Forget ICOs, crypto miners are looking to IPO

Click the video link above to watch Saxo Bank Head of Cryptocurrency Strategy Jacob Pouncey's take on the Canaan and Ebang IPOs, as well as Bitmain's rumoured offering.

Two of the world’s largest blockchain chip manufacturers, Canaan and Ebang, have recently filed to IPO on the Hong Kong Stock Exchange, while the third and largest miner in the world, Bitmain, is speculated to file in September of this year. Collectively this will be a historic event for the burgeoning blockchain industry as this will give investors exposure to over 90% of the cryptocurrency mining market by revenue. Additionally, the Bitmain IPO will offer investors exposure to roughly 45% of the bitcoin mining rewards. The three companies are all Chinese, making China the world leader in cryptocurrency ASIC (Application Specific Integrated Circuits) production. Investing in cryptocurrency mining comes with several systemic risks, and investing in Bitmain comes with additional risk due to its direct exposure to the underlying cryptocurrencies.

Business model

Bitcoin mining involves using specialized hardware to secure public blockchains. Miners are rewarded with new cryptocurrency in return for providing security to the network through computing power. The possibility for rewards is primarily based on the percentage of computing power contributed to the network by a particular miner. Mining operations purchase ASICs from manufacturers like Ebang, Canaan and Bitmain. 

The miners preparing to IPO use a fabless manufacturing model where the firm designs the chip and then commissions the production from chip manufacturer like the Taiwan Semiconductor Manufacturing Company (TSMC).  ASIC manufacturers only engage in the inspection and packaging of the fabricated chips to arrive at the final product. All three of the firms are responsible for the design, packaging and inspection of the ASIC. Each company varies on the degree to which they outsource various steps in the process. The chart below displays the ASIC manufactures upstream and downstream value chain.
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Blockchain ASICs value chain (source: Saxo Bank, Bitmain)
All three stocks offer interesting opportunities in the blockchain hardware market, which is estimated to grow at 72% globally from 2017-2020. Bitmain leads the market with anywhere between 60-65% market share measured by the total computing power shipped, depending on which IPO filing referenced. Canaan is stated to have a market share between 17-20% while Ebang is third globally with 6-11% of the global computing power. The range of percentages is based on the IPO documents from Canaan and Ebang. Each firm’s IPO filing states that their respective market share is more substantial when compared to the other’s IPO filing.
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Source: Saxo Bank, Ebang, Canaan
Innovation expansion

All three companies are planning to use the funds raised in their IPOs to expand their innovation initiatives in the AI industry. Frost & Sullivan estimate that the global market for AI chips will reach $15.3 billion by 2020 translating into 43.3% annualised growth while the specific market for ASICs in AI will grow to USD 4.6 billion at a 66% annualised growth rate.

The demand for chips within AI represents a massive opportunity for existing ASIC producers. All three companies cite their success in blockchain chip design and execution in the cryptocurrency mining sector as reasons for their potential success in the growing AI market. AI still represents an open playing field in which neither company has a dominant position but must compete with incumbents such as NVIDIA. However, on the ASIC mining front, each company is experiencing various levels of success and progression. 

Canaan has developed a 7nm  ASIC for blockchain algorithms. This represents one of the most advanced ASIC designs on the market. Therefore, the smaller the connections, the less energy consumed by the chip. Canaan’s 7nm ASIC is set to commence mass production in the second half of 2018. The third largest ASIC manufacturer, Ebang, has 10nm shipping currently, and the firm has completed the front-end design on a 7nm chip which can be expected to enter production in 2019. Both Canaan and Ebang are looking to apply their ASIC design prowess to other blockchain-based algorithms and cryptocurrencies. Bitmain, on the other hand, has successfully released ASIC for other cryptocurrencies but has seen less success concerning smaller ASIC designs since the launch of its 16nm design over two years ago. Analysts have raised concerns around Bitmain’s efficacy in designing any chip lower than 16nm. Bitmain has attempted to release chips at the 16nm, 12nm, and 10nm scales, all of which have not been successful.

Additionally, Bitmain has since lost its director of design, who left to found a competing firm, thus causing many to speculate that Bitmain has lost its competitive edge in chip design.  However, Bitmain has release a new water-cooled ASIC miner recently, but it still uses the old 16nm ASIC. Of the three companies looking to IPO, Bitmain appears to be lagging behind its close competitors when it comes to chip design and efficiency. Despite its disadvantages, Bitmain’s 16nm design seems to be the workhorse of the industry in terms of scale and reliability. 

Financials

Profit margins across the industry vary from 28% to 46%. Bitmain is by far the most profitable business in the sector with a margin of 46% in 2017. Ebang is a close second with 39% net profit margins up from 9% in 2016. Canaan, on the other hand, has the lowest profit margins among the three at 28% up from 17% in 2016. The increase in profit margins across the industry is a result of the increase in revenues and gross profit margins in 2017.
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Source: Saxo Bank, IPO documentation
In terms of valuation we will focus on Bitmain as it’s the largest blockchain chip manufacturer company in the industry. In addition indications from previous financing rounds in terms of size and valuation have been leaked given a good insight to the company’s valuation. The $400mn financing round in June at around $14bn indicates a P/E ratio of around 10-11. 

Using an exchange rate on USDCNY of 6.8344, Bitmain reportedly delivered $1.1bn in net income in FY'17 and rumoured to have generated a net income of $1bn in FY'18 Q1. However, we know the cryptocurrency market has cooled significantly since Q1 so the FY18 net income could maybe reach $1.65bn in FY'18. Rumours are indicating that Bitmain is looking to IPO at a valuation of $18bn which translates into a P/E ratio of 10.9 – significantly below TSMC, NVIDIA, and AMD's respective P/E ratios of 19.3, 35.5, and 62.1 respectively. 

The lower indicated P/E ratio for Bitmain is likely due a couple of factors. The Chinese IPO market has cooled in 2018, Bitmain is a very high risk company given the uncertainty over the cryptocurrency market, regulation discount, China country risk discount, Bitcoin Cash translation risk into income statement, and rumours of lower competitiveness versus other chip makers such as Canaan and Ebang.

Risks 

Investing in the Blockchain mining and ASIC design comes with many risks. The following list is far from exhaustive. Considering the downturn in the cryptocurrency markets, investing based on the growth from 2015-2017 lead to poor investment decisions. Conversely investing on the 2018 number alone could lead to a miscalculation of the fundamental value of the firm.

The process of Bitcoin mining consumes a lot of energy which could lead to environmental regulation of the industry which could drive down growth and sales in the sector. The three companies listed above are currently geographically centralized within the PRC, and a majority of their sales are to the domestic Chinese market more than any other country. However, with the funds raised the firms are looking to expand geographic location globally. Ebang also has a telecommunications business, which could be adversely affected depending on the growth of 5G expansion and regulation in the PRC.

Additionally, the valuation of these companies is highly correlated with the cryptocurrency market cap. Bitmain may also have a higher correlation to the cryptocurrency market because it mines and holds cryptocurrencies on its balance sheet. Additionally, the firm has made a considerable investment in Bitcoin Cash, which is a highly illiquid market, making the assets challenging to move off the balance sheet for the foreseeable future. Also, Bitmain has announced it will start doing KYC requirements on orders; this could lead to a reduction in sales both domestically and abroad as well as the creation of secondary markets for the equipment, which could hurt the brand.

Finally, since Bitmain is the leader in the industry, other firms may follow suit in requiring identification for sales orders. 

As each company nears its IPO date and as we receive more recent numbers, we will continue to issue the most up-to-date publications and primers on each company.

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