power back resulted in the equivalent of mining 361 BTC. Given Riot's $10.6 million in proceeds from 400 BTC sold, selling energy back to ERCOT was actually a more profitable business than mining and selling BTC at the market rate. BTC Equivalent Revenue Rev per BTC BTC Sales 400 $10,600,000 $26,500 Power/Demand Response 361 $10,000,000 $27,701 Source: Riot Platforms, Analyst calculation There are two ways to look at this. On one hand, it's savvy by the company to get the best return on assets that it can even when Bitcoin's price is struggling. On the other hand, if Bitcoin's price is struggling and there isn't high demand for power sales back to the grid, one could argue it makes more sense to just turn the machines off. Longing RIOT is A Levered BTC Bet Data by YCharts Riot simply doesn't make money at today's BTC prices. But not only does Riot not make money at today's BTC price, Riot doesn't make money at the all-time high of $69k BTC either. Cost of Revenue $211,200,000 Total Opex $348,200,000 Subtotal $559,400,000 BTC Mined 6,241 Breakeven price $89,633 Source: Seeking Alpha, Analyst's calculation Given the trailing twelve month operational expense and cost of revenue figures, Riot's breakeven price over the last 4 quarters was just under $90k per coin by my calculations. There are some who would say there is no way BTC ever gets to that level. I actually believe it's a possibility longer term. If the price ever does actually get to that level, it would also revalue the 7,250 BTC Riot is holding on the balance sheet closer to $650 million - which would be another source of revenue if the company decides to sell BTC holdings from the treasury. Data by YCharts At $3.2 billion, the company is quickly approaching three year market cap highs. It's also trading at 11x sales. Which makes it one of the more overvalued BTC miners by that metric. If we assume $90k BTC can eventually become a reality, RIOT is still trading at 5 times future sales at an approximate average of 650 BTC per month. Of course, this doesn't take into consideration capacity expansion plans or the potential for declines in monthly production in spite of exahash capacity growth as global hash rate grows. All this said, RIOT still theoretically works as a leveraged bet on Bitcoin because of the FOMO that comes with buying bitcoin proxy equities. These bitcoin proxies have a history of multiple expansion in bull markets and I suspect that would continue if/when BTC makes a new high post-halving. But the larger point is, if you're buying Riot Platforms as a long term investment, there's a long way to go before the company is a profitable business given the spending required to purchase and maintain mining machines. And until transaction fees become a permanent source of miner revenue to a meaningful degree, the booms/busts from halving cycles will continue to play a role in how these stocks perform. Risks Dilution. Since Riot Platforms doesn't go the debt route, it raises capital through shareholder dilution. This is common in the public Bitcoin mining space but there aren't many offenders that are as bad as Riot over the last 5 years: Data by YCharts Since 2019, the number of RIOT shares outstanding has increased by over 1,100%. This level of dilution is far worse than competing firms like HIVE Digital Technologies (HIVE) and Hut 8 Mining (HUT). Summary Is Riot Platforms a great long term investment? I can't say that. However, as a leveraged bet on Bitcoin, I think it works well so long as shareholders manage their allocations well and refrain from getting overexposed to the idea. To reiterate, the reason why I like RIOT over the other miners is because of the company's large BTC stack, low debt, and high production capacity compared to peers. But Riot Platforms still loses a lot of money and the tradeoff for the low debt load is shareholder dilution. Longing Riot Platforms is a levered bet on BTC. If one takes the view that BTC is going far higher than $30k in the years ahead, as I do, then it might make some sense to buy the shares in small increments over time to hedge against quarterly dilution. But the argument can quite justifiably be made that if you believe BTC is going much higher, then it just makes sense to buy and hold BTC directly or through an ETF/Trust instrument instead. Everyone's risk tolerance is different. And I think that tolerance needs to be high to play in the miner space. While I'm still long RIOT, I have not been buying this rip.