Cryptocurrency mining rigs in a data center

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Canaan (NASDAQ:CAN) is an attention-grabbing firm in the case of the AI chip house, particularly for the cryptocurrency mining sub-industry. They’ve made some good progress on their mining chips and have seen gross sales steadily rise over the previous few years as they save them and their prospects on power prices.

However there is a fixed unfavorable to all of this – most of their enterprise and long run prospects are nonetheless tightly tied to the worth of Bitcoin (BTC-USD). There are a couple of elements to this, so let’s discover these earlier than reaching and increasing on my funding conclusion.

A number of Negatives With Bitcoin Ties

The primary unfavorable is that the urge for food for the corporate’s chips, and the worth which they will cost for these chips, is nearly straight tied to the worth of Bitcoin. The CEO and CFO each acknowledged that as the worth of Bitcoin falls, the worth for which they will promote their merchandise drops and so they lose their skill to generate any significant earnings.

The second a part of that is that the corporate has a number of bills which aren’t tied to the worth of Bitcoin like the worth of power which they use to mine their very own Bitcoin. That is additionally true with Wafer costs, which signifies that when the worth of Bitcoin is down the hit to their earnings might be considerably larger than the hit to their revenues.

Larger power costs are additionally a unfavorable to the corporate’s personal mining of Bitcoin, which the corporate does numerous. As of their latest report, the corporate held simply shy of 347 Bitcoins, valued right this moment at round $6.9 million. That is additionally the opposite unfavorable for the corporate’s valuation and steadiness sheet in the case of the worth of Bitcoin – the worth of these 347 Bitcoins was roughly $17.5 million a few yr in the past however is now greater than halved. This fluctuation, as the worth of Bitcoin is anticipated to stay underneath strain, can spell bother for the corporate’s steadiness sheet and valuation.

Here is the abstract the CFO made of their newest earnings name:

Because the Bitcoin worth additional decreased within the second quarter, we responsively lowered our product worth for spot gross sales to shoulder the strain with our purchasers. Then again, wafer worth stays excessive on the fee entrance. Due to this fact, we anticipate the gross margin to lower dramatically within the second half of this yr. Trying ahead to the approaching quarters, we see a harder market surroundings from the decrease Bitcoin worth degree, general elevated power worth, and varied pandemic and geopolitical uncertainties globally…

Let’s Develop On These A Bit

The cryptocurrency mining market projections have shrunk in current months as the worth of Bitcoin and different cryptocurrencies have plummeted from their highs. Now, analysts and market specialists anticipate the cryptocurrency mining market to grow at a CAGR (compound annual development price) of simply 2.8% via 2028.

In the case of the corporate’s price, it is their exact existence which is inflicting these worth will increase. Even because the chip scarcity is resolving and provide chain constraints are easing, corporations which create the Wafers that are used to create these mining chips are raising prices by around 20% to accommodate for the elevated demand from cryptocurrency miners.

The worth of power within the Folks’s Republic of China can be anticipated to stay excessive. Despite the fact that the world’s soon-to-be largest financial system is transitioning in the direction of renewable energies, they nonetheless devour most of it from gasoline and the cost generating that electricity is expected to rise through 2024.

There Are Positives

The corporate does have a bunch of constructive elements going for it, with the principle one being that there’s nonetheless demand for his or her merchandise around the globe as they work with their headquarters in Singapore to be able to increase their enterprise internationally into different East Asian nations to be able to keep away from a number of the limits by the Folks’s Republic of China on cryptocurrency mining.

The corporate grew their revenues fairly a bit on a yr over yr foundation, however there is a issue of comparisons occurring right here as their predominant base of operations was locked down throughout the 2021 COVID-19 spike within the Folks’s Republic of China. Even so, in comparison with the 2020 interval, the corporate noticed a giant surge in revenues and is expected to report $724 million in sales this yr.

This determine is anticipated to then develop by over 31% to $954 million in 2023 after which one other 6.4% to only over $1 billion by 2024. Despite the fact that I do not consider these estimates might be met, it reveals that the corporate’s merchandise are good and that present demand is powerful.

Valuation Is not Doable, However Future Is Shaky

I do not suppose that given the truth that the corporate’s core development is so depending on the worth of an exterior and sporadic cryptocurrency, a good worth is even doable to fantastic. Consequently, I have a look at the corporate from a danger to reward standpoint relatively than a particular worth level.

General, there’s loads of good factors which might generate significant development for the corporate and they do currently have about $394 million in cash and equivalents to fund operations and worldwide growth, which is able to in flip enhance their high line numbers.

However the sensitivity of their gross sales margins to the worth of Bitcoin has me extremely skeptical about their skill to generate actual long run worth. Even when the worth of Bitcoin shot up via the roof, the corporate’s fundamentals haven’t improved all that a lot, other than their worth as they owned a sure variety of these Bitcoins.

Conclusion – Nonetheless Avoiding

Despite the fact that there are a number of constructive elements within the firm’s long-term prospects, the uncertainty relating to the worth of cryptocurrencies basically and the worth of Bitcoin particularly makes Canaan’s know-how and gross sales avenue extra vulnerable to fluctuations which might flip an funding bitter.

Consequently, I’m persevering with to keep away from the corporate’s shares and might be specializing in different chip makers which have a extra numerous enterprise till the corporate can present some sustainable skill to generate some constant gross sales and earnings.

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