CA - How The Bitcoin Bear Market Benefited CleanSpark's Valuation

Summary

• CLSK has gained our trust as it kept its promise to achieve 3.2 EH/s capacity back when its capacity was only 0.35 EH/s in Dec 2020.
• Analysts claim that CLSK is undervalued based on market price to capacity ratio, but we found no such support after considering its expected future capacity and Bitcoin reserves.
• CLSK's Bitcoin reserve severely trails competitors due to high costs in the past and unwillingness to dilute shareholders, this will subtract CLSK's ability to benefit from a bullish Bitcoin reversal.
• Bitcoin is now trading below CLSK's cost of sales (electricity + depreciation) per BTC, should Bitcoin fall below the $10,000-$14,000 range, CLSK risks insolvency.
• We retain our stance to invest in Bitcoin rather than miners.

Introduction

CleanSpark ( CLSK ) is one Bitcoin (BTC-USD) mining company that did not catch our attention but was highly recommended to us by our readers. We were reluctant to cover it because its capacity was too low to be taken seriously. Less than 2 years ago , its capacity was only 0.315 EH/s with promises to bring it up to 3.2 EH/s by 2022Q3. This is a promise to grow 10x in 8 quarters.

Was CLSK's 3.2 EH/s capacity by 2022Q3 achievable? Absolutely. The guidance aligns with MARA and RIOT's historical QoQ capacity growth rate, which is 0.4 EH/s. The issue is history taught us that these capacity targets are often pushed back or downgraded. For instance, MARA targeted 10.37 EH/s in CY2021Q1 by early 2022 but only achieved 3.9 EH/s (40% of the targeted capacity).

Hence, even though CLSK's capacity target is modest and achievable, we did not have the confidence for it to follow through. Now, CLSK has shown us that the company did not overpromise and targets were issued with diligence. CLSK also showed us that they can achieve that targets. This is what got us really interested in CLSK. We weren't the only ones starting to pay attention to CLSK. For instance, Hive Blockchain Technologies ( HIVE ) has also included CLSK in their comps (Fig 1).

CLSK has just recently achieved 4 EH/s of capacity and is on track to 5 EH/s by end of 2022. Its latest target for the end of 2023 is 22.4 EH/s , which would make it the largest self-mining company on our watchlist (Table 1). Given its track record, we shouldn't discount its ability to meet guidance.

Hence, the aim of this article is to determine CLSK's investment value proposition with focus on cost control and dilution. We find that these are the 2 key factors affecting shareholder value.

Table 1: Near Future Expected Capacities of Bitcoin Mining Companies

Source: Author, company reports

Let's Start Off With Valuation

In this section, what we want to know is how much of CLSK's growth potential has been priced in. For instance, MARA has a similar capacity target as CLSK but already has a 75% higher capacity than CLSK. Based on this observation, we should expect MARA to be priced higher than CLSK.

According to HIVE, CLSK has the best valuation (most upside) compared to other mining companies (Fig 1) based on

Market Cap per PH/s CAD

. However, we should refine this comparison further for more accurate insights.

Firstly, assets on the balance sheet contribute to the overall value of the company as well. The more Bitcoin a company owns, the more valuable it should be. By subtracting the value of Bitcoin (at $26,500 CAD) from the market cap, we arrive at the following valuation (market cap per PH/s).

Table 2: Market Cap Per PH/s Cad Less Bitcoin Reserve Value

Source: Author

By this standard, CLSK remains the most undervalued Bitcoin mining company. What about expected future capacity as the basis? Although CLSK still remains the most undervalued in comparison, we can see that the degree of undervaluation is diminishing.

Table 3: Market Cap per Future PH/s CAD Less Bitcoin Reserve Value

Source: Author

This led us to dive further and what we discovered was shocking. We hypothesize that CLSK's massive undervaluation right now is contributed by the depressed Bitcoin price. If Bitcoin were to rebound today to 50% ($42,000 CAD) from its peak or 100% ($84,000 CAD) to its peak, what would the comps look then?

Based on current built-up capacities, if Bitcoin were to rebound to 50% from its peak today, CLSK would lose its spot as the most undervalued Bitcoin mining company to HUT . If Bitcoin were to rebound back to its peak, CLSK's undervaluation would lose its spot to HUT and BITF (Table 4).

Table 4: Market Cap per Current PH/s CAD Less Bitcoin Reserve Value If Bitcoin Rebounds Today ()

Source: Author

Based on future expected capacities, if Bitcoin were to rebound to 50% from its peak today, CLSK would still lose its spot as the most undervalued Bitcoin mining company to HUT . However, if Bitcoin were to rebound back to its peak, CLSK's undervaluation would lose its spot to HUT and BITF and almost MARA (Table 5).

Table 5: Market Cap per Future PH/s CAD Less Bitcoin Reserve Value If Bitcoin Rebounds Today ()

Source: Author

Therefore, what we can conclude from this observation are:

1. Market Cap to Current Mining Capacity Ratio does not provide insights to the upside, only the premium one is willing to pay for a particular miner.
2. Despite many analysts claiming CLSK is the most undervalued Bitcoin mining company by market cap to PH/s, we found no such support when considering assets and future expected capacity.
3. The Bitcoin bear market is masking CLSK's fatal flaw in the Bitcoin mining business: Not retaining the Bitcoins mined, which resulted in very low Bitcoin reserves.
   • This will only get worse with time as other Bitcoin miners accumulate more Bitcoin to boost their intrinsic value but not CLSK.

CLSK's Fatal Flaw: Not Retaining Bitcoins Mined

Contrary to HUT, CLSK does not retain the Bitcoins mined. What we liked about HUT is that it adopts a 100% Bitcoin retention strategy. According to HUT :

Hut 8 continues to strategically emphasize its "HODL" strategy, taking active steps to generate Canadian and US dollars to help fund operating expenses, so as to avoid selling Bitcoin. During Q3-2021, 100% of self-mined Bitcoin ( 905 BTC ) was deposited into custody .

But it does come at a very steep cost: shareholder dilution. We found that :

The hidden cost of HUT's HODL strategy is shareholder dilution which saw HUT issue 74.4% new shares in 2021 and diluted shareholders' claim on assets and upside potential by 40%.

Regardless, the unparallel investment value proposition of HUT is you're getting its entire mining business for free PLUS some bonus Bitcoin when Bitcoin recovers. That is what the negative Market Cap per Future PH/s CAD Less Bitcoin Reserve Value meant. It means that the value of Bitcoin on HUT's balance sheet exceeds the value of the entire company.

Now that you know the significance of retaining Bitcoins mined, we had to look at CLSK's lack of retention. Is there any evidence that CLSK isn't retaining its Bitcoins mined?

Yes. Table 6 showed that CLSK has not been growing its Bitcoin reserves for over a year now and is not expected to grow its reserves anytime soon either for 3 reasons:

1. CLSK's Bitcoin mining operation is too costly to retain Bitcoins mined.
2. CLSK is unwilling to dilute shareholders to retain Bitcoins mined.
3. Uncompetitive all-in business cost per BTC mined.

Table 6: CLSK's Bitcoin Reserves Over Time

Source: Author

Why Won't CLSK's Bitcoin Reserve Grow In The Near Future? 3 Reasons.

* All figures from now on will be in USD unless specified

Bitcoin's average Q3 price is official below CLSK's cost of sales (mining). By referring to table 7, we can see it that the mining operation alone cost CLSK an average of $29,000 to mine one Bitcoin whereas one Bitcoin is only worth $21,900 on average in Q3.

Although CLSK's cost of sales per BTC mined aligns with HUT ($27,700), HUT is willing to dilute shareholders to commit to its HODL strategy (Table 9), but not CLSK. We're not saying which is better. What we're saying is that CLSK's Bitcoin reserve isn't expected to grow anytime soon.

What's worse is that CLSK's direct cost (electricity/hosting) stands that $14,300 per BTC. Should Bitcoin fall below $14,300, CLSK's entire mining operation is expected to be halted. This aligns with our Bitcoin outlook since May 2021.

What about other business costs? Up to this point, we have yet to consider all other business costs such as administrative costs, payroll, and etc. Once we consider these costs (Table 10), the problem we discussed above gets amplified (Table 11). That being said, kudos to CLSK for bringing down their all-in business cost per BTC to reach an industry average of around $35,000. Let's hope that CLSK can continue to achieve economic of scale.

Table 7: CLSK and HUT's Cost of Sales (Mining) per BTC Mined

Source: Author

Table 8: CLSK's Direct Cost Over Time

Source: Author

Table 9: CLSK and HUT's Common Shares Outstanding

Table 10: CLSK and HUT's All-in Business Cost per BTC Mined

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