Hut 8 Post-Merger Comprehensive Thesis: JCapital Research Might Be Right

Summary HUT falls into our "slow or unsteady loses the race" Bitcoin miner Bucket and must step up its expansion efforts. At worst, USBTC-merger may not have shareholder's best interest in mind; At best, it is a move out of desperation to solve the declining Bitcoin Production. Amidst the many controversies around JCapital Research's short report, many of our findings align with it. HUT has one of the worst cost efficiencies at $80k per BTC and HUT might've also overpaid for USBTC by 10x. HUT's USBTC merger could spark a broader sector consolidation as the halving event could render more Bitcoin mining businesses unfeasible. Introduction This Hut 8 Mining ( HUT ) analysis came right after we analyzed Bitfarms ( BITF ). Coincidently, our take on BITF was that BITF's declining Bitcoin ( BTC-USD ) production was caused by a slow expansion rate. The slow expansion eventually caused BITF to lose its share in the Bitcoin network, which directly reduced Bitcoin production. That's how we phrased it " Slow and steady loses the race ." We highly recommend reading it to grasp the full context of this article. In this very same aspect, we found that Hut 8 Corp ((HUT)) mirrored BITF, and in some areas, worse than BITF. We know that HUT's angle to differentiate itself has always been its large Bitcoin holdings. This could make it a buy if HUT is trading below its adjusted net asset value (adj NAV). Yet, we did not favor HUT for the following concerns, and these concerns were proven valid: Overly ambitious and unachievable guidance: At the beginning of 2021, HUT had 2.0 EH/s and guided 6 EH/s expansion by the end of 2022 which we did not think was possible 3 quarters later, HUT only had 3 EH/s and revised down its year-end guidance to 3.5 EH/s. Its capacity did not grow until the completed merger with USBTC. This brings us to the next concern. Sustainability of 100% HODL: We showed that HUT was diluting shareholders to maintain its 100% HODL policy, also should the Bitcoin price fall below HUT's mining cost. Due to the drastic increase in mining cost, HUT's 100% HODL streak ended in 2023Q1. HUT is expected to lose its ability to add Bitcoins to its balance sheet. Timing is key for HUT : Shareholders would be better off timing HUT to avoid severe dilution and exposure to unsystematic risks. Today, we have a lot to unpack. So please bear with us. The 2nd-Order Impact of HUT's Bitcoin Production Decline HUT was right when it said that the decline in Bitcoin production (Table 1) was caused by the increased Bitcoin network difficulty. In other words, HUT's share in the Bitcoin network has decreased. If this continues, then HUT could suffer a long and losing battle. This thesis is explained here in detail. Table 1. HUT's Declining Bitcoin Production Quarter ((CY)) Capacity (EH/s) Bitcoin Network Hash Rate (EH/s) Share in Network Share in Network Chg (QoQ) Bitcoin Production Production Chg QoQ 2023Q3 2.6 400 0.65% 0% 330 -17% 2023Q2 2.6 398 0.65% -13% 399 -16% 2023Q1 2.6 347 0.75% -18% 475 -32% 2022Q4 2.5 272.5 0.92% -31% 698 -29% 2022Q3 3.07 232.17 1.32% 3% 982 4% 2022Q2 2.78 217 1.28% -1% 946 0% 2022Q1 2.54 197 1.29% 23% 942 19% 2021Q4 2 190.65 1.05% 789 -13% Source: Author The 2nd-order impact of declining Bitcoin production is the broad-based increase in Business costs per Bitcoin. Overall, HUT's mining cost has been flat (Table 2). We don't consider the slight decline as an actual decline because the decline in some costs (such as operating costs) is caused by downtime (e.g. suspension of operations at the Company’s North Bay facility). Table 2. HUT's Historical Bitcoin Mining Business Cost Quarter ((CY)) Cost of revenue = Operating + Depreciation Operating Depreciation General and Admin, includes SBC ($mil) Share-based Comps ($mil) Interests ($mil) Total Mining Cost ($mil) 2023Q3 15.9 8.3 7.6 8.84 1.7 1.85 26.59 2023Q2 17.85 10.75 7.13 9.38 4.13 1.05 28.225 2023Q1 18.9 10.8 8.15 11.42 2.25 1.13 33.695 2022Q4 31.94 10.92 21 7.22 1.19 1.43 41.8 2022Q3 34.2 15.2 19.05 6.98 1.43 1.43 44.025 2022Q2 37.2 21 16.3 8 1.56 1.43 46.8 Source: Author However, when we compute HUT's cost on the "per BTC" basis, HUT's cost structure falls apart (Table 3). Notice that even though the total cost declined, the total cost per BTC increased. This is one of the worst per Bitcoin cost efficiencies when compared to CLSK ($33,000 per BTC), RIOT ($65,900 per BTC), ((BITF)) ($44,600), and IREN ($33,640). This observation aligns with one of JCapital Research's claims: In a game of efficiency, the combined company ((HUT)) is the least efficient Bitcoin miner on the market. Table 3. HUT's Bitcoin Mining Per BTC Quarter ((CY)) Total Mining Cost ($mil) Bitcoin Production Total Cost per BTC 2023Q3 26.6 330 80,606 2023Q2 28.225 399 70,739 2023Q1 33.695 475 70,937 2022Q4 41.8 698 59,885 2022Q3 44.025 982 44,832 2022Q2 46.8 946 49471.4588 Source: Author Because our model only projects Bitcoin to be around the $42,500 price level until April 2024 before providing an average of $66,000 from April 2024 to April 2025. At $80,000 per BTC mined, HUT has a 50% negative profit margin, making a $40,000 loss for every Bitcoin mined. Moreover, these losses are realized because HUT has now forsaken its 100% HODL policy and sold nearly all production in 2023Q1 and 2023Q2, and 1 third of production in 2023Q3 and 2024 (Table 4). If it cost HUT $80,000 to mine 1 Bitcoin from shareholders' point of view, shareholders would be better off just buying Bitcoin at market price. Table 4. HUT Violated Its 100% HODL Policy Quarter ((CY)) Bitcoin Production Bitcoins Sold Sold % 2023Q4 955 365 38% 2023Q3 330 100 30% 2023Q2 399 396 99% 2023Q1 475 428 90% Source: Author In addition, the halving event in April (expected) will further halve HUT's Bitcoin production, thus doubling HUT's cost per BTC. Since USBTC was a private company, it is pretty impossible to accurately estimate its mining costs. Moreover, USBTC allegedly used tricks to under-report their actual costs (reported by JCapital Research ). So there's just no way of knowing. This is also the reason why we have not considered Q4 post-merger Bitcoin production. But if it's anywhere near a $160,000 total business cost per Bitcoin (which is unlikely), HUT would unlikely survive the coming halving cycle. USBTC Merger Does Not Make Sense Based on the problems discussed above, HUT is likely desperate for expansion, while the USBTC merger provides HUT with this exact opportunity. Whether the merger is done out of the shareholder's best interest in mind (discussed in the JCapital Research Short Report), we do not know. But we do know that HUT has to look for more energy suppliers and also acquire more mining rigs to solve this downward spiral. JCapital Research suggested that HUT could've just waited a few more days to get HUT at a cheaper valuation. This we cannot verify. What we could verify though is how much could the 4.5 EH/s expansion cost HUT. Based on CLSK's and RIOT's pricing of $16mil per 1 EH/s, 4.5 EH/s worth of equipment would only cost it $72mil (4.5 EH/s x $16mil). HUT paid $655mil enterprise value for USBTC with another $90mil planned spending. This is a 10x discrepancy. Are the land, buildings, and energy contracts worth the $700mil? We don't think so. Furthermore, little is known about what mining rigs are used by USBTC. If these rigs are older models, HUT's mining cost per BTC would remain elevated due to inefficiencies. We also do not know what kind of financial obligations or unfavorable contractual commitments USBTC has to creditors or clients. For Instance, RIOT's hosting service has been making losses for a while now due to legacy contracts, which RIOT is working hard to address this issue. JCapital Research's short report and HUT's vague and standard response do not give us confidence. Until we have better insights into HUT's cost structure post-merger, we will refrain from generating any price targets. But based on its $372mil adjusted NAV value (=$15.9mil cash + 9,195 BTC * $40k + $70.5 PP&E + $17mil Deposit = $99.25mil Total Liability), HUT's current $750mil market cap (2x adjusted NAV) does not provide sufficient safety to justify its unsystematic risk, especially when compared to other miners: CLSK (2.13x), RIOT (1.55x), BITF (2.9x), and IREN (1.1x). Verdict There was a lot to unpack in this article. In short, we will continue to avoid HUT for the following reasons: HUT falls into our "slow and (un)steady loses the race" Bitcoin miner bucket One of the worst per Bitcoin cost efficiencies when compared to CLSK, RIOT, BITF, and IREN. Our analysis showed that HUT overpaid USBTC by about 10x. Unknown unsystematic risks (e.g. post-merger cost structure, commitments, balance sheet) cannot justify HUT's 2x Adjusted NAV valuation. This USBTC merger might be the start of a broader consolidation in the Bitcoin mining sector.