Marathon Digital: Dilution And Halving, Better To Just Own Bitcoin

Summary Dilution could hurt Marathon Digital's share price in the short term as the number of shares outstanding jumps from 174.3 million to 206 million. Marathon Digital management would rather dilute shareholders than hold to 2026 a cheap debt instrument. Tough times could be ahead for Marathon Digital due to the Bitcoin halving hence management elected to dilute existing shareholders to gain liquidity. Marathon Digital’s ( MARA ) stock has been quite the rollercoaster ride year to date. MARA stock price movement has been correlated with the price of Bitcoin ( BTC-USD ). Given the recent strong performance of Bitcoin in the past few weeks, it was no surprise to see MARA stock do well. Bitcoin started 2023 with a price of $16,670 and nearly doubled as it rallied to a high of $31,475. Bitcoin is currently trading at $27,003 as of writing for a 62% YTD return. Marathon Digital’s stock on the other hand had an even more blockbuster performance. MARA stock started 2023 at the price of $3.40 per share and has delivered a 150% return YTD as it is currently trading at $8.50. This gap is not unusual for mining/commodity companies, as typically asset price increases flow straight to the bottom line. However, due to the recent issues with Marathon Digital (and a lot of Bitcoin miners), I believe that there is a risk that MARA stock will underperform Bitcoin. Marathon Dilutes Shareholders It might be tempting to attribute the decline of MARA stock from its peak of $20 to the corresponding decline in Bitcoin’s price. While that may be the case, the recent dilution may continue to depress the share price. Data by YCharts Marathon Digital recently completed the exchange of its 1% Convertible Senior Notes. The company exchanged its $417 million worth of notes for 31.7 million new shares. This implies an actual conversion price of around $13 per share. According to the press release, the transaction represents a 21% discount to the bond's par value. While this is a good discount to get, I am not sure if this was the absolute best deal for the shareholders as I’ll discuss below. As you can imagine this is good news for the company as it suffers from liquidity issues. The company reduced its long-term convertible debt by around 56% leaving $331 million worth of debt remaining. The company is calculating savings of $101 million in cash savings from reduced interest expenses. There’s a lot of “happy talk” going on in the company’s press release but dilution generally hurts share prices in the short-term. The number of shares outstanding jumps from 174.3 million to 206 million, an increase of 18%. The company claims that this conversion would result in an accretion in shareholder value. However, this assumes that the company’s price will stay steady. New shares coming into the market in a bad macro environment have the tendency to be sold off though. So I think this might end up being an overhang on MARA stock price. Accretion analysis (Company Press Release) Reading Between the Lines There are a lot of things about this conversion that don’t make sense to me. Obviously, as I am not an insider in the company these are all conjectures and speculations I have based on pieces of publicly available information. The first thing that is confusing me is that as far as I know the notes were supposed to be due on 2026 which is still 3 years from now. The interest rates on these notes is also incredibly favorable at 1%. Based on the company’s Q2 2023 financial statements, Marathon Digital had an interest rate expense of $2.8 million in Q2 2023 and $6.6 million in YTD 2023. Now unfortunately we can’t calculate the traditional Interest Coverage ratio as the company has been operating at a loss. However, compared to Q2 2023 Revenue of $81.7 million and 2023 YTD revenue of $132.8 million, interest expense is a small driver of costs. Furthermore, had the company decided to wait until 2026 the holders of the debt would either get their principal back or convert at a much higher price. These debt notes were issued near the peak of the market in 2021. Because of this, it has a very high conversion rate of 13.127 shares per $1000 worth of principal implying a price of $76.17. It's unlikely that these debtholders would have converted though given that Marathon Digital’s share price is $8.50. They would have taken a substantial haircut if they did. So, the most likely scenario is that the principal amount would be needed to be repaid. If this is the situation that management wants to avoid, it is imperative to analyze why. In its press release, Marathon Digital management has weighed the refinancing option. However, they were fearful of the increase in interest rate expense due to having to refinance in a higher interest rate environment. Management also mentioned that its cash flows would have been burdened by this additional expense. Marathon Digital management would rather dilute shareholders than hold to 2026 a cheap debt instrument. Furthermore, it is this line in the press release that worries me, “the Company believes it is crucial to increase resilience and reduce its risk profile prior to the next Bitcoin halving event”. The next Bitcoin halving event is April 2024, only a few months from now. A “halving event” would increase the price of Bitcoin. However, it is detrimental to miners as it cuts in half the Bitcoin they are able to mine. So despite Marathon continuing to increase its operational hash rate, its efforts will be negated by this upcoming halving. Marathon hash rate (Investor Presentation) Conclusion It is my view that Management believes that tough times could be ahead for Marathon Digital hence they elected to dilute existing shareholders to gain liquidity. The company posted a loss of -$0.13 EPS missing both revenue and earnings analyst estimates. Marathon Digital’s EPS miss of -$0.13 was much lower than the average analyst estimate of -$0.08. The company had a cash burn from operating activities of $142.8 million in the six months of 2023. The company has a combined Cash and Bitcoin position of $445 Million. It also has, as of August 2023, an Installed Hash Rate (EH/s) of 23.1 and an Average Operational Hash Rate of 13.2. Despite these improvements, the company still sits on a knife’s edge when it comes to liquidity, especially given the circumstance of the Bitcoin halving in only a few months. I still believe in the long-term potential of Bitcoin but with Bitcoin ETFs coming soon there will be other options for investors. I believe that MARA stock is something that investors should avoid due to the myriad of issues facing the company.