CleanSpark: Benefiting From Bitcoin Surge

Summary CleanSpark offers a compelling small-cap opportunity, combining undervaluation with direct exposure to rising Bitcoin prices and a significant Bitcoin treasury. Operationally, CleanSpark has boosted its hash rate above 50 EH/s and shifted to a ‘produce and sell’ Bitcoin strategy, enhancing liquidity and decoupling somewhat from Bitcoin price swings. Rising energy costs and lack of transparency on mining costs present risks, but higher Bitcoin prices currently offset these pressures, supporting strong margins. Despite inherent volatility and risks, CleanSpark trades at an attractive valuation, remains profitable across various Bitcoin price scenarios, and I maintain a buy rating. Amid a sky-high stock market, I continue to believe that investors have to rotate more and more of our portfolios to lesser-known names in order to beat the major indices. For me, that means increasing my exposure to small-caps. CleanSpark ( CLSK ), in my view, is an excellent company that gives exposure to both an undervalued small-cap name plus rising Bitcoin prices. One of the most prominent Bitcoin miners in the U.S., half of CleanSpark’s value alone sits in its current Bitcoin treasury, while the company continues to add to its hash rate to increase Bitcoin production. Year to date, shares of CleanSpark have jumped ~25% – roughly mirroring the rise in Bitcoin. And yet, in my view the stock still remains quite undervalued. Data by YCharts I last wrote a buy opinion on CleanSpark in April, when the stock was trading near $9 per share. Since then, CleanSpark has boosted its operational throughput while also adopting a strategy of selling more Bitcoin, to take advantage of higher prices and to ensure more consistent liquidity flow. I remain at a buy rating here, though I’m cognizant of several new risks that have emerged. Hash rate boost, increased selling Let’s now start with the positive news that CleanSpark has to report. As a reminder for investors who are newer to this name, the company reports the results of its Bitcoin mining operations every month. In July, the company reported mining results for the month of June, in which CleanSpark crossed a significant threshold: exceeding a hash rate of 50 EH/s for the first time, which was its stated goal for the mid year. Meanwhile, during the month of June, the company produced 685 Bitcoin – on an annualized basis, this would equate to ~8,200 bitcoins produced annually. CleanSpark June mining results (CleanSpark July press release) But perhaps the most significant operational strategy change for CleanSpark is the fact that the company is now actively looking to sell more Bitcoin, rather than holding the majority of its production for investment. This is a fantastic way for CleanSpark to benefit from Bitcoin’s meteoric rise this year (at the time of writing, up 25% to ~$118k since the start of January). The company initiated what it calls a “Digital Asset Management” strategy, owned by the company’s treasury team. The goal is to be able to drive spot sales of Bitcoin with “derivative overlay” in order to take advantage of rising prices. In June, the company sold 578.5 Bitcoin, or 84% of what it produced. I view the pivot to a “produce and sell” strategy as a positive that should help decouple CleanSpark’s value from the price of Bitcoin itself. Today, the company’s Bitcoin treasury represents roughly half of its market cap value – to me, bringing down that treasury unlocks the possibility of buying back shares of reinvesting into additional production capacity. Rising energy costs and less transparency This being said, we do have to be aware of one risk: CleanSpark didn’t report its usual customary “cost per Bitcoin mined” in its most recent quarter, only citing that mining costs have increased due to rising energy prices. The company most recently reported $34,000 per coin mined in Q1 (the December quarter), and $36,250 in Q4 (September). We had been hopeful for a falling cost trajectory, but now we know only that Q2’s (March quarter) mining cost was above what it had been in Q1. Per CEO Zach Bradford’s remarks on the Q2 earnings call in May on mining costs and mining difficulty: Average revenue per Bitcoin was up 10.5% quarter over quarter and nearly 69% year over year, while our marginal cost per coin rose, reflecting both increased network difficulty and higher nationwide power prices. We remained focused on margin and long-term performance rather than any single metric. I want to be clear on what that means. That means we do not manage the power prices, and when margins are healthy, we run through slightly elevated power prices, as long as this drives more value to the bottom line. As a result, the average power price printed higher while delivering increased gross profit […] Mining difficulty rose 3.6% during the quarter, while power costs increased. Yet, thanks to improved fleet efficiency, our gross margin compression nearly matched the difficulty change, demonstrating our ability to absorb external pressures through operational gains. Our approach has never been about chasing the lowest cost per kilowatt hour. Instead, we managed to margin, making deliberate decisions, including running through higher price periods when doing so generates positive cash flow.” Still, at least for now, we take comfort in the fact that the rise in Bitcoin price should dramatically outweigh the rise in energy prices. If, taken together, increased mining difficulty plus higher electricity cost yields a ~10% sequential jump in cost per coin (from ~$34k in Q4 to ~$37k today), that gap is still more than covered by Bitcoin’s rise from ~$100k in May to $118k today. We note one additional risk: in spite of the company’s boost in hash rate to 50 EH/s, CleanSpark’s monthly coin production has actually not increased (thanks to rising mining difficulty, which will always be the case and is at the heart of Bitcoin’s scarcity). The 685 coins that the company produced in June was -1% lower than 694 coins produced in May (but higher than 633 in April). Valuation scenarios Now, we turn to a perennially difficult question to answer about CleanSpark: how do we value this company? It’s an exercise that can be done, but one that rests on a number of critical assumptions. These are the key levers of my pro forma P&L: Mining throughput: 8,220 Bitcoin per year (based on current 685 monthly production, annualized) Cost per coin: $40,000 (a conservative figure based on management’s directional commentary on rising difficulty and energy costs, relative to $34,000 most recently reported in Q1) Gross margin per coin: $75,000 or ~65% (based on $115k selling price and $40k cost per coin), or $616 million in gross profit dollars per year Opex: $136 million (based on 15% y/y growth versus $118.1 million in costs of payroll, G&A, and professional fees in FY24. The growth rate in opex is roughly in-line with the company’s growth in hash rate). This would give us a rough adjusted EBITDA of $480 million ($616 million in gross profit dollars, less $136 million in opex excluding depreciation and amortization as above). Of course, a lot here is truly beyond CleanSpark’s control, including and especially Bitcoin prices, but also energy prices and mining difficulty. It’s prudent for us to stress-test the company’s profitability based on a range of different Bitcoin price outcomes. Holding mining cost constant at $40k/coin: At BTC of $100,000, gross profit per coin falls to $60k, gross profit per year falls to $493 million, and adjusted EBITDA falls to $357 million (-26% less than my “base case” using current BTC prices). At BTC of $80,000 (roughly where BTC dipped when the market dropped in April), gross profit per coin falls to $40k, gross profit per year falls to $329 million, and adjusted EBITDA falls to $193 million. Needless to say, we think CleanSpark can remain quite profitable against a wide range of Bitcoin price outcomes, and its valuation still remains modest. At current share prices near $12, the stock trades at a $3.82 billion market cap. After we net off the 12,608 of BTC holdings in its latest June report (worth $1.49 billion at current market values), alongside $97 million of cash and $647 million of debt on the company’s latest Q2 balance sheet, the company’s rough resulting enterprise value is $1.78 billion. Against a “doomsday” scenario of ~$80k BTC prices, the stock still trades at only ~9x adjusted EBITDA, whereas in the “base case” scenario at current BTC prices of $118k, the company trades at Risks and key takeaways We’ll emphasize here that CleanSpark is, of course, a very risky investment. The greatest driver of its profitability is Bitcoin prices – something that has proven very volatile and is completely outside of CleanSpark’s control. We’re also watchful of the fact that CleanSpark’s rising hash rate has not really translated into a meaningful jump in monthly coin production, and we’re also looking for more transparency on what rising energy prices means from a mining cost perspective. That being said, in spite of the uncertainty, I think CleanSpark remains quite substantially undervalued, thanks to its Bitcoin treasury and the sharp recent jump in Bitcoin prices. Stay long here.

Source: Seeking Alpha