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Canaan (NASDAQ:CAN) is an interesting company when it comes to the AI chip space, specifically for the cryptocurrency mining sub-industry. They’ve made some good progress on their mining chips and have seen sales steadily rise over the past few years as they save them and their customers on energy costs.
But there’s a constant negative to all of this – most of their business and long term prospects are still tightly tied to the price of Bitcoin (BTC-USD). There are a few parts to this, so let’s explore those before reaching and expanding on my investment conclusion.
Multiple Negatives With Bitcoin Ties
The first negative is that the appetite for the company’s chips, and the price which they can charge for those chips, is almost directly tied to the price of Bitcoin. The CEO and CFO both acknowledged that as the price of Bitcoin falls, the price for which they can sell their products drops and they lose their ability to generate any meaningful profits.
The second part of this is that the company has multiple expenses which are not tied to the price of Bitcoin like the price of energy which they use to mine their own Bitcoin. This is also true with Wafer prices, which means that when the price of Bitcoin is down the hit to their profits will be significantly higher than the hit to their revenues.
Higher energy prices are also a negative to the company’s own mining of Bitcoin, which the company does quite a lot of. As of their latest report, the company held just shy of 347 Bitcoins, valued today at around $6.9 million. This is also the other negative for the company’s valuation and balance sheet when it comes to the price of Bitcoin – the value of those 347 Bitcoins was roughly $17.5 million about a year ago but is now more than halved. This fluctuation, as the price of Bitcoin is expected to remain under pressure, can spell trouble for the company’s balance sheet and valuation.
Here’s the summary the CFO made in their latest earnings call:
As the Bitcoin price further decreased in the second quarter, we responsively lowered our product price for spot sales to shoulder the pressure with our clients. On the other hand, wafer price stays high on the cost front. Therefore, we expect the gross margin to decrease dramatically in the second half of this year. Looking forward to the coming quarters, we see a tougher market environment from the lower Bitcoin price level, overall increased energy price, and various pandemic and geopolitical uncertainties globally…
Let’s Expand On These A Bit
The cryptocurrency mining market projections have shrunk in recent months as the price of Bitcoin and other cryptocurrencies have plummeted from their highs. Now, analysts and market experts expect the cryptocurrency mining market to grow at a CAGR (compound annual growth rate) of just 2.8% through 2028.
When it comes to the company’s cost, it’s their precise existence which is causing these price increases. Even as the chip shortage is resolving and supply chain constraints are easing, companies which create the Wafers which are used to create these mining chips are raising prices by around 20% to accommodate for the increased demand from cryptocurrency miners.
The price of energy in the People’s Republic of China is also expected to remain high. Even though the world’s soon-to-be largest economy is transitioning towards renewable energies, they still consume most of it from gas and the cost generating that electricity is expected to rise through 2024.
There Are Positives
The company does have a bunch of positive factors going for it, with the main one being that there is still demand for their products around the world as they work with their headquarters in Singapore in order to expand their business internationally into other East Asian nations in order to avoid some of the limits by the People’s Republic of China on cryptocurrency mining.
The company grew their revenues quite a bit on a year over year basis, but there’s a factor of comparisons going on here as their main base of operations was locked down during the 2021 COVID-19 spike in the People’s Republic of China. Even so, compared to the 2020 period, the company saw a big surge in revenues and is expected to report $724 million in sales this year.
This figure is expected to then grow by over 31% to $954 million in 2023 and then another 6.4% to just over $1 billion by 2024. Even though I don’t believe these estimates will be met, it shows that the company’s products are good and that current demand is strong.
Valuation Isn’t Possible, But Future Is Shaky
I don’t think that given the fact that the company’s core growth is so dependent on the price of an external and sporadic cryptocurrency, a fair value is even possible to fine. As a result, I look at the company from a risk to reward standpoint rather than a specific price point.
Overall, there’s plenty of good points which can generate meaningful growth for the company and they do currently have about $394 million in cash and equivalents to fund operations and international expansion, which will in turn boost their top line numbers.
But the sensitivity of their sales margins to the price of Bitcoin has me highly skeptical about their ability to generate real long term value. Even when the price of Bitcoin shot up through the roof, the company’s fundamentals have not improved all that much, aside from their value as they owned a certain number of these Bitcoins.
Conclusion – Still Avoiding
Even though there are several positive factors in the company’s long-term prospects, the uncertainty regarding the price of cryptocurrencies in general and the price of Bitcoin in particular makes Canaan’s technology and sales avenue more susceptible to fluctuations which can turn an investment sour.
As a result, I am continuing to avoid the company’s shares and will be focusing on other chip makers which have a more diverse business until the company can show some sustainable ability to generate some consistent sales and profits.
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