Riot Blockchain: 79% Downside Potential Makes It A Beautiful Short Opportunity
May 10, 2021
Summary
Historical cyclical price pattern suggests a 57%-79% downside from the current price of $33.39.
The company shows persistent negative EBITDA-Capex, due to persistently high cash-outflows into new mining rigs as hash rates increase.
Shares outstanding have risen by a monumental 3000% since 2014, as the company finances its operations via equity issuance.
Insider ownership at 2.4%, with the CEO owning 0.34% of the company, raises doubts about management's belief in the company's prospects.
Thesis
Riot Blockchain (NASDAQ: RIOT) has been declining since its February 2021 peak. Based on a historical cyclical price pattern, there is a likelihood that the stock could experience a significant price decline, in the vicinity of 57%-79% from its current price of $33.39.
Fundamentally, the company has been showing increasing revenues, with declining EBITDA losses each year but with persistently negative EBITDA-Capex due to high investments into acquiring new mining rigs.
New mining rigs drain significant capital resources as older ones become obsolete as the hash rate consistently increases. Persistent share-dilution as evidenced by direct offerings finances the existence of RIOT, as it is unprofitable.
Insider holdings of the CEO come in at 0.38%, which raises significant doubts of management's future belief in the company. Last insider transactions showing purchases date back to 2017; no insider purchases have occurred ever since.
Short-interest is hovering at approximately 13%, suggesting future price decline. I believe a target price range of $7-$14 is reasonable, presenting investors an opportunity for a beautiful short.
Riot Blockchain
The company, primarily engaged in mining Bitcoin (BTC-USD) and, to a lesser extent Litecoin (LCC-USD), has experienced a swift price surge in its share, peaking in February 2021 and now slowly descending.
Riot Blockchain: Good For A Swing Trade
Riot Blockchain: An Efficient Bitcoin Miner
Analyzing the chart, we can clearly identify the correlation between RIOT's share price and BTC price. A degree of cyclicality seems to exist between these two, with peaks in BTC prices correlating to peaks in the price of RIOT. Short-interest also follows this pattern, with short-interest peaking simultaneously as RIOT and BTC peaks.
Extreme price declines usually follow in RIOT's stock as BTC prices come to a stalemate. There is reason to believe that this pattern is currently unfolding since the February peak, as the share price is currently dipping. Judging on the chart alone could mean a peak to trough decline of 80-90%.
I believe that RIOT's share price to reach an 80%-90% decline from the peak price of $71.33 on February 19th, 2021. Such a decline would represent stock prices of $7.13 or $14.27, respectively.
While this might seem rather extreme at first glance, let us analyze why such price depreciation is a realistic scenario.
The hash rate has been consistently rising since the inception of BTC and accelerated significantly since the BTC-price bubble in 2017-2018. This hash-rate acceleration was likely fueled by an increased interest in mining due to market participants identifying revenue potential in engaging in mining operations. A shift from small-scale mining operations by individuals to professional mining operations by corporations also increased competition and changed market dynamics.
The continuous increase in hash rate forces companies, such as RIOT, to continuously update their mining equipment (ASICs) to more powerful mining rigs (higher hash-rate) as older rigs become inefficient at extracting BTC due to their lower hash rates compared to more novel mining rigs.
This exerts tremendous cost pressures on RIOT, as it has to buy new equipment continuously. In addition, the cost of novel ASICs has started to show a correlation to the price of BTC. Prices of ASICs tend to move higher as BTC surges, offsetting the increased profitability that RIOT would enjoy from selling BTC as the price of BTC rises, as the price of each mining rig also rises.
Reports have been released that the prices of new miners are adjusted according to the price of bitcoin. As a result, the cost of new machines can be unpredictable, and could also be significantly higher than our historical cost for new miners. Similarly, as bitcoin prices have risen, we have observed significant increase in the demand for miners.
As a result, at times, we may obtain Bitmain miners and other hardware from Bitmain or from third parties at higher prices, to the extent they are available. For example, in the second half of 2020 and continuing into 2021, we have observed a significant appreciation in the market price of bitcoin, as well as an increase in the per-unit price of the new Bitmain Antminer model S19-Pro and S19j-Pro miners we purchased during this same period.
While we cannot know definitively if these two phenomena are linked, we have seen a measurable increase in the prices for new miners offered by Bitmain.
RIOT - 10K
The financing of novel mining rigs has led to substantial share dilution, as seen in the Koyfin-chart, as the company has primarily relied on equity issuance to fund operations. The company admits to being dependent on additional future equity issuance to finance operations.
Further, we have experienced recurring losses and negative cash flows from operations. As of December 31, 2020, we had approximate balances of cash and cash equivalents of $223.4 million, working capital of $233.9 million, total stockholders’ equity of $277.1 million, and an accumulated deficit of $229.9 million.
To date, we have, in large part, relied on equity financings to fund our operations and, if cryptocurrency prices are not sufficiently high to enable us to sell the cryptocurrency we mine at prices above our cost to mine it, then we are likely to continue to be unable to fund our operations without raising additional capital.
Even if prices are sufficiently high for our mining activities, we are likely to need to raise additional capital to fund the acquisition of new miners to replace our existing miners and expand our fleet to be competitive in our volatile and highly competitive industry.
RIOT - 10K
The swift increase in the number of shares outstanding makes the share price more vulnerable to accelerated price declines, as dilution is continuously increased. In other words, if the historical cyclical price pattern of the stock holds, the current price decline since February 2021 is likely to accelerate even further.
If we analyze revenues, EBITDA, and EBITDA-Capex, the fundamental picture becomes even more dissatisfying.
Source: Koyfin
Revenues are consistently rising, but EBITDA has been persistently negative, albeit successively rising. EBITDA-Capex, a more useful metric in RIOT's case due to the significant Capex created by the purchasing of new mining rigs, is consistently negative.
EBITDA-Capex shows the struggle of RIOT in reaching profitability. It is also likely one reason the stock has been an attractive target of short-sellers and the current short-interest hoovering at 13%.
Furthermore, high retail ownership of the stock and low levels of insider holdings and institutional holdings suggest a questionable belief in the company's future.
Insider holdings are tiny, and more concerning is that the CEO, Jason Les, owns less than 0.34% of the company.
Arguably, these holdings by management might have been slightly diluted due to consistently increasing equity issuance. Still, it is not usually a very good sign that management owns such a small piece of the company. The issue of small management ownership level is exacerbated even further as the CEO has sold portions of stock since late 2020.
Detailed transactions data shows options have been exercised as well. Exercising options and obtaining shares gives the impression of more static share ownership. Shares are sold, options are exercised, granting fresh shares - share ownership has not changed (or so it appears). Certainly, one can state that the CEO sold shares before the aggressive price ascension in RIOT, peaking in February 2021 and that there isn't any room for concern as the CEO did not sell any shares at the peak.
Of course, that is an excellent argument.
But if RIOT is such an excellent company, why isn't management buying shares, even in the tiniest amounts?
Scrolling through Fintel insider transactions data, one has to go back all the way to early 2017 to find any purchase transactions. In light of the presented arguments, it is becoming increasingly obvious that RIOT is not an ideal investment and deserves a sell recommendation, with a target price of $7 in the next 12 months. In fact, I would even suggest shorting the stock and using a protective stop-loss.
Borrowing fees for RIOT are at very low levels (1%), which would also explain why the short-interest has been hovering at a steady 13%, as it is cheap to stay in a short position for extended periods of time.
Risks
The most obvious risk would be if BTC prices were to substantially rise, a scenario that could potentially unfold due to the increasing popularity of utilizing cryptocurrencies as a means of payment worldwide. This could likely accelerate as societies move away from cash-based systems to electronic payments, favoring cryptocurrencies such as Bitcoin.
In addition, the acquisition of Whinstone by RIOT could cause intermediate upside movement as the total hashing power is increased, leading to temporary increased revenues.
While these risks are real, they are primarily outweighed by the increased costs of acquiring new mining rigs, which would increase further in cost if BTC prices were to rise further. Adopting BTC and other existing cryptocurrencies in society will likely take time. It is likely to compete with several proposed digital currencies by central banks.
In addition, investors will have to execute proper risk management in determining a suitable stop-loss for a potential short position. Due to the high historical volatility of the share, I would suggest a stop-loss based on analyzing historical volatility. This would provide some leeway for the share to fluctuate and the trade to pan out in its intended direction.
Furthermore, increases in borrowing fees could potentially eat into potential profits, which requires investors to calculate a sustainable breakeven level. Based on historical borrowing fees, this possibility seems rather remote.
Summary
RIOT is a company that has been struggling to reach profitability, as evidenced by an increasing amount of direct offerings throughout its history. Direct offerings are likely to continue in the future and cause significant dilution of existing shareholders, as the company needs to finance its operations.
In addition, the competitive space has increased the cost of mining rigs, which eats into any potential profit obtained from rising BTC prices. Wear and tear and consistently increasing hash rates drains significant capital resources in purchasing new mining rigs, reducing the likelihood of achieving future profitability even further.
Meager insider holdings do not instill faith in the prospects of the company. The stock has displayed a historical cyclical pattern, characterized by a boom & bust pattern. Based on the existing fundamentals and existing short-interest, there is reason to expect a continuation in price declines.
I would therefore recommend shorting the stock and place a target price of $7-14 in the next 12 months.
