Bitcoin mining stocks generally follow the price of BTC as they directly influence company profits. These stocks were heavily demolished in the last quarter of 2022, particularly in the month of December. The slowdown after The collapse of FTX worsened with bankruptcy filings from the largest US-based Bitcoin mining company, Core Scientific.
Meanwhile, other mining stocks, such as Marathon Digital Holdings (MARA) in the chart below, showed low correlation with the price of Bitcoin, suggesting that the December downturn was likely overdone.
The negative trend reversed in early 2023, with most mining stocks posting impressive gains. The mining stock index Hashrate Index, which tracks the average price of listed mining and equipment manufacturing companies has risen 62.5% since the start of the year. The positive price surge also restored the strong correlation between the price of BTC and mining stocks.
However, the mining industry remains under stress, with low profit levels waited for long periods. Since the second quarter of 2022, mining companies have financed operations to sell BTC from reserves, sell newly mined BTC, raise debt and issue new shares. Unless the price of Bitcoin consolidates above $25,000, the industry will likely see a few takeover attempts or further cash selling to pay off debt.
Some mining companies operate at a loss
Currently, the price-earnings (PE) ratio of major mining companies is negative, suggesting that they are operating at a net loss, making their stock prices vulnerable to sharp declines.
Riot Blockchain, Bitfarms Ltd, Hive Blockchain Technologies, Cleanspark Inc, Marathon Digital Holdings, and Hut 8 Mining are the largest publicly traded Bitcoin mining companies with over 1% global hashrate share. The top 15 state-owned mining companies hold a combined share of around 19%.
Notably, the PE ratio of most companies in the sector are between 0 and 2, with the exception of Marathon, Hive and Hut 8. This raises concerns that these companies are overvalued at their current valuations.
A net loss position is not a reason to reject a stock as markets are generally forward looking. If one is long-term bullish on Bitcoin, mining stocks are obvious choices. However, these companies need to survive the bear market before reaping the rewards of the next bull run.
Shareholders suffered losses due to bad debts and dilution
Companies that are over-indebted or in debt, which must meet their interest obligations, are particularly stressed and vulnerable to insolvency.
Marathon, Greenidge, and Stronghold have debt of over $200,000 per unit of Bitcoin mining, with Marathon’s debt peaking at $1.1 million per BTC mined. Marathon has secured its loans with Bitcoin in its treasury. And the company now holds 10,055 BTC worth around $235 million.
At the end of October 2022, Marathon took out $100 million in loans, which are at risk of being liquidated if the price of Bitcoin falls below the loan threshold value. For example, if the loan threshold is 150%, the company will be forced to sell some of its BTC to repay the loans if the price of Bitcoin falls below $15,000.
In that regard, it’s encouraging to see that Hive, Hut8, and Riot are mostly debt-free and essentially run on equity. This reduces the pressure of paying interest rates on debt and provides flexibility in raising funds or expanding by absorbing some of the market share left over from now bankrupt mining operations.
However, there is another way to raise funds. Instead of increasing debt, miners can dilute their shares. Companies raise investments from public market investors in exchange for additional shares. This lowers the shareholder ownership ratio. Hut 8 mining and Riot had diluted north of 40% of their shares in the second quarter of 2022. Hut 8 again diluted around 15% of their shares in the third quarter of the same year.
The need to raise funds has exposed these indebted companies to liquidation risks, while excessive dilutions have also significantly reduced the value of investors’ holdings.
Warrants of mining companies on Treasury assets
As mining companies grapple with profitability, they are determined to hold on to their Bitcoin cash levels. Despite losses since the second quarter of 2022, Marathon has been able to maintain cash levels.
At the same time, Hut 8 mining uses a more aggressive policy to sell its mined BTC. This has led to a sharp increase in its holdings since mid-2022.
While others like Riot and Hive have been using their BTC cash to cover running and expansion costs. Hive’s holdings have decreased significantly since Q3 2022, from 4,032 BTC to 2,348 BTC. Hive relies on expanding its miner fleet and reducing costs to sustain itself.
Clearly, Bitcoin mining companies remain vulnerable to the price of BTC, debt liquidations, and shareholder losses due to excessive dilution. According to on-chain analyst and founder of Crypto Quant Ki Young Ju2023 will see entities take over entire mining companies with a chance to buy them at a discount.
Although this does not affect the price of Bitcoin much, mining stocks are still exposed to the threat of considerable losses.