CA - HIVE Digital: The Right Cocktail Of Bitcoin And AI For 2024

2023-12-19 06:20:17 ET

Summary

• The ChatGPT phenomenon has boosted chip maker Nvidia's stock while Bitcoin has seen triple-digit gains, but HIVE Digital has not seen the same level of success.
• This should change in 2024, as the stock provides investors with access to both the AI and Bitcoin realms.
• The company faces challenges ahead of the halving event but has a strong balance sheet and displays operating efficiency.
• There are risks as the crypto world is synonymous with a high degree of market volatility.
• HIVE also has an appeal as it is diversifying into an asset class that is not correlated to Bitcoin.

Talking technology, this year's stock market performance has largely been determined by the Fed adopting a more dovish stance and the ChatGPT phenomenon with AI-enabling chip maker Nvidia ( NVDA ) shining as charted in orange. Bitcoin ( BTC-USD ) also delivered triple-digit gains, but, tellingly, HIVE Digital Technologies ( HIVE ) which provides exposure to both the Bitcoin mining and AI realms was unable to hold on to its mid-year gains.

However, as we advance into 2024, this thesis aims to show that things are likely to change as HIVE's diversification strategy into an asset class not related to crypto starts to bear fruits while also progressing on the mining difficulty front.

First, to cope with the high prevailing interest rates, a strong balance sheet is needed together with the ability to optimize operating expenses given that less than six months from now there is going to be a halving event, a key obstacle for miners that will reduce the reward obtained from producing digital coins by 50%.

Healthy Balance Sheet and Operating Efficiency

There was only $4.5 million of cash at hand at the end of the second quarter of fiscal 2024 (Q2) as pictured below. However, looking deeper, there is also the treasury of digital currencies whose equivalent dollar amount is $46.9 million. This means that in effect there is $50.4 million of liquidity in case HIVE disposes of its treasury, sufficient to pay the debt of $32.4 million. Also, for those not convinced given BTC's volatility, HIVE's total current assets exceed liabilities by over $38 million.

The company also sells part of the Bitcoins produced and invests the money both in higher efficiency mining rigs and HPC (high-performance computing) as part of its AI vision.

Now, higher efficiency machines are required to face up to the Bitcoin halving event to occur in April 2024 whereby miners will be paid 3.125 BTC instead of 6.25 BTC (as is the case currently) for each block added to the blockchain network or for validating the information in a blockchain block through cryptography. This means a 50% decrease in revenue per block, while at the same time, inflation-led pressures have increased operating costs. Consequently, miners' profits will be dented unless they optimize costs by bringing efficiency measures, but margins also depend on mining difficulty which is due to miners competing against one another all the time on the blockchain network.

Now, given these constraints, it is essential to reduce expenses like G&A (General and Administrative). Making a comparison with peers, it is found that HIVE has the lowest G&A as a percentage of annual revenue at 17.93% (as per the chart below) which means that it is relatively well-equipped to navigate the tough times lying ahead.

HIVE's Growth, Profitability, and Diversification

It is precisely thanks to cost optimization that it has been able to improve Q2's EPS by 68% YoY despite having seen a fall in revenue by $6.8 million during the same period. Still, with an EPS of -$0.29 , it is loss-making.

However, analyzing in more detail, the revenue shortfall was due to the miner stopping Ethereum ( ETH-USD ) production in September 2022, as part of its strategy to diversify towards artificial intelligence. Consequently, the YoY growth and profitability have declined to such an extent that they have been assigned grades of D+ and F respectively as pictured below. This implies that investors purely focused on financial metrics may miss the broader picture, or one involving temporary shortfalls in revenue and profits due to part of its mining infrastructure being redeployed for diversification purposes, as the fruits do not bear straightaway.

Detailing further, after buying around $70 million worth of GPU chips initially used for mining Ethereum, the company pivoted them to be used for HPC/AI earlier this year. These chips consist of Nvidia's A40 model, which is not necessarily that cutting edge compared to its A100 or H100, but can still be used for meeting data-heavy tasks required by demanding AI and data science applications.

Talking figures, approximately $250K were generated from GPUs per month in November, with the company gradually increasing production as illustrated below.

An increase in production to $250K/week implies around $1 million per month with a further capacity upgrade to $250K per day implying about $7.5 million (0.250 x 30) of monthly revenues, which if sustained for one year should bring HIVE closer to its aim of $100 million of GPU-related sales. Adding this to the $104.2 million revenue consensus for the fiscal year 2025 which ends in March 2025, the company could double its topline.

Equally important, HPC/AI enjoys higher margins, or about fifteen times more compared to Bitcoin mining according to the HIVE's AGM 2023 circular. Noteworthily, the diversification is built upon its expertise in mining Ethereum using GPU chips, with the strategy having already been planned since July 2021 , or 1.5 years before the actual production phase.

Therefore, going into the halving event, it can rely on the AI diversifier to offset the fall in mining profitability.

Volatility Risks but Deserves to Be Valued Better

Still, adopting a cautious tone, rebranding from HIVE Blockchain to HIVE Digital in July did not shield it from the volatility inherent in the crypto world. For this matter, the brief surge of its share price to the $6.64 level as per the introductory chart before sliding back to the $3 level coincided with Bitcoin falling below the $30K support level.

Moreover, while production is in progress, it is important to bear in mind that crypto mining and running AI loads are two different domains and require different capabilities, in terms of infrastructure deployment, power availability, and cooling requirements. This is the reason HIVE is proceeding through beta tests.

Along the same lines, and, as evidenced by a comparison of the price performances with RIOT Blockchain ( RIOT ) and Marathon Digital ( MARA ), the market tends to favor large miners that have been boosting production capacity (or network hash rate) and HODLing (or holding on to the maximum number of Bitcoins produced) to tackle the halving event instead of diversifying into new fields. Thus, RIOT and Marathon held 7,358 BTCs and 14,025 BTCs respectively as of November compared to only 1,627 BTCs for HIVE whose strategy has been to strategically sell its Bitcoins and invest the proceeds in expanding its AI footprint.

Well, being positioned on larger miners certainly makes sense from an M&A perspective, as not everyone has the most efficient machines or access to the cheapest electricity sources, which means that many small players gonna fall off a bridge, and constitute acquisition targets.

Still, in a conjecture where the law of demand and supply is in favor of higher prices, smaller plays with a healthy balance sheet should also profit. In this respect, according to the Blockchain Council, only 21 million coins in total can be mined and over 19 million have already been produced, meaning that less than 10% are to be mined. Now, with fewer supplies coming out and rising adoption, especially after Wall Street heavy-weights have filed for applications to launch Bitcoin spot ETFs, demand for crypto-related assets has surged.

Therefore, HIVE's revenues can be boosted by the fact that one Bitcoin is now being exchanged at more than $40K compared to less than $30K during HIVE's last reported quarter, or 33% more. Apply this multiplier to the roughly $104 million expected for fiscal 2025, and you get around $138.6 million. This reduces the forward P/S to 2.05x (3.06 x 0.67) in turn resulting in a target of $4.77 based on the current share price of $3.59 as shown below.

A Buy Position on HIVE for 2024

This will depend on BTC sustaining its upside, but, equipped with two growth drivers (in the form of Bitcoin and GPUs), the miner can deliver more revenues one way or another. Also, a formal announcement as to GPU sales opportunities could constitute a catalyst for the stock just like Bit Digital ( BTBT ) which has also diversified into AI. The miner has enjoyed a sustainable upside after announcing AI contracts followed by more than $35 million of related revenues for 2024.

Furthermore, HIVE's diversification can help it offset the disadvantages of its smaller size with a hash rate (production capacity) of only 4.18 EH/s , well below RIOT's 12.4 EH/s , and Marathon's 23.1 EH/s. In this case, larger miners can negotiate better terms on the purchase of either mining equipment or KW/Hs of electricity based on the concept of economies of scale. Therefore, going into the halving event, it will not be easy for small-scale producers to optimize their Bitcoin production costs to the same degree as their larger peers given that there is no certainty that prices of mining equipment and electricity costs will fall anytime soon.

In response, HIVE has reduced its G&A to a higher extent than its larger peers (on relative terms) while its diversification into a non-correlated asset class is progressing. Moreover, factoring in equipment depreciation over time, ASIC or Bitcoin mining rigs tend to depreciate faster than GPUs in turn impacting a company's book value. To this end, in recognition of its over 38K Nvidia GPU chips, HIVE also deserves a better valuation as its price-to-book multiple is trading at a double-digit percentage discount relative to the IT sector.

Moreover, to put things into perspective, while this year benefited crypto and tech as the Fed confirmed its dovish stance on interest rates for the second time in early November, next year is supposed to see actual cuts which should augur well for equities. However, at the same time with the effects of higher borrowing costs, economic growth should decelerate while inflation remains above the Fed's target of 2%. Consequently, what worked well this year may not in 2024. Taking this view, this thesis has shown that HIVE which is diversifying into AI, an area of high demand is appropriate to shield against volatility risks in crypto, but the halving event means opportunities for those miners who manage to survive.

Finally, this is a stock to buy with a potential 33% upside, but, after some recent comments by the SEC's Chairman, Gary Gensler one could expect a lot of volatility in January as regulators take a new look at the applications for Bitcoin Spot ETFs.

Editor's Note : This article was submitted as part of Seeking Alpha's Top 2024 Long/Short Pick investment competition , which runs through December 31. With cash prizes, this competition -- open to all contributors -- is one you don't want to miss. If you are interested in becoming a contributor and taking part in the competition, click here to find out more and submit your article today!

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