IREN - Great Optionality: Iris Energy Limited Is A Leveraged Bet On Renewable Bitcoin Mining

2023-12-12 05:52:01 ET

Summary

• Iris Energy specializes in sustainable energy for Bitcoin mining, with facilities in Canada and Texas.
• The company is expanding its capacity in Texas to take advantage of low-cost renewable energy.
• Iris Energy's profitability projections are promising due to the increase in Bitcoin price, making it a compelling investment in Bitcoin mining.

Iris Energy Limited ( IREN ) specializes in sustainable energy for Bitcoin mining. With facilities in British Columbia, Canada, and Childress County, Texas, IREN is expanding its capacity, particularly in Childress, Texas, to take advantage of low-cost renewable energy. Its commitment to environmental sustainability is worth highlighting. The profitability projections are optimistic due to the increase in Bitcoin price. On the other hand, IREN is moving to AI cloud services to increase its portfolio in the technological innovation field. However, its main focus remains Bitcoin mining. In my valuation analysis, IREN is effectively a leveraged bet on Bitcoin’s price, being viable at a post-halving price of $50,000 or higher. This optionality and scale make IREN a compelling speculative investment in Bitcoin mining.

A Mining Venture: Business Overview

Iris Energy Limited specializes in Bitcoin data mining centers. IREN was founded in 2018 and IPOed in November 2021. It is headquartered in Sydney, Australia. The company operates under the principle of prioritizing using renewable energy sources. IREN owns and operates next-generation data centers powered by 100% renewable energy, generating revenues from its hashing power that awards IREN Bitcoin, which in turn sells and receives its revenues.

Currently, IREN has four facilities : three in British Columbia, Canada: Canal Flats with 30 megawatts, Mackenzie with 80 megawatts, and Prince George with 50 megawatts; and one in Childress County, Texas, USA, with 20 megawatts for initial capacity. This last site is in the West Texas Load Zone with access to low-cost renewable energy, which is beneficial as a mining operation. Also, IREN is expanding with an additional 80 megawatts of energy, and the region has 37 gigawatts of renewable energy (wind and solar farms) with only around 18.5 gigawatts of transmission line capacity. The periods of oversupply lead to reduced energy costs, making it an ideal region for IREN’s business model, as power costs are likely to remain within a reasonable range.

IREN’s facilities are optimized for Bitcoin mining. The company plans to nearly double its Bitcoin mining capacity by Q2 2024, increasing from 5.6 EH/s (exa hashes per second) to about 10 EH/s. To increase profitability, IREN wants to reduce its electricity cost by moving more of its operations to Childress, Texas. The company is building a new 1,400 megawatt data center in Childress, Texas, expected to be in service in late 2026. On November 30, to improve efficiency, IREN acquired 1.4 EH/s of Bitmain S21 miners, a mining rig model, to increase its mining capacity. IREN operates data centers using 180 megawatts, with 80 megawatts under construction and 500 megawatts of additional power available.

The company plans to expand to Cloud services with ongoing customer and financing negotiations, including generative AI firms, aggregators, and start-ups. In August 2023, IREN acquired 248 NVIDIA H100 GPUs to exploit growth opportunities, such as the increasing demand for power-dense computing with generative AI. In September, IREN reported the prospectus to sell ordinary shares, debt securities, warrants, subscription rights, purchase contracts, and units to raise $500 million. Further, IRES partnered with the AI software provider WEKA to obtain storage and data management for generative AI in October. Following its vision, IREN aims to help build a sustainable future with green energy data centers, offering local employment and supporting local communities.

Projections in Bitcoin Mining for IREN

As you might expect, IREN’s financials are related to the Bitcoin price. The financial projection computing profitability of the mining operation under different circumstances can be estimated with a Capex of approximately $31 million. The annual profits for the mining operation under different Bitcoin price scenarios from $25,000, $35,000, $50,000, and $100,000, with a hash rate of 1.1 EH/s, the hypothetical profits under these circumstances are estimated to be $16, $24, $36, and $75 million for the respective Bitcoin prices, before the halving. After the halving that occurs every four years, the hypothetical profits decrease when the reward for mining Bitcoin is cut in half. However, we could assume a 20% reduction in the global hash rate, leading to less mining competition. The estimated annual profits post-halving are $9, $14, $21, and $46 million for the respective Bitcoin prices.

On December 6, IREN announced that it mined 369 Bitcoins in November. In October, IREN mined 376 Bitcoins. However, the mining revenue for the month was $13.7 million compared to $11.2 million in October due to the increase in the Bitcoin price. The price of Bitcoin is bouncing due to the confidence that the U.S. Securities and Exchange Commission will approve an exchange-traded fund [ETF] to allow investing in Bitcoin in open crypto markets connected to traditional bank institutions. Also, the Federal Reserve may reduce interest rates. Both of these dynamics could theoretically become tailwinds for the price of Bitcoin, further propelling IREN’s mining revenues.

A Leveraged Bet on Bitcoin: Valuation Analysis

From a valuation perspective, the equation comes down to understanding the electricity costs of mining Bitcoin and the revenue IREN makes from selling that Bitcoin. Some miners sometimes try to time the market by holding inventory and attempting to unload it when prices increase, locking in additional profits over traditional miners. However, that involves price risk beyond our valuation assessment and is likely irrelevant to IREN’s situation.

In the image above, you can see that IREN’s mining operation remained relatively stable in hashing terms. The company generated approximately the same computing power over these three months. July, August, and September showed 5,562 PH/s, 5,493 PH/s, and 5,554 PH/s, respectively. However, electricity costs, network hashing rate, and Bitcoin prices fluctuated, which is how IREN’s bottom line fluctuated. This means that IREN’s fundamentals are inextricably linked to Bitcoin’s price action, a risk layer investors must consider.

Nevertheless, using the table above, I estimate that the revenue per Bitcoin for July, August, and September was $30,023.64, $28,048.78, and $26,410.26, respectively. These figures are remarkably close to the average monthly price of those corresponding months, indicating that IREN sells its Bitcoin relatively as soon as it mines it, locking in ongoing market prices. Furthermore, using a 30-DMA on the price of Bitcoin, I derive that IREN’s revenue per Bitcoin for October and November is likely around $30,000 and $36,600, respectively. This is a notable increase, though it’s worth considering that the hash rate required to mine Bitcoin has also increased, likely reducing the mining output.

Overall, the key metric is IREN’s profit per Bitcoin, which for July, August, and September was $14,420.33, $17,560.98, and $12,564.11, respectively. However, note that this “profit per Bitcoin” metric is more representative of IREN’s overall gross profits, not net income because it excludes other operating expenses.

We can use IREN’s most recent Net CAPEX and Operating Expense figures to estimate the current annual run rate. These figures were $17.8 million and $28.0 million, respectively. If we combine and annualize these figures, we get a run rate of $183.2 million at the current 5.6 EH/s operating scale. In my view, this serves as a breakeven reference point for IREN. The remaining expenses would be interest payments and taxes, so we’d have an adjusted EBIT number. Using the figures from the table above, the pre-halving gross profits at a $35,000 Bitcoin are $24 million per 1.1 EH/s. Thus, the yearly revenues would be $134.4 million, which is still below the breakeven I estimated.

However, if Bitcoin traded at $50,000, the revenues would increase to $201.6 million, giving IREN an adjusted EBIT figure of $18.4 million. This looks cheap at IREN’s current enterprise value of $323.02 million, implying an EV/EBIT ratio of 17.55, below the sector’s median TTM EV/EBIT ratio of 20.25.

I want to highlight that the previous valuation assessment doesn’t factor in IREN’s new planned expansion, which should improve its mining efficiency and grow its scale to 10 EH/s by 2024. Ostensibly, this would only underscore its undervalued profile even further. Moreover, if the Bitcoin price continues to increase, it will significantly boost IREN’s results.

Investment Thesis Risks

However, IREN’s new breakeven price with its added EH/s capacity is difficult to estimate as several variables are at play, notably electricity costs, Bitcoin’s hashing rate, and Bitcoin’s price. It would be best to have an outlook on these three variables to estimate IREN’s fair value. Moreover, by 2024, these variables will likely be substantially different, further complicating a long-term assessment of the company.

Nevertheless, electricity costs will likely keep rising following its current manageable trend. On the other hand, Bitcoin’s hashing rate has been essentially increasing monotonically since its inception, so I expect that trend to remain. Higher hashing rates decrease the number of Bitcoin mined, typically an ongoing headwind. Lastly, the price of Bitcoin is anyone’s guess. However, my take is that if the price of Bitcoin breaks through $50,000 and sustains that price while IREN’s capacity expands, then IREN’s pre-halving gross profits jump up to $36 million per 1.1 EH/s. However, by then, the halving likely occurred already, which means the yearly revenue would be $21 million per 1.1 EH/s or $190.91 million yearly. So, IREN's post-halving valuation wouldn't make sense unless Bitcoin’s price increases to $50,000 or above, and that’s not guaranteed.

Conclusion

Overall, IREN is undoubtedly a Bitcoin bet. This is not a bad thing, but it does mean you require an outlook on Bitcoin’s price over the long run. Moreover, the upcoming 2024 halving will change the economics of IREN’s business. Historically, halvings have been associated with price increases that make mining viable again. However, this is not a guarantee, which makes it an embedded risk in IREN’s investment thesis. Nevertheless, I believe it’s relatively reasonable to assume that as cryptocurrencies continue to grow, the demand for Bitcoin will follow. Thus, over time, I foresee a rising Bitcoin price, and at IREN’s planned expansion, prices above $50,000 start to make IREN a compelling investment alternative. Moreover, IREN is akin to a leveraged play on Bitcoin as further price increases quickly provide substantial upside to shareholders. Thus, I think, on balance, IREN stock is a good speculative “bet” on the crypto mining sector.

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