Summary Does Hut 8 intend to continue as a Bitcoin miner? Or is it diversifying and morphing into something else? Five crypto miners are up more than 200% YTD; Hut is up 120% but its mining capacity is in trouble. The next earnings call has essential questions to answer and should provide further evidence about their plans for the future. The surge in the valuation of Bitcoin ( BTC-USD ) miners, fuelled by a recovery in Bitcoin price, got me searching the Crypto Miners Sector for a short–medium-term trade in this super volatile sector. In my last article, I looked at the industry, discussed the crypto winter and the increase in the valuations of Miners. I analyzed HIVE Blockchain Technologies ( HIVE ) in detail, ultimately deciding to pass and continue searching. Perhaps Hut 8 Mining Corp. ( HUT ) is the Miner I am looking for. Hut managed the 2022 Crypto Winter quite pretty well (this is the same graph I used to compare several Miners in the previous article) Hut debt v equity over time (Author database) Its cash level is higher than its debt, which has not increased significantly. Until recently, Hut kept its Bitcoin as an asset and funded operations by diluting shareholders, almost 30%, in 2022. The company is 85% owned by the general public and has practically zero institutional investment. (Bitfury owns 4%). Hut had 9,000 Bitcoins on its balance sheet at the end of 2022. Hut is changing Hut looks to be in the middle of a significant business pivot. The production of Bitcoin is dropping and might be more of a secondary business line in the future. M&A activity is driving the change; Hut bought TerraGo Inc's data center s and will merge with U.S. Bitcoin in Q2 2023, a merger of equals, we are told. The Pivot away from mining The actual production of Bitcoins from the mining operation is falling precipitously. In March, they produced 131 coins, down from 156 in February, continuing the trend from last year in Q4 2022; Hut averaged 232 Bitcoins monthly. Bitcoin mining is far more profitable now than in 2022, so we should see increased production. Many miners throttled back production in 2022 as the business became unprofitable (the cost of electricity needed was greater than the price of Bitcoins mined). However, the Bitcoin price is currently up, and electricity prices have steadied. The reasons for the drop in production at Hut must be more fundamental. Hut has three mining sites (Medicine Hat, North Bay, and Drumheller), all based in Canada. Only one of them appears to be fully operational. North Bay is closed completely. From the Q4 2022 Earnings call ... dispute with Validus related to our North Bay mining facility, where we stopped mining in mid-November Validus is the energy supplier to the site and has cut off the electricity supply. Legal action is taking place over the dispute between the two companies. Management has not given a timeframe for restarting production. In the Q4 earnings call, we learned that 1,000 of the nearly 9,000 miners at the site had been moved from North Bay to Medicine Hat. The remaining 7,800 miners have been stored as Hut has no premises to house them. Seven thousand eight hundred miners in storage is a waste. It is not a good situation. The second site, Drumheller, is running well below capacity due to electrical issues. In the earnings call, CFO Shenif Visram implied that, as yet, no plan to solve these problems exists. He said the next earnings call might be when he can give an update (an answer to a question from George Sutton in the earnings call). The Third Site Medicine Hat appears to be fully operational ; it hit an all-time high, thanks to the extra 1,000 miners moved from the North Bay site, operating at 1.7 Exahash in March. To put this into context, Riot Platforms Inc. ( RIOT ) is running at 9.8 Exahash. It is unclear if Hut will reverse this drop in mining; it could be temporary, and perhaps all the miners will be back fully powered soon, or perhaps Hut is looking at other avenues and is less concerned with being a Bitcoin miner. High-Performance Computing High-p erformance computing is a significant and fast-growing market, forecast to be at $49.9 bil lion by 2027, the customer base is small and medium size companies, and currently, there is insufficient supply to meet growing demand. Hut entered this market when it bought five data centers from TerraGo Inc . in January 2022. The deal included 36,000 square feet of data center space with room for expansion at one site, all 400 customers, 30 employees, and the business's products. December 2022 report (Hut 8 website) High-performance computing had a turnover of $4.5 million in Q4 2022, which is $1.5 million monthly and will likely be a regularly recurring income. Any growth here will represent new customers and be a good sign. It would appear to be a hugely profitable business with revenue of $16.9 million, costs of $8.4 million, and depreciation of $5 million. 50% gross margin is an outstanding result. In the earnings call, management was asked about this sector and said Jaime Leverton I can't give you any forward looking guidance. But what I can say is, we are very pleased that we did that acquisition. It's been just over a year since we diversified into that area and then ultimately we're able to not just integrate the business, but spent a significant amount of time focusing on upgrading that business. So I think we've timed the market incredibly well and we continue to be bullish on the space and really thrilled that we're a bit ahead of the curve on that diversification strategy. We've got an incredible sales team in place that's actively driving expansion of the pipeline. But I don't know how to get into more specific details with you. We do have some expansion capabilities remaining in a few of the sites, not all five are expandable. But we'll continue to look to expand as required when the capacity that we have built out already is filled up. So it's really a data center by data center question as opposed to a fleet demand question. I will watch the performance closely in the next earnings (May). $5 million in revenue would be an excellent result. I will also be listening for clues about how this business will progress. If the focus is moving away from Bitcoin mining, then this high-margin operation is an excellent one to focus on and grow. Diversification is a word that keeps cropping up from Hut management. U.S. Bitcoin a merger of Equals Last year Hut announced its intention to merge with the private company U.S. Bitcoin Corp. The CEO said it is a chance to leverage the Bitcoin stack they have hodled, which is a big departure from the normal Hut mode of operation. They have always kept the Bitcoin they mine but will use it in this merger. Is that another sign of a change of direction? The rationale for the deal is important; in the earnings call, the CEO gave an overview. He explained that the combined group would be a highly diversified U.S. domiciled organization with self-mining operations at three mines in the U.S. and two in Canada. They will have six exahash of hosting capacity (for the use of other miners) and have some of the largest miners as clients. A different business line will be managed infrastructure operations; he said they would look after the optimization of miners as well as property management and maintenance. The customer would be the site's owner, and the new Hut would be paid a monthly amount to manage the facility; the owner would receive the mined Bitcoin. That gives four business lines, high-performance computing, hosting Mining operations, managing mining facilities, and finally, self-mining Bitcoin. Where will the focus be going forward? Is it a good deal? The shareholders of each company will own 50% of the new entity (called Hut 8 Corp.). USBTC has been through 5 rounds of funding, but Finding any financial details on the company isn't easy. The last two funding rounds are shown. USBTC funding rounds (CB insights) To make sense for Hut shareholders, the new entity must be worth double what Hut is now, about $850 million. Does it make sense? I am not convinced. The Current U.S. Bitcoin Corp Business The main body of the USBTC business was acquired from the Compute North bankruptcy. A quick review of the bankruptcy . Feb 2022 Generate Capital loans Compute North $300 million to develop 400mw of mining facilities at two sites in Texas. July 2022 Generate Capital asserts technical defaults September 2022 Compute North goes into Chapter 11 unable to service its debts November 2022 Generate Capital bought the facilities (built with the original loan) for $5 million; Generate was the only bidder. USBTC has three different businesses; it is a Bitcoin miner, manages the Bitcoin mining sites owned by Generate Capital, and manages a site it bought in the Compute North bankruptcy. USBTC self-mines at its Niagara Falls site: a 1.1 maximum exahash site mired in controversy over noise pollution . It has had to pay a $1 million fine and install noise reduction dampening and an independent noise monitor. $150,000 in compliance fees may also be due. It is not yet clear if the Niagara site is fully operational again, mining has re-started, but no mining figures have been released so far. USBTC owns and operates the King Mountain mining site in Texas: acquired from the bankrupted Compute North. Marathon Digital ( MARA ) have miners at this site, and they were one of Compute North's largest customers. The bulk of MARA's miners are at this facility . It is unclear how much free capacity is at this site and how much self-mining USBTC does there. USBTC manages the sites that Generate Capital bought out of bankruptcy, totaling 400MW. It is unclear who owns the miners at these facilities or how much spare capacity there is. U.S. Mining Infrastructure Operations USMIO is the USBTC division managing Bitcoin mining sites. It manages the Kearny sites for Generate Capital and believes that this model can drive future revenue that will not depend on the price of Bitcoin. As yet, we have not been given enough information to make an informed decision on USBTC, its management of facilities is the same business Compute North was doing and at the same sites. What is USBTC doing to make this more profitable? Earnings call May 2023 For me to invest in Hut, I need clarity. I need answers to the following questions. 1. What will be the focus going forward, and how much growth can we expect in each business line? Bitcoin mining, hosting, managed facilities, and high-performance computing. I want to see some clear guidance. 2. What is the plan for the 7,800 miners in storage? 3. What is the plan to solve the electrical problems, and what is the Drumheller site's timeline? 4. Why is US Bitcoin Corp worth the same as Hut 8? It has a much smaller mining operation, we do not know its financial position, and we have no information about the income it generates from its hosting business or its facilities management. Conclusion I cannot invest in Hut 8 stock yet; there are too many unknowns, and the next earnings call will be very important. I like the high-performance computing business but have no idea what the plan is, and so far, management has declined to give forward guidance. I like the look of Bitcoin Mining in 2023, but I am unclear about the capacity Hut will have and, as a result, can not make any projections about income. I might like the facilities management business, but Hut must give me some figures to work with. If we get answers, I will update following the next earnings call.
