Survival of the fittest - this old adage applies to crypto miners this year, as the sell-off in the broader market is squeezing out some companies in the crowded industry.
Mining digital assets, especially bitcoin, has seen a surge in competition in recent years, as several new entrants entered the industry during its peak in 2021. However, given the drop in prices, the survival of many new miners may depend on whether those companies are able to sell themselves or merge with another peer, according to industry participants.
"I think we're likely to see some M&A activity in the next six months or so," said Amanda Fabiano, head of mining at Galaxy Digital, "because some miners that entered the sector during the peak simply won't be able to meet their demands."
During the crypto market's bull market in 2021, profit margins for some bitcoin miners were as high as 90%, leading many new entrants and miners to want to grow at top speed. To that end, companies ordered mining rigs at high prices and paid money upfront for their orders.
Today, in 2022, bitcoin prices have fallen and profit margins have shrunk. The Bitcoin network's hash rate is at an all-time high, and operating costs are higher due to increased energy prices - putting miners in a bind. "A falling bitcoin price means miners' margins are shrinking," said Mason Jappa, co-founder and CEO of blockchain infrastructure and cryptocurrency mining company Blockware Solutions. "In addition, margins have also decreased because the difficulty of bitcoin mining on the network is increasing" as more miners join the network, he added.
A less profitable environment for bitcoin mining
Many of these companies that entered the mining sector in the last 12-18 months lacked a "solid balance sheet," Mike Levitt, CEO of Core Scientific (CORZ), the largest publicly traded miner in terms of hashrate, told CoinDesk.
"These companies were in a position where they made plans and commitments assuming that external capital, whether from public or private markets, would always be readily available," he said. "Now the cost of capital, if available, has simply become more expensive, and some of these miners don't have enough capital to finish what they started."
In addition, supply chain issues and lack of access to capital are exacerbating the situation for many miners. "The ability to secure large advance orders from ASIC miners is no longer the main bottleneck to growth," Jonathan Petersen, an analyst at Wall Street bank Jefferies, said in a recent research report. "Construction delays caused by difficulties in procuring construction materials and signing power purchase agreements are a bigger barrier to new fleet deployment."
This perspective was echoed by crypto-mining company Hive Blockchain. "The crypto mining industry in general appears to be at a crossroads, with a supply of very expensive ASIC chips and few places to plug them in," the miner said in a statement. "In our market monitoring, the company has seen significant supply disruptions for electrical equipment needed to build data centers, such as transformers and switchgear."
All of these factors combined have meant that some of the newer and less well-funded miners are now in a state of limbo as they struggle to fund their operations on the terms set during the bull market.
"I think mining companies will take a beating this year, unlike last year when we saw the rise of public mining companies," Fabiano said. Some of the mining companies that have signed longer-term contracts will have to raise a lot of money to meet those obligations, she added.
On top of that, ASIC markets are moving down, which means miners won't be able to make the profit they could on the secondary market by simply selling their machines when their operations aren't running, Fabiano said. Bitcoin's price decline is making some of the older mining rigs, such as Bitmain's Antminer S9, increasingly unprofitable, leading miners to shut them down to avoid paying the costs.
This will likely cause some miners to look for an exit strategy by selling their business or merging with other companies. "I think those [miners] who have no operational experience, no background in bitcoin mining, are probably going to be the ones looking for mergers and acquisitions, or they're going to have a hardship where they have to take on [expensive] debt," she said.
This tight market environment has already led larger, more established mining companies such as Core Scientific and Bitfarms (BITF) to lower their growth expectations for the current year to a level that can be better served with the capital they already have on their balance sheets. Meanwhile, Marathon Digital (MARA) remains "cautiously optimistic" about its hashrate growth outlook.
As the larger miners cut back on their growth prospects, the newer and smaller miners will likely find themselves in a more difficult position. This will likely lead to mergers fairly quickly, given how long these new entrants can actually sustain some of that market volatility in a bear market, according to Michael Ashe, head of investment banking at Galaxy Digital. "I think we're going to see all kinds of merger and acquisition opportunities in this cycle," he said.
In fact, Core Scientific said it is already receiving merger and acquisition inquiries from mining companies that are feeling the pinch. "There are a number of companies whose commitments are contingent on their ability to raise additional capital and are having difficulty raising that capital," Core Scientific's Levitt said during a conference call, adding, "Frankly, we're already being presented with opportunities now."
Core Scientific will look at two types of potential M&A deals: One is cheap mining companies and the other is a deal that will help the company grow, Levitt told CoinDesk. "Those are the two areas we're looking for. It's either value or growth, and if you're really lucky, it's a combination of both," he said.
He's also getting calls from other parts of the mining ecosystem, including companies with electrical equipment and electric utilities that now suddenly have a surplus of both and need buyers. "Companies that haven't prepared for this downturn have to make very difficult strategic decisions. In terms of consolidation, we are aware of the current complexities in this industry, and we will continue to look to acquire the best companies in our industry when such opportunities present themselves," Levitt added.
Mining companies that are more capitalized and have a sound strategy will likely view such a market as a favorable opportunity to acquire assets or businesses at lower valuations. "This cycle is an interesting opportunity from an M&A perspective because there are some of these more established mining companies that have already survived past bear markets and will now see this as an opportunity to acquire assets and properties at attractive values," Galaxy's Ashe said.
Who will survive?
With listed mining stocks down more than 50% on average this year, investor confidence in the sector could be shaken. However, for longer-term investors, this could be an opportune time to fish for an attractive stock. "It's not easy to determine the exact timing of the bottom, but many on-chain and market indicators suggest that now is a good time to buy both bitcoin and bitcoin mining rigs," said Blockware Solution's Jappa. So what should investors look for in a miner to filter out the winners?
One answer is to look at past downturns. "The mining companies that survived the bear markets of the past will survive the next round," said Galaxy's Fabiano. "Being extremely opportunistic with ASICs over the next six months [when their prices fall] while having a really strong growth strategy on the infrastructure side will be an amazing opportunity for miners to really stand out from the crowd."
Miners who are prepared and have the latest generation of equipment with locked-in power rates will be able to take advantage of the current market conditions, said Zach Bradford, CEO of bitcoin miner CleanSpark (CLSK). "At this stage of the economic cycle, miners who have consistently delivered value to their shareholders and the bitcoin ecosystem will be rewarded," he added.
Another important factor is miners who already have cash and still have access to capital markets to fund their growth. "As the BTC mining industry increasingly finances its growth with debt, we expect miner profitability to continue to diverge, with the larger public miners extending their cost of capital advantage," wrote analyst Gregory Lewis of Wall Street investment bank BTIG in a recent research report.
Petersen of Jefferies sees larger miners such as Marathon Digital and Core Scientific as having an "advantage" in access to debt capital compared to smaller miners. He also expects companies to start selling some of their mined Bitcoins, which they typically hold on their balance sheets to cover operating costs.
Recently, miner Argo Blockchain (ARBK) said during its first-quarter conference call that it is taking on debt and selling some of its mined Bitcoins to cover some of its expenses. Meanwhile, Core Scientific said it has sold some of its mined Bitcoins this year and will continue to do so.
Other miners such as Marathon are also considering selling some of their mined Bitcoins, while peer company Riot Blockchain (RIOT) has already started selling its mined digital assets.
Arcane Research analyst Jaran Mellerud wrote in a recent report that "to assess which miners are best prepared to weather the bear market and even potentially profit from it by buying assets from distressed competitors, it is important to look at two factors: each company's bitcoin production costs and the strength of their balance sheets."
Based on the latest information, Riot Blockchain has the lowest electricity prices among the top five miners by market cap, paying only $24 per megawatt per hour (2.4 cents per kilowatt per hour), Mellerud wrote. He also pointed out that electricity prices have likely increased for all miners in recent months.
"Overall, Riot appears to be in the strongest position among the five largest publicly traded mining companies at this time simply because of its low power costs and healthy balance sheet," Mellerud said.
The bottom line is that investors trying to pick winners in a down market should look for mining companies that have a proven operating track record, lower costs and good treasury management strategies and hedging options.