Bitmain IPO Guide

IPO Process

Bitmain is expected to submit an IPO application to the Hong Kong Stock Exchange at the end of August 2018 and is expected to go public at the end of 2018. The company just completed a pre-IPO round of financing based on a valuation of $14 billion and raised hundreds of millions of dollars. Therefore, we believe that the company will be valued at more than $20 billion when it goes public and raise billions of dollars in funds.

Documents regarding the aforementioned financing (including Bitmain’s financial data) have been circulated on Twitter. We have reason to believe in the authenticity of these documents, and the contents of these documents will serve as the basis for this report.

Bitmain’s position in the mining industry

Is there any subscription demand for IPO?

Based on the table above, Bitmain is a dominant player in most areas related to cryptocurrency mining. Bitmain is likely the largest and most profitable company in the blockchain space, which makes the company very attractive to many investors.

Over the past few years and even decades, investors have learned one thing when analyzing the technology industry: whether they are right or wrong, they must invest in the leading companies in the industry. The number one company usually benefits from network/scale effects and other smaller competitors tend to fail more easily. The following list illustrates this phenomenon:

Whether it makes sense or not, many people now believe that blockchain is one of the next most important Internet-based technologies, and Bitmain is the leading company in this field. It is unclear whether this network effect logic can be applied to ASIC design and distribution companies, and the benefits of blindly expanding companies can also be more beneficial to traditional industries. We believe that cryptocurrency mining should be viewed not only from a technical perspective, but also from the perspective of energy-intensive industries such as natural resource extraction. These industries can bring more limited economies of scale than Internet industries. Therefore, we do not think that just because it is the largest cryptocurrency mining company at present, it should be blindly invested, but it is clear that some investors are naive to think so.

Bitmain's own mining business revenue fell

As we mentioned above, one of the most interesting findings in Bitmain’s pre-IPO filings is the sharp decline in Bitmain’s own mining business. While its share of total revenue has dropped significantly, in absolute terms, self-operated mining revenue still grew by 250% in 2017, but it was overshadowed by the 948% growth in mining machine sales.

Bitmain – Proportion of revenue from self-operated mining business

We believe this decline represents a (relatively) smart strategic decision by Bitmain to withdraw from an increasingly competitive and less profitable space. We believe that competition is more intense and changes more rapidly further down the mining chain, and that Bitmain has therefore made a smart strategic move to focus on the upstream of the chain, where the value of the entire chain is increasing. In some ways, this is good news for Bitcoin decentralization, as a dominant miner has exited. We believe that the design and sale of ASICs is less important to the security of the network system than mining itself, where miners can theoretically choose the mining pool that builds the block and choose which block to build a new block on. Of course, Bitmain's dominant power and dominance in the ASIC space remains a significant problem for the Bitcoin system.

Currently, Bitmain is likely to be making a loss

In the document, Bitmain disclosed the sales volume, sales volume, and crucially, gross profit margin of its main mining-related products. We have shown the relevant data in the table below. The data shows that Bitmain sold more than 1 million S9s in 2017, and then sold a total of 700,000 units in the first quarter of 2018.

Financial indicators of mining machines and related products

(Source: Bitmain pre-IPO documents, BitMEX research, Bitmain official website)

Using the disclosed gross margins for 2017, we calculated the implied cost per machine. Assuming costs remain constant (which is unlikely), we can further calculate the gross margin based on the latest prices on Bitmain.com. This analysis shows that Bitmain is currently losing money, with a negative 11.6% margin on its main S9 product and over negative 100% margin on its L3 product. In reality, costs have likely fallen, so the situation may not be that bad, but we believe that Bitmain is likely suffering significant losses.

The low-priced products are likely a calculated move by Bitmain to drive their competitors out of the market by hitting their sales through a price war, causing them financial difficulties. In our opinion, this is one of the main reasons driving Bitmain to IPO. A successful Initial Public Offering (IPO) could give Bitmain the firepower it needs to implement this strategy and eliminate the advantage that competitors have from IPOing first.

Another reason for the low price and loss-making sales could be that Bitmain has too much inventory on its balance sheet. As of March 2018, Bitmain had $1.2 billion in inventory on its books, equivalent to 52% of its 2017 sales. Therefore, Bitmain may need to revalue its inventory, which could generate a greater loss than a loss-making sale.

Operating Cash Flow and Balance Sheet

These documents contain aggregate balance sheet data. Bitmain's strengths are that it is completely debt-free and the company had strong cash flow in 2017. Its weaknesses include:

1. The total advance payment to TSMC in 2017 was close to $866 million, which weakened Bitmain’s working capital position;

2. Huge inventory levels, about $1.2 billion (more than 50% of peak year sales), suggest overproduction;

3. Holding a large portfolio of altcoins, which costs approximately $1.2 billion, illustrates where the bulk of Bitmain’s cash flow goes.

One of the company’s key assets is its crypto portfolio, which was valued (at cost) at nearly $1.2 billion as of March 2018. This included over 1 million Bitcoin Cash as of March 2018. The market value of the altcoin portfolio has fallen since Bitmain’s investment, with almost all of the losses coming from Bitcoin Cash, as shown in the chart below.

The chart below shows that the amount of money invested in Bitcoin Cash is very large. Bitmain used 69% of its operating cash flow to purchase Bitcoin Cash in 2017. Although this may be exaggerated, as some Bitcoin Cash may have been obtained through Bitcoin hard forks. From the data we can infer that out of the 1,021,316 Bitcoin Cash, approximately 71,560 were obtained in this way.

The situation is even worse than indicated above. Bitmain has invested not only the majority of its 2017 cash flow into Bitcoin Cash, but also the majority of its cash flow generated throughout its entire operating history. The filings show that Bitmain generated no cash flow in 2016 and only $25 million in the first quarter of 2018 (likely due to a large advance payment to TSMC).

In a sense, none of this matters. Bitmain is willing to spend its own money on risky assets, and they know what risks they are taking. But for a listed company, the situation is different, and shareholders will expect the company to invest in its core business or return excess funds to investors. Of course, it may be that our expectations of Hong Kong regulation may be too high.

Why does Bitmain want an IPO?

We believe that the main reasons for the IPO are simple. First, Bitmain's competitors are also planning IPOs, and the industry is highly competitive, as Bitmain's loss-making pricing shows. Its competitor Canaan is planning an IPO, and Bitmain is unlikely to give them a financial advantage. Bitmain's initial public offering (IPO) should divert some of the funds originally intended to be invested in Canaan or other mining machine companies in the market, so the IPO is a reasonable tactic to continue the price war.

Another reason for the IPO could be that the funds raised from the IPO could be used to strengthen the balance sheet, given that the majority of operating cash flow has already been invested in Bitcoin Cash. As of March 2018, Bitmain only had about $105 million in cash on its balance sheet, a figure that would have been closer to $1 billion if the company had not purchased so much Bitcoin Cash. At the same time, the business does require a lot of cash, such as the cash advances required to pay TSMC, which peaked at $866 million in 2017.

The narrative surrounding Bitmain’s technical capabilities has been both good and bad, and the truth will probably always lie somewhere in the middle. However, one thing is clear, if these mining companies do go public, the industry will be more transparent and clear to the market, which we believe is a major positive for cryptocurrencies as a whole.

in conclusion

In a way, some of Bitmain’s major mistakes, such as producing too many mining machines and buying too many speculative cryptocurrencies during a bull market, are somewhat similar to the behavior of traditional mining company management teams. For example, gold mining companies often invest in high-cost assets during a bull market and then do not invest in high-quality, low-cost assets during a bear market. Perhaps these companies cannot be blamed alone, and hedge funds and institutional investors who hold shares in these companies also need to bear some responsibility. Greed, fear and other market emotions all affect our decisions. Therefore, although Bitmain made mistakes, in many ways these mistakes were not uncommon or unexpected.

We are sure you have heard the phrase “cryptocurrency will survive.” In that environment, we believe Bitmain has the potential to be the greatest company in the space. Bitmain can become a cryptocurrency legend and deliver strong returns to shareholders for decades to come, but in order to achieve this goal (and it is much harder than it says), Bitmain’s management team may need to improve the management of the company’s resources. Once the company goes public, it will become very difficult to make decisions about capital allocation in a volatile and unpredictable market, and investment decisions influenced by emotions will not be tolerated by the market.