The shares of Bitcoin miners usually follow the price of BTC because it directly influences the profits of the companies. These values suffered sharp falls in the last quarter of 2022, especially in the month of December. The post-FTX crash slump was made worse by the bankruptcy filing of the largest US-based Bitcoin mining company, Core Scientific.
During this period, other mining stocks, such as Marathon Digital Holdings (MARA) in the chart below, showed a weak correlation with the price of Bitcoin, suggesting that the December drop was likely exaggerated.
The negative trend was reversed in early 2023, with most mining stocks posting impressive gains. The Hashrate Index, which tracks the average price of publicly traded mining companies and hardware manufacturers, has risen 62.5% year-to-date. The positive price rally also restored the strong correlation between the BTC price and mining stocks.
However, the mining industry remains stressed, with low profit levels expected for extended periods. Since the second quarter of 2022, mining companies have financed their operations by selling BTC from their reserves, selling newly mined BTC, taking on debt, and issuing new shares. Unless the Bitcoin price consolidates above $25,000, the industry is likely to see some takeover attempts or more treasury sales to pay down debt.
Some mining companies operate at a loss
Currently, the price-earnings (PE) ratio of the major mining companies is negative, indicating that they are operating at a net loss and making their prices vulnerable to sharp falls.
Riot Blockchain, Bitfarms Ltd, Hive Blockchain Technologies, Cleanspark Inc, Marathon Digital Holdings, and Hut 8 Mining are the largest publicly traded Bitcoin mining companies, with more than 1% of the global hashrate share. The top 15 public mining companies have a combined share of around 19%.
It should be noted that the PE ratio of most companies in the sector is between 0 and 2, except for Marathon, Hive and Hut 8. This raises alarm bells that these companies could be overvalued at their current valuations.
A net loss position is not a reason to reject a security, because markets tend to look to the future. If one is long-term bullish on Bitcoin, mining stocks are obvious choices. However, these companies must survive the bear market before reaping the rewards of the next bull run.
Excessively leveraged or indebted companies, which have to meet their interest payment obligations, are especially stressed and vulnerable to insolvency.
Marathon, Greenidge, and Stronghold have over $200,000 in debt per Bitcoin mining rig, with Marathon’s debt peaking at $1.1 million per BTC mined. Marathon collateralized its loans with Bitcoin in its treasury. And the company now owns 10,055 BTC worth about $235 million.
At the end of October 2022, Marathon took out $100 million in loans, which risk being paid off if the price of Bitcoin falls below the loan threshold value. For example, if the loan threshold is 150%, the company will be forced to sell some of its BTC to pay off the loans if the price of Bitcoin falls below $15,000.
In this regard, it’s encouraging to see that Hive, Hut8 and Riot are mostly debt free and run essentially on equity. This reduces interest rate pressure on debt and provides flexibility in raising funds or expanding by absorbing some of the market share left by now-bankrupt mining operations.
However, there is another way to raise funds. Instead of going into debt, miners can dilute their shares. Companies attract investment from public market investors in exchange for additional shares. Thus, the proportion of shareholder ownership is reduced. Hut 8 mining and Riot had diluted more than 40% of their shares in the second quarter of 2022. Hut 8 again diluted around 15% of the shares in the third quarter of the same year.
The need to raise money has exposed these indebted companies to liquidation risks, while excessive dilution has also significantly reduced the value of investors’ holdings.
Mining company mandates on treasury holdings
As mining companies struggle with profitability, they are determined to preserve their Bitcoin treasury levels. Despite suffering losses since the second quarter of 2022, Marathon was able to maintain its treasury levels.
At the same time, Hut 8 miner uses a more aggressive policy in selling its mined BTC. This has caused a sharp increase in their holdings since mid-2022.
While others like Riot and Hive have resorted to using their BTC treasury to cover operational and expansion costs. Hive holdings have dropped significantly since Q3 2022, from 4,032 BTC to 2,348 BTC. Hive relies on expanding its miner fleet and cutting costs to sustain itself.
It is clear that Bitcoin mining companies remain vulnerable to the BTC price, debt liquidations, and shareholder losses due to excess dilution. According to the on-chain analyst and founder of Crypto Quant, Ki Young Juin 2023 there will be entities that take over entire mining companies with the possibility of buying them at a discount.
Although it will not affect the price of Bitcoin much, mining stocks are still exposed to the threat of considerable losses.
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