Huaqiangbei's 20,000 yuan mining machine costs 2,000 yuan and the factory price is 4,000 yuan. Canaan's prospectus also revealed these secrets

After failing in its A-share asset restructuring in 2016 and withdrawing its application for listing on the New Third Board in 2017, Canaan Creative’s current target capital market is the Hong Kong stock market.

The outside world was able to get a glimpse into the business of mining machines through the prospectus submitted by Canaan Creative to the Hong Kong Stock Exchange on May 15. Canaan Creative's main product is the Avalon mining machine for mining Bitcoin, which ranks second in the world in terms of delivery volume.

Mining machines are obviously a highly profitable industry. In just three years, Canaan's revenue soared from 47.699 million yuan in 2015 to 1.308 billion yuan in 2017, with a compound annual growth rate of 423.7%; gross profit margin also increased from 29.1% to 46.2%.

Mining machines are still a hot industry with supply exceeding demand. Canaan Creative's prospectus shows that as of March 31, 2018, it has received more than 1 billion yuan in advance payments, which is most likely related to mining machine orders.

On the other hand, mining machine manufacturers are in a weak position compared to chip foundries and need to pay large advance payments to ensure production capacity, which also leads to large cash flow outflows from mining machine manufacturers.

Ant or Avalon?

Canaan Creative positions itself as a chip design company. Its founder Zhang Nangeng invented the first batch of cryptocurrency mining machines with built-in ASIC chip technology.

ASIC mining machines with higher computing power have gradually replaced computers and graphics card mining machines and become the mainstream choice for miners. However, Canaan Creative's market share is far smaller than that of Bitmain.

Canaan's prospectus shows that in 2017, Canaan delivered 294,500 mining machines, with a market share of 20.9% (Bitcoin mining machines) by delivery volume, ranking second in the world; the first place was 940,100 units delivered, with a market share of 66.6%. The first place is Antminer, manufactured by Bitmain.

At SEG Digital Plaza in Huaqiangbei, the world's largest digital currency mining machine distribution center, almost all mining machine sales counters sell Antminers, while Avalon mining machines are relatively rare.

A retailer told reporters that the Antminer runs more stably and has very good after-sales service. If there is a problem with the miner within six months after sale, the manufacturer can be asked to replace it with a new one. For stalls, selling Antminers will reduce a lot of trouble. In addition, the Antminer is well-known and has far more buyers than other brands of miners. The Avalon 741 series miners were once popular for a while, but later lost their market.

Another merchant who started selling Avalon just as the mining machine became popular in the market said that Antminer is updated very quickly and its price is relatively cheaper than Avalon, while Avalon mining machines are updated very slowly.

Bitmain not only has Bitcoin chip mining machines, but also L3 and other Litecoin mining machines are also popular in Huaqiangbei.

Canaan is also expanding its production lines. In its prospectus, it stated that in addition to Bitcoin chips, the company is currently developing ASIC chip products for another cryptocurrency. The front-end IC design has been completed and mass production is expected to begin in the fourth quarter of 2018. The company has received orders worth 53.6 million yuan so far.

Data from third-party websites show that the threshold for self-designed mining chips may not be as high as the outside world thinks. On May 20, the top three mining machines in terms of yield were Equihash 40K, DragonMintB29 and D9DecredMaster, with daily yields of $144.51, $86.98 and $86.98 respectively. These three mining machines are not from Bitmain or Canaan Creative.

The unit cost of a mining machine is less than 3,000 yuan

The investment attribute of mining machines is obvious when they are circulated in the market. The higher the price of coins, the higher the mining yield, and the price of mining machines will rise accordingly, and vice versa.

The high price of Bitcoin was also the time when Avalon mining machines were the hottest. At its peak, Avalon 741 was sold for 20,000 to 30,000 yuan. On December 17, 2017, the price of Bitcoin reached 19,666 US dollars, approaching the 200 million US dollar mark. For miners, the mining machines purchased at high prices can be recovered in about a month, so it is difficult to get one.

In Huaqiangbei, mining machine sellers have been experiencing a three-month "mining disaster". The price of Bitcoin began to fall in February and was only around $8,000 on May 20. Data from third-party websites showed that the daily profit of Avalon 841 on May 19 was $3.11. The current market price of this mining machine is around 6,600 yuan - if the daily profit of $3.11 can be guaranteed, miners will get their money back in 200 days.

In Huaqiangbei, mining machine sellers will show mining machine yield websites to customers who come to buy mining machines. However, the price of Bitcoin fluctuates violently, and no one can predict the yield of the next day. Discounting has also become difficult. The decline in the price of the currency also means a plunge in the price of mining machines. Reselling mining machines is more like a gamble.

A merchant in Huaqiangbei said that one of his peers had stockpiled 8,000 Avalon 741s when the price was high, and has since lost more than 10,000 yuan on each unit - the Avalon 741 has been discontinued, and only second-hand units are currently available, with a market price of around 1,600 yuan - less than one-tenth of the price at its peak.

Although the price was hyped up to 20,000 to 30,000 yuan at its peak, Canaan Creative's prospectus shows that the ex-factory price of the Avalon mining machine is between 3,122 yuan and 4,402 yuan, and the unit cost is only between 2,354 yuan and 2,600 yuan.

Conservative pricing makes the production of mining machines a business that is guaranteed to make money regardless of the weather. In just three years, Canaan's revenue soared from 47.699 million yuan in 2015 to 1.308 billion yuan in 2017; its gross profit margin also increased from 29.1% to 46.2%.

Huge cash outflow

Among the merchants in Huaqiangbei, Avalon Miner is the only "listed" mining machine manufacturer, which seems to have formed an endorsement effect.

As of March 31, 2018, Avalon Miner’s “advance payments, deposits and other assets” amounted to 1.102 billion yuan - this means that Canaan Creative’s strong sales position has resulted in advance payments of nearly 1.102 billion yuan from channel partners.

In Huaqiangbei, there are more buyers of popular mining machine futures than spot buyers. Canaan's prospectus shows that customers' advance payments account for 30%-50%, "generally requiring buyers who intend to be included in the waiting list, which is usually up to three months, to prepay 30% to 50% of the purchase price, and the balance is settled before the product is shipped. The order time determines the priority in the waiting list."

On the other hand, mining machine manufacturers are at a disadvantage in front of suppliers. Canaan's prospectus shows that TSMC is Canaan's only foundry partner. From 2015 to 2017, TSMC's orders accounted for 75.7%, 66.2% and 63.5% of the company's purchases respectively.

This is obviously not comparable to the orders from traditional mobile phone chip manufacturers. Canaan Creative stated in its prospectus that it did not have TSMC's production capacity guarantee, and that the company did not sign a long-term contract with TSMC, but instead obtained supplies in the form of purchase orders and prepaid the purchase amount.

TrendForce analyst Lin Jianhong told reporters that TSMC and many of its customers adopt a pre-paid (prepaid order) approach to chip processing, that is, customers prepay fees to reserve production capacity, and ultimately deduct this fee based on actual production. The purpose is only to hope that customers will not transfer orders, and production capacity cannot be guaranteed.

From 2015 to 2017, Canaan Creative paid TSMC advance payments of RMB 28.4 million, RMB 36.6 million and RMB 606 million respectively.

Despite its lucrative profits, large advance payments to suppliers resulted in huge cash outflows for Canaan, whose cash flow from operating activities was negative until 2017.

From 2015 to 2017, Canaan Creative's cash generated from operating activities was -18.821 million yuan, -68.994 million yuan and 8.2220 million yuan, respectively, which is far from the net profits of 1.511 million yuan, 52.544 million yuan and 361 million yuan.

Entering AI chips

Canaan Creative did not disclose the specific amount of the IPO. According to the announcement of the Hong Kong Stock Exchange, Canaan Creative's IPO net proceeds will be invested in four projects, namely the research and development of ASIC chips for artificial intelligence algorithms and applications; ASIC chips for blockchain algorithms and applications; expanding its global artificial intelligence and blockchain business through overseas strategic investments and the establishment of new offices around the world; and optimizing the supply chain and repaying debts incurred by the restructuring.

It can be seen that AI chips are the focus of Canaan Creative's layout.

Coincidentally, Bitmain, a leading mining machine manufacturer, also regards AI chips as a key focus of future development. At the end of 2017, Bitmain, known for its low profile and silent wealth, held a press conference to introduce its AI chip products.

Canaan Creative's prospectus shows that the proportion of R&D personnel and R&D investment indicate that it is indeed a technology-driven technology company.

As of March 31, 2018, Canaan Creative had a total of 234 employees, including 35 managers, 25 sales and marketing personnel, 94 R&D personnel, and 80 others.

From 2015 to 2017, Canaan Creative's R&D expenses were RMB 5.1 million, RMB 41 million and RMB 105 million, respectively, accounting for 10.6%, 13.0% and 8.1% of its revenue, respectively.

But can the advantages of mining machine manufacturers in chips be extended to AI chips? The head of the chip business of an AI company in Shenzhen once told Yicai Technology that mining requires a large number of repeated logical operations, and mining chips can repeat a large number of simple logical operation units, and the design is relatively simple. However, AI chips not only require massive operations, but also require high flexibility and efficient data interaction efficiency to cater to the rapid and ever-changing evolution of deep learning algorithms and constantly adapt to the whims of neural networks in the industry. This is quite different from the dedicated design purpose of mining chips.

Debt-raising and restructuring before IPO

The last project that Canaan Inc. plans to invest the net proceeds from its IPO is to optimize its supply chain and repay debts incurred by restructuring. In the early stages of its IPO, Canaan Inc. carried out debt restructuring.

Canaan Creative's main operating entity is Hangzhou Canaan, which was established in 2013 by Zhang Nangeng and Li Jiaxuan. Later, Liu Xiangfu joined as a co-founder. As of January 2015, Zhang, Li and Liu held 33.4%, 33.4% and 33.2% of the shares respectively.

In April and July 2015, Hangzhou Canaan introduced external shareholders twice and obtained RMB 11 million and RMB 17 million in financing respectively.

In December 2015, Hangzhou Canaan established Canaan Supercore for employee shareholding, and subscribed for approximately 14% of Hangzhou Canaan’s equity for RMB 300,000; at this point, Zhang, Li and Liu’s equity were diluted to 17.0%, 17.0% and 16.9% respectively.

In February 2016, the shareholders of Hangzhou Canaan transferred their shares. One shareholder acquired 2.32% and 1.18% of Hangzhou Canaan's shares from two other shareholders for RMB 3.95 million and RMB 2 million respectively. Based on this calculation, Hangzhou Canaan's valuation was RMB 170 million.

In March 2016, Hangzhou Canaan issued new shares. Shenglan Investment and Beishen Investment subscribed for 1% and 1.25% of the company's equity for RMB 30 million and RMB 37.5 million respectively. In April 2016, Counselor Peter subscribed for 2.0% of Hangzhou Canaan's new shares for RMB 61.2 million. This also means that Hangzhou Canaan's valuation in March and April 2016 was RMB 3 billion, an increase of more than ten times in one year.

In April 2017, Ningbo Zhuoxian subscribed 4.6712% of Hangzhou Canaan's registered capital for RMB 150 million. At this time, Hangzhou Canaan's valuation was RMB 3.2 billion.

In February 2018, Canaan Creative registered an offshore holding company in the Cayman Islands and simultaneously established a wholly-owned subsidiary, Canaan Hong Kong, in Hong Kong, starting its overseas listing. The Cayman Islands company 100% controls Canaan Hong Kong, and Canaan Hong Kong 100% controls Hangzhou Canaan.

On March 21, Canaan Hong Kong signed a contract with other shareholders of Hangzhou Canaan, agreeing to acquire all the shares of Hangzhou Canaan for RMB 700 million. This also means that the valuation of Hangzhou Canaan has reached RMB 700 million, and Hangzhou Canaan has become a wholly-owned subsidiary of Canaan Hong Kong.

In order to facilitate the acquisition, Canaan Hong Kong raised funds.

On March 24, 2018, Canaan Creative signed a contract with CMB International, agreeing to borrow a principal loan of up to HK$885 million (approximately RMB 707 million) from the latter with a loan term of 12 months, and the equity of Hangzhou Canaan would be used as collateral.

Just one month later, Canaan Creative repaid the loan by "taking money from one pocket to pay another".

On April 25, 2018, Canaan Hong Kong signed a contract with China Merchants Bank (Hong Kong) Branch, agreeing to borrow up to HK$930 million (approximately RMB 743 million) from the latter. HK$921 million of this financing was used to repay the aforementioned loan from CMB International.