SDIG - Stronghold Digital Mining: Turning Coal To Coins

2023-07-28 17:27:03 ET

Summary

• Stronghold Digital Mining is an environmental reclamation company that uses waste coal to mine Bitcoin.
• The company has lowered debt significantly but still loses roughly $26 million per quarter.
• At current Bitcoin prices, SDIG shareholders face continued risk of dilution.

Stronghold Digital Mining ( SDIG ) has arguably the most unique approach to Bitcoin ( BTC-USD ) mining in the public equity market. What makes Stronghold particularly intriguing is that the primary focus of the operation is as an environmental reclamation company. Stronghold utilizes waste coal in Pennsylvania as part of a two-segment business model that includes Bitcoin mining and energy sales.

Through an elaborate process that involves fluidizing waste coal, Stronghold turns coal that is both environmentally hazardous and uneconomical for steel or power generation otherwise into usable energy. Essentially, Stronghold is cleaning up the environment and producing energy as a biproduct of the cleanup effort. It then either uses that energy to mine Bitcoin or sell to the grid depending on unit economics of each segment at a given time.

At a sub-$100 million market capitalization, SDIG is a microcap and should be considered higher risk because of it. As one of the smallest Bitcoin miners in the public equity market, it's also one of the more volatile from a share price swing standpoint.

Production and Capacity

In Stronghold's June production update , the company disclosed 225 BTC mined in the month. This gave Stronghold a total Q2-23 figure of 626 BTC mined. That was up from 618 BTC in Q1-23 despite global hash rate growth of 23% over the prior quarter:

While small, Stronghold's quarter over quarter growth in BTC production was well ahead of many larger mining peers in the industry:

Source: Company releases

At the end of May, Stronghold had 3.0 EH/s in operational mining capacity with plans to scale production to 4.0 EH/s by the end of the September. The company has been on a buying spree lately, having purchased 2,000 new miners from Canaan ( CAN ) for $3 million at the end of July after buying 5,000 MicroBT M50s in late April.

Stronghold's waste reclamation facilities are Scrubgrass and Panther Creek. Scrubgrass has power generation of 85 MW and Panther Creek has 80 MW.

At these sites, the company utilizes mobile data centers which are referred to as a " StrongBox " to mine the Bitcoin.

Revenue and Profitability

From where I sit, it's difficult to take issue with the company's mission to clean up the environment. However, this doesn't necessarily mean Stronghold Digital Mining is actually a good investment. With $17.3 million in operating revenue, $15.9 million in cost of revenue, and an additional $15.9 million in opex, Stronghold had an operating loss of $14.5 million in the quarter ended March 31st 2023.

With the exception of a $28.7 million loss from debt extinguishment shown above in other expenses, the biggest loss in the last quarter came from the company's energy operation. Energy sales have become a smaller portion of the company's total revenue over the last year:

Source: Stronghold Digital Mining, 10-Q

Year over year, crypto mining and hosting has gone from 63.7% of total revenue in Q1-22 to 78.9% in the last quarter. Despite the 67% decline in energy revenue year over year, fuel is still a large input cost for Stronghold because the company has to pay to truck the waste coal from the waste site to the power plants. After the waste coal is burned, the company then has to truck the ash back to the waste site to fertilize the reclaimed land.

Source: Stronghold Digital Mining, 10-Q

As I see it, the big problem with the company's energy model is it is monetizing resources that aren't economically viable without tax credits and/or subsidized by Bitcoin mining.

Even with the aforementioned credits, Stronghold still lost about $26 million per quarter over the last year and seems entirely dependent on higher BTC prices to get to profitability.

Balance Sheet

From a balance sheet standpoint, the company has spent crypto winter deleveraging its operation and has reduced total liabilities by over $322 million in the last 5 quarters. As part of the company's debt restructuring, Stronghold had to amend obligations with 6 different counterparties.

Part of this debt restructuring included forfeiting 26,000 mining machines to a lender last August. Those machines represented approximately 2.5 EH/s in mining capacity. Current liabilities are down from $144 million at the end of Q2-22 to just $28 million at the end of Q1-23:

The company has very little cash at just $6.4 million as of quarter ended March. However, there are positive signs. Stronghold earned $11.3 million on 618 BTC mined in the last quarter. That equates to a Bitcoin sales price of roughly $18.3k. Bitcoin has oscillated between $28-31k for most of Q2. At what might be a conservative estimate of $27k per average BTC sold, Stronghold's revenue from crypto mining could be closer to $17 million for the upcoming quarter. All else being equal, that would result in Stronghold's net operating loss of $14.6 million moving closer to $8.5 million.

Risks

Of course, even at an author-forecasted operating loss estimate of just $8.5 million in Q2-23, Stronghold still wouldn't have had enough cash on the balance sheet to make it through the quarter without raising capital. In April, the company raised $10 million through a securities purchase agreement that included $1 million from Stronghold CEO Greg Beard and $9 million from an institutional investor. This was just 7 months after the company's last capital raise through share dilution in September of last year.

Adjusting for a 1 for 10 reverse split in May to remain compliant with Nasdaq listing requirements, SDIG shares outstanding have tripled in the last three quarters. Without much higher Bitcoin prices, Stronghold is highly likely to continue to lose money from the company's waste coal operation. Given the motive to restructure the company's previously high debt load, I believe shareholder dilution will be the continued strategy for raising capital.

Investor Takeaways

Philosophically, I don't dislike what Stronghold Digital Mining is trying to do. I think reclaiming land that is currently serving as a toxic waste coal dumping ground is an admirable endeavor. However, without dramatically higher Bitcoin prices or significantly more revenue from energy sales, Stronghold is likely going to be reliant on dilution to get by and that's going to ultimately be bad for shareholders. However, I'm not willing to call Stronghold a sell.

It is by far the cheapest publicly traded Bitcoin miner based on a 0.5 price to book multiple. Like all miners, the economics look a lot better if the price of the coin is higher. While there is certainly no guarantee of higher BTC prices from here, I do think we've probably hit the bottom for this halving cycle. I'm not personally long SDIG, but for the truly risk tolerant among us, there are probably worse companies to support.

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