Riot Platforms' Ambitious Expansion To Be Overshadowed By 2024 Bitcoin Halving

Summary Even though RIOT is expected to triple mining capacity in 2024, we expect Bitcoin production to halve due to the Bitcoin network's 93% CAGR and the 2024 Bitcoin halving event. Our model only valued RIOT at a $1bn market cap post-halving despite its ambitious expansion plan due to the Bitcoin halving event. Although RIOT may still trade in tandem with the Bitcoin price, exposure to RIOT and Bitcoin mining companies, in general, poses extreme risks without sufficient support from fundamentals. Introduction: The Missing Puzzle About a month after our previous coverage , we've finally gotten a critical piece of the puzzle to evaluate Riot Platforms (RIOT) intrinsic value. That missing piece of the puzzle was RIOT's expansion guidance beyond 2023. In our previous coverage, the lack of guidance beyond 2023 is one of the big nos that prevented us from giving RIOT our buy rating. The lack of guidance beyond 2023 could also be one of the reasons why RIOT trailed behind other Bitcoin (BTC-USD) mining companies in this rally. Data by YCharts Now, RIOT has guided investors that it expects to expand mining capacity from the current 12.7 EH/s to 20.1 EH/s by mid-2024 and further option to expand to 35.4 EH/s by the end of 2024. To put this into perspective, this expansion plan will make RIOT the biggest Bitcoin mining company in the industry in the future, surpassing Marathon Digital Holdings (MARA) and CleanSpark (CLSK) (Table 1). It will now be up to MARA whether to take on RIOT and retain its share in the Bitcoin network. RIOT MARA CLSK Expected Capacity 20.1 EH/s(Mid of 2024) or 35.4 EH/s (End of 2024) 23.5 (End of 2023) 16 EH/s (End of 2023) That being said, this ambitious expansion plan has 2 major implications on feasibility and its valuation. The objective of this article is to discuss the feasibility of this expansion plan and the resulting RIOT price targets. Implication 1: Operational Feasibility It is rather risky that RIOT's mining operation is centered in Texas. Operating in Texas presents a major problem. We detailed Texas' energy woes by showing the fragility of the Texas power grid and its process to climate. During the winters , Bitcoin miners in Texas risk curtailment due to winter storms; During the summers , Bitcoin miners in Texas risk curtailment due to heat waves. On the other hand, Bitcoin miners could also suffer curtailment when power demand is high. For instance, RIOT's Bitcoin production dropped 32% in June due to high temperatures and power demand. With July and August being the hottest months in Texas, we should expect more severe curtailment to come over the next 2 months. This observation is not a one-off event but is consistent with past observations in 2022 where RIOT's Bitcoin production also declined in 2022Q3 . Hence, there seems to be a pattern of curtailment during the summers. Furthermore, RIOT is not the only Bitcoin mining company affected. In short, what we're trying to say is that the capacity of RIOT might not matter if it is eventually going to get curtailed. Recall that Marathon, is one of the largest (if not the largest) Bitcoin mining companies, and many Bitcoin mining companies are also located in Texas. Competition between other Bitcoin mining companies could put more strain on the fragile power grid and risk further curtailment. Implication 2: Financial Feasibility RIOT is required to purchase about 100,000 M56S++ from MicroBT to add 23 EH/s mining capacity. Since each M56S++ machine costs around $7000 , about $700mil is required to fund this expansion. RIOT primarily sells Bitcoins mined and issues new shares to fund mining operations and expansion . So the first thing that came to mind is how much is RIOT going to dilute shareholders to achieve this. Let's make a rough estimate. Based on the 2023Q1 financial report, RIOT is cash flow positive (~$30mil) due to the liquidation of Bitcoins mined. Since Bitcoin is trading rather flat in 2023Q2 and 2023Q3 so far, we should also expect cash flow to be similar for the 2 quarters. Assuming Bitcoin to trade flat in Q4, we expect RIOT to receive additional $90mil cash from operation in 2023. On the other hand, RIOT also has about $150mil at the end of 2023Q1. The $50mil worth of deposits were not included as we expect it to be used to get RIOT to 12.5 EH/s. Therefore, we estimate RIOT to have about $240mil by the end of 2023. $240mil is likely to be sufficient to get RIOT to 20.1 EH/s by mid-2024 (estimated cost = $220mil) but is unlikely to be sufficient to get RIOT to 35.4 EH/s (estimated $450mil additional cash required) by the end of 2024. Fortunately, we are optimistic towards Bitcoin in 2024 where we expect Bitcoin to reach $70,000 by April 2024 and $100,000 by April 2025. We estimate the Bitcoin price to average about $50,000 in H1 and $75,000 in H2. We also estimate RIOT's capacity to average 16 Eh/s (deployed) in H1. RIOT's gross profit margin is about 50%. These assumptions translate to roughly $100mil additional cash flow from operation for 2024H1. Under these assumptions, RIOT only has to raise the remaining $300mil from equity offering (or about 10% shareholder dilution) in 2024H1 to get to 35.4 EH/s capacity by the end of 2024. This looks to be a good deal right? Not quite. Price Targets At 35.4 EH/s Capacity Here's probably where we'll receive heated debates, but hear us out: We expect RIOT to mine fewer Bitcoins even at 35.4 EH/s due to the upcoming Bitcoin halving event in 2024. By the end of 2024, we expect the Bitcoin network to break 1,000 EH/s as it has been growing by 93% CAGR . A 35.4 EH/s capacity represents about 3.5% of the Bitcoin network and is expected to produce only 5,800 Bitcoins after the halving. Although RIOT is operating cash-flow positive, RIOT is still making losses. RIOT's all-in business cost per Bitcoin averages about $41,700 . Based on our Bitcoin thesis (considering a Bitcoin bear market in 2025), we expect Bitcoin to trade average between $60,000 - $80,000 in 2025. So we'll use $75,000 as the baseline Bitcoin price for 2025. Under these assumptions, RIOT could only make $197mil profit annually. With a P/E of 5, our model values RIOT only at a $1bn market cap while RIOT is currently trading at a $3.11bn market cap. We're aware that Bitcoin mining companies trade in tandem with the Bitcoin price and are often more volatile than Bitcoin itself. But without proper support from the underlying fundamentals, HODL-ing Bitcoin mining companies is extremely risky. Consider this, even when Bitcoin is trading at its current all-time high, Bitcoin mining in 2021, Bitcoin mining companies are hardly profitable. Unless Bitcoin outperforms our expectations, we could see severe value destruction across the Bitcoin mining sector. Even with an ambitious 35 EH/s expansion plan, we don't think that RIOT could mitigate this risk. Data by YCharts Verdict We started this analysis on RIOT in a positive light but it did not turn out the way we expected. If you're shocked by our model's price target for RIOT, we were equally shocked as well. However, we do think that this price target makes sense after connecting the dots. The next Bitcoin halving cycle is going to put the entire Bitcoin mining sector at risk. The 2024 Bitcoin halving will double the sector average total business cost per Bitcoin or cut Bitcoin mining revenue by half. The sector average total business cost per Bitcoin ranges from $30k-$60k while the currently known Bitcoin all-time high is only $69,000. Many Bitcoin mining companies might not survive a 50% cut in Bitcoin mining revenue. Q ('CY') CLSK MARA RIOT 2023Q1 $33,276 $32,100 $46,200 2022Q4 $30,500 $44,400 $53,000 2022Q3 $35,627 $91,200 $55,000 2022Q2 $37,600 $81.683 $35,300 2022Q1 $42,800 $31,700 $30,800 Unless Bitcoin outperforms our Bitcoin thesis, we don't see any way where the Bitcoin sector can come out unscathed. Even with RIOT's ambitious 35 EH/s, our model suggests that Bitcoin needs to trade above $98,000 to justify RIOT's current valuation (post-halving). Therefore, we do not recommend any exposure to the Bitcoin mining sector even though we're bullish on Bitcoin.