Evaluating Bitmain’s Initial Public Offering: The Good, Bad and Ugly Edition

Bitmain Prepares to Launch Mega-IPO. But Is It Exactly?

Last week, the market got a glimpse of Bitmain’s much-awaited initial public offering (IPO). To many, the mega-IPO signals a new era in the crypto space – a fundamental readjustment of what it means to invest in crypto. In a market dominated by initial coin offerings (ICOs) and VC funding, this sort of investment model gives users access to a funding paradigm which is based primarily on the  financials, operating strength and macro outlook of a business.

The main difference however, is the level of exposure to cryptocurrencies, and this is where things get complicated.

Pure Crypto Investment?

Bitmain's cryptocurrency holdings make up approximately 28 percent of all its assets. Some have suggested that this effectively makes it a soon-to-be-listed crypto fund in disguise. In reality however, while cryptocurrencies have a remarkable weight in the health of the business, the other assets (mainly physical inventory and financial instruments) offer a different risks and opportunities.

Cryptocurrencies are also valued at cost, which means that they will not gain valued if cryptocurrency prices go up. Therefore, a bull market cannot have a direct impact on the balance sheet by boosting the value of crypto asset holdings, though it would almost certainly have a positive impact on sales of mining equipment and on profit made from sales of cryptocurrency.

The flipside of that is that they will also not necessarily be written down if prices goes down.

An excerpt from the draft prospectus reads:

“…If circumstances indicate that the carrying amount of cryptocurrencies may not be recoverable, an impairment loss may be recognized”.

It is unclear how that carrying amount breaks down – the prospectus states that the weighted average of cost is used to calculate it. Since more than $700 million-worth of crypto entered the balance sheet in the second half of 2017, it is safe to say that the bulk of that was at higher prices than that of today.

Bitmain, in the first half of 2018, logged an “impairment loss” of more than $100 million. Since a large chunk of the crypto holdings is apparently in bitcoin cash, it is notable that the write-down wasn't larger.

There may also be more coming in the second half of the year, which will have a negative effect on year-end figures. However, it should be noted that under the accounting principles Bitmain uses, an impairment loss can be altered if market conditions change.

It should also be noted that despite the weak markets so far this year, Bitmain raked in more than $180 million of profit on cryptocurrency sales in the first half.

Therefore, while cryptocurrency markets are a major determinant in the health of its business, Bitmain is not solely a cryptocurrency-driven concern. Apart from market volatility, other risks that must be accounted for include operational error, supplier concentration, declining margins, technology obsolescence, financial mismanagement and increasing competition.

There is of course, also the security. In 2017, Bitmain experienced the theft of about $27 million-worth of cryptocurrencies. So far, according to the draft prospectus, no details have been given yet regarding custody arrangements to prevent a recurrence of this.

Not Just a New Crypto Investment

All of this then raises the question – what sort of investment is Bitmain actually? A manufacturing company or a mining stock? Just as it is difficult to fit cryptocurrencies into the pre-established categories of financial instruments, it is also difficult to place Bitmain into a neat little box.

Bitmain is a business that makes a physical product, produces a virtual asset, and also provides a service to others in the sector. There is also its exposure, both direct and indirect to the cryptocurrency markets. As recognized in  IPO application:

“Our business and financial condition correlate closely with the market price of cryptocurrencies.”

Will Bitmain's share price move with the price of bitcoin or bitcoin cash? It is very difficult to tell. In other words, Bitmain is not just a new kind of crypto investment, but also a new type of investment in its own right.

Its Values

 Bitmain has a staggering historical revenue growth, and a dominant position in its sector, reportedly dominating more than 70 percent of the ASIC mining rig market at its peak. It is also pivoting into artificial intelligence chip design, and expanding its geographical concentration.

However, whether or not it is a great opportunity actually depends on your market view, your thoughts on the management and assessment of the risks, and – very importantly for many – on the IPO price. Fundamentals are evidently important, but the key metric is perceived value.

Howard Marks of Oaktree Capital Management summed it up saying:

“It's not what you buy, it's what you pay.”

However, the Bitmain IPO is very encouraging because it sets a benchmark for others to emulate. It's not the only one in the pipeline – two others (Canaan and Ebang) have publicly declared their intention to file for a listing, and we are waiting for an opportunity to see their financials. Others will definitely follow, and not just from the mining segment.

This does not only present investors with a wider range of crypto-focused assets to select from. It also attracts more participants from traditional finance (analysts, investors, investment bankers, and lawyers), which, while it is betraying crypto's “alternative” origins, closes the gap between the two concepts and provides even greater legitimacy on cryptocurrencies as a product.

The fact that both investors and entrepreneurs will be provided with a deeper well of information is even more important. Greater transparency and more understanding of how the sector works should contribute to a more resilient infrastructure, which will result to generating more investment and financing opportunities. There is definitely value in whatever happens to the cryptocurrency markets.

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