On 30 August 2018, the research arm of BitMEX, the world’s largest crypto derivatives exchange (by trading volume), released a report that discussed the upcoming Initial Public Offering (IPO) of Bitmain Technologies, the world’s largest manufacturer of crypto mining hardware.

As previously covered by CryptoGlobe, Chinese crypto mining giant Bitmain has been preparing to file this September for what could be the world’s largest-ever IPO. Reports suggest that this IPO will be underwritten by ABC Capital Management, and listed on the Hong Kong Stock Exchange in Q4 2018 or Q1 2019. The company closed a $1 billion pre-IPO financing round (led by China International Capital Corporation) on 23 July 2018 at a $15 billion valuation.

Before we go any further, it is important to note that BitMEX Research has compiled its report based on leaked (on Twitter) financial documents about Bitmain. Although the documents appear to be genuine (to BitMEX and many others), it is impossible to verify their authenticity at this time.

With that in mind, here are the main highlights from BitMEX’s report:

“The company has just conducted a pre-IPO round, raising several hundred million dollars at a valuation of around $14 billion. Therefore we believe the company is likely to attempt to raise several billion dollars at the IPO stage, with a valuation north of $20 billion.”

Bitmain is the dominant player in the area of ASIC-based crypto mining hardware, and this is its core business. “In 2017 Bitmain claims to have had a cryptocurrency market share of 85% and a Bitcoin share of 77%.” Competitors in this include Canaan Creative, Ebang, Innosilicon, and Bitfury.

Amongst mining pool operators, Bitmain, once again, enjoys a dominant position, owning two of the largest mining pools (BTC.com and Antpool). “Bitmain is also an investor in ViaBTC. In the last six months these three pools had a combined global market share of around 48%.”

Bitmain may have been dominant as a mining farm operator in 2016, but “the pre-IPO documents show Bitmain has significantly scaled back in this area.”

BitMEX says that “Bitmain is likely to be the largest and most profitable company in the blockchain space.” (However, there are quite a few people who believe that BitMEX itself, which is very profitable already, if not already the most profitable company in this space, is on its way to getting there.)

“Justified or not, the blockchain space is now regarded by many as one of the next big internet based technologies and Bitmain is the number one player in this space. Whether this network effect type logic can apply to ASIC design and distribution is not clear to us and the benefits of being big may be limited to the more traditional economies of scale… Therefore we don’t completely agree that one should blindly invest in the largest cryptocurrency mining entity, we just think than some investors, perhaps naively, may think this way.”

“… one of the most interesting discoveries in the Bitmain pre-IPO documents was the sharp decline in Bitmain’s own mining farm business.” (“Revenue from own mining operations has fallen from 18.4% of total revenue in 2016 to just 3.3% in Q1 2018.”)

“We believe this decline represents a smart strategic decision by Bitmain to divest (relatively speaking), from an increasingly competitive and lower margin area.”

“In some ways this is good news for Bitcoin decentralisation, as a dominant mining player has stepped back.”

“The data shows that Bitmain sold over a million S9’s in 2017 and then over 0.7 million in Q1 2018 alone.”

With regard to Bitmain’s crypto mining hardware products (such as the Antminer S9), BitMEX’s analysis “implies Bitmain are currently loss-making, with a negative profit margin of 11.6% for the main S9 product and a margin of over negative 100% on the L3 product”, although they note BitMEX notes that “costs are likely to have declined so the situation may not be as bad, however we think it is likely Bitmain are currently making significant losses.”

“These low prices are likely to be a deliberate strategy by Bitmain, to squeeze out their competition by causing them to experience lower sales and therefore financial difficulties. In our view, herein lies the key to one of the main driving forces behind the decision to IPO. A successful IPO may increase the firepower available to continue this strategy and eliminate an advantage rivals could have by doing their IPOs first.”

“Another reason for these low prices and apparent losses may be that Bitmain has too much inventory on the balance sheet. As at March 2018 Bitmain had $1.2 billion of inventory on the books, equal to 52% of 2017 sales. Bitmain may therefore have had to suffer inventory write downs, which could have generated further losses in addition to the loss making sales.”

“The documents contain summary balance sheet data. On the positive side is that Bitmain has no debt and the company was highly cash generative in 2017.” As for the negatives, BitMEX says that they are the large prepayments to TSMC (totalling almost $866m in 2017), a large inventory balance of around $1.2 billion (indicating over-production), and a large portfolio of altcoins (“with a cost base of $1.2 billion which represents the primary use of Bitmain’s cash flow”).

“One of the key assets of the company is its portfolio of cryptocurrencies, valued (on a cost basis) at almost $1.2bn as at March 2018. As at March 2018 this consisted of over 1 million Bitcoin Cash. The market value of the altcoin portfolio has fallen in value since Bitmain invested, with almost all the losses attributable to Bitcoin Cash.”

“…the Bitcoin Cash investment itself is very significant, to the extent that the company spent around 69% of its 2017 operating cash flow on purchasing Bitcoin Cash.”

“Not only did Bitmain spend a majority of the 2017 cash flow into Bitcoin Cash, they also spent a majority of cash flow from their entire history of operations, into Bitcoin Cash.”

“In our view the primary motivating factor for the IPO is simply that Bitmain’s competitors are also planning on doing them and the industry is fiercely competitive, as Bitmain’s loss making prices indicate. Rival Canaan Creative are planning on an IPO and Bitmain are unlikely to let them obtain such a funding advantage. Bitmain’s IPO should deduct money from the pool of capital that could otherwise be invested in Canaan as well as the other miners and it is therefore a good complement to the strategy of lowering prices.”

“The other reason for the IPO may be to strengthen the balance sheet after investing the majority of the operating cash flow into Bitcoin Cash. Bitmain only had around $105 million of cash on the balance sheet as at March 2018, when this figure could have been nearer a billion dollars if the company hadn’t acquired so much Bitcoin Cash.”

Although Bitmain’s rivals in the crypto mining hardware business have released machines that more efficient (e.g. the ShenMA M10 has an efficiency of around 65W/TH compared to Bitmain’s S9, which has an efficiency of around 110W/TH), Bitmain’s products tend to be more reliable and have less variance with respect to the hashrate; also, none of them can deliver products to the market on the same scale as Bitmain.

“Bitmain has lost its technological edge as key staff, such as former director of design Dr Yang Zuoxing, have left.”

“Without the ability to innovate and produce better equipment, the only way Bitmain can generate sales is by lowering prices, until eventually the company loses its dominant market position.”

“Bitmain can be a legendary crypto company, generating strong shareholder returns for decades to come, but in order to achieve this (and it’s a lot harder than it sounds) the Bitmain management team may need to improve their management of company resources.”

Finaly, it is worth noting that it is not only BitMEX that has concerns about Bitmain’s operations. For example, last week, as covered by CryptoGlobe, the research team at AllianceBernstein, in a report published on 22 August 2018, said that Bitmain’s “cash flow appears to be questionable and the company may be gradually losing technological edge.”