Questioning Hut 8 Mining’s “Doing Things Differently” Strategy (NASDAQ:HUT)
Hut 8 (NASDAQ:HUT) is not looking to capture or even aggressively defend its share of the total network hash rate of Bitcoin (BTC-USD) this year. While the company’s goal is to more than double the current installed mining capacity by the end of the year, increased emphasis on prudent capital spending, monitoring the mining economy and further diversifying away from sole reliance on grid mining Bitcoin.
With the above in mind, during the fourth quarter 2021 earnings call last month, CEO Jaime Leverton highlighted the company’s January acquisition of the cloud data center business and colocation from TeraGo. While listing all the diversification and differentiation efforts, she gave the most importance to the purchase of TeraGo and said:
…and most importantly, seize a crucial acquisition opportunity that will place Hut 8 at the forefront of infrastructure innovation at the intersection between blockchain and Web 3.0.
And a moment later, Leverton said:
But as we said, we are not just miners. We are corporate building technologists.
During the commentary and Q&A, Leverton explained and, to some extent, was compelled to defend the new direction for the longtime miner and bitcoin holder. The article below develops and comments on some of his remarks in the following areas.
- Where is Hut 8’s bitcoin mining headed this year relative to the competition and the network’s total hash rate.
- The upcoming challenge for their GPU mining business with The Merge on the Ethereum (ETH-USD) platform.
- The acquisition of the TeraGo data center company in prospect with the largest company.
Exploration of digital assets
On the recent call, when asked about electricity costs, the new North Bay mine site and expected changes in cost per coin mined this year, Leverton made an important distinction. What drives the cost thinking are not incremental changes in the structure of the electricity supply, but rather the ever-increasing difficulty of mining. She answered the question about electricity costs as follows:
…everyone kind of needs to run their own patterns on where they think the hashrate and difficulty is going in the short to medium term.
It should be noted here that the mining difficulty of Bitcoin has increased by 15% in the first quarter and by 40% in the last two quarters. Given the current total network hash rate of 200 PE/s, industry players are predicting a year-end total of between 300 and 350 PE/s.
As a result, Hut 8’s position on mining growth is slightly nuanced. On the one hand, they are bringing 35 megawatts online in North Bay, which will increase capacity by 1 PE/s over the next few months. But as far as the rate of return on new equipment expenditure is concerned, they are currently cautious and are not contracting for the total amount of equipment needed to reach their target of 6 PE/s for the year. With an optimistic outlook, Leverton explained as follows.
..the prices we had seen over the last few months were, we thought out of sync with the economic situation, from an IRR point of view, we expected the price per terra hash to go down, especially as we see a new entry[sic] enter the ASIC manufacturing space. And we’re starting to see some of that slowdown now and actually better delivery times as well.
As a final consideration on the subject of mining, a good comparison to make is between Hut 8 and Bitfarms (BITF), another Canadian miner. Among many other factors, they both have remarkably similar market capitalizations, hash rates, primary equipment vendor, cooling systems, and hodl policy. But there is a growing dichotomy of growth strategy that deserves recognition.
Bitfarms has similar energy expansion plans in Canada, but is also making an even larger investment in Argentina. Their current orders for MicroBT equipment under contract are stronger and their plans to make 8 PE/s by the end of the year are stronger than those for Hut 8’s smaller 6 PE/s target.
Commenting this week on achieving 3 PE/s, Bitfarms CEO Emiliano Grodzki highlighted the company’s “laser focus” on increasing hashrate, completing the construction of new power supplies and their “deliveries.” robust miners planned”.
The Merge Problem on Ethereum
Hut 8 settles its Ethereum mining operation in bitcoins, which facilitates economic comparison. In March, Ethereum mining accounted for 13% of total production and had an average BTC equivalent cost of around CA$2,600. The energy requirements of mining Ethereum are relatively low, and the average equivalent costs are only about one-eighth of the cost of mining the Bitcoin network. Thus, Hut 8’s purchase of Nvidia GPUs last year and diversification into Ethereum mining proved to be a good tactic to generate profits.
However…apparently within the next three to six months, Ethereum will transition from a proof-of-work consensus mechanism that requires mining to a proof-of-stake mechanism that does not. When asked, Leverton made the following remark:
We really don’t have a timeline for that move to – for Ethereum to become proof-of-stake, obviously that’s been talked about for many years. If and when that happens, we would move our computation to the next most profitable blockchain to mine using our GPUs and I think that’s currently an Ethereum classic, but I haven’t checked it in a while.
Thus, the company can use the equipment to mine Ethereum Classic (ETC-USD), which split from Ethereum in 2016, or another smaller-cap coin like Dogecoin (DOGE-USD). GPUs can also be reused for new data center activity. But either way, at 13%, substantial production with high gross margins will be significantly impacted and equipment profitability could be cut in half.
Mine gold and sell pickaxes
Hut 8’s new data center business is very adjacent to their existing mining operations. But one of the main differences between mining and data center business is the customer experience component. And note that in February they added Joshua Rayner as VP of Sales. Rayner has a background in data center sales, management and operations and, from the outside, seems a good fit for Hut 8’s new hybrid model.
Looking back to compare revenue brackets, Hut 8’s annual mining-based revenue last year was C$174.0 million and applicable revenue from TeraGo acquired through the acquisition was $174.0 million. approximately C$19.0 million. For perspective on the new power supply, prior to the current North Bay, Ontario expansion, Hut 8 was operating at 107 MW total at two locations in Alberta. The acquisition of the data center represents approximately 4.1 MW, expandable to an additional 1.5 MW and located in Ontario and British Columbia.
Leverton donated the following color:
With our acquisition of TeraGo’s data centers and cloud business, we welcomed more than 400 enterprise customers into the Hut 8 family. We also gained 36,000 square feet of geo-diverse data center space and cloud capability powered by emission-free energy sources.
Looking at Hut 8 using Seeking Alpha’s quantitative rankings and factor ratings shows that the company ranks well on valuation with strong, albeit slowing, growth. The company appears reasonably priced with a forward P/E of around 10 and a forward EV/EBITDA close to 7. Note that the “F” profitability rating is skewed due to a number of quirks such that how bitcoins mined and stored are not taken into account. into metrics such as free cash flow and operating cash flow. And while Momentum has been volatile and dependent on Bitcoin’s underlying price, the January lows could mark another reversal. And notably, prices maintain a 20% gain from this low.
Look for continued strong earnings with Bitcoin price below but close to the 2021 average. fixed assets for new mining equipment.
In summary, consider the following from Leverton:
Listen, we’ve been transparent and will continue to drive growth through organic and inorganic means. We have proven that we are patient with our balance sheet and opportunistic when it comes to deploying capital and that is something you will continue to see from us.