Abstract: Following on from our August 2018 piece on Bitmain’s IPO, in this note we look at new information made available in Bitmain’s IPO prospectus, which was published in the last few days. The new filing confirms our suspicion that Bitmain has been making large losses recently, with a net loss of US$395m in Q2 2018. The magnitude of wasted production costs is also revealed, with almost US$0.5 billion spent on failed chips in the last 18 months. However, the document also confirms that Bitmain successfully raised US$442m from investors in August 2018, significantly strengthening their balance sheet. At the same time, this brings the IPO closer, which is good news for Bitmain and something its rivals should be concerned about.

The Income Statement to June 2018

The prospectus discloses financials up to June 2018, one extra quarter compared to what had previously been available. The new income statement confirms our suspicion (driven primarily by lower sales prices) that Bitmain has been making losses recently. As the below table shows, the company lost US$395m in Q2 2018. The IPO prospectus document shows the company making a net profit of US$742m in the first half of 2018, however since we know from the “leaked” pre-IPO presentations that Bitmain made a $1,137m net profit in Q1, we can tell that Q2 was a loss making period.

2015 2016 2017 2018 Q1 2018 Q2 Sales 137.3 277.8 2,529.3 1.896.4 949.1 Gross Profit 71.5 158.1 1,447.1 1,137.3 (107.3) Net Profit 48.6 118.9 1,249.4 1,137.7 (395.0)

(Source: Bitmain IPO prospectus, BitMEX Research)

However, the losses only relate to a period of one quarter and business conditions may change. One quarter of losses should not be a significant concern to long term investors, especially in a volatile business like crypto-currency mining. Although mining machine prices remain low and Q3 is also likely to be a loss making period, therefore moving back into the black may be challenging. Bitmain may need to raise prices to return to profitability, in our view.

In the document, Bitmain do acknowledge some potential strategic mistakes which may have contributed to the losses, and how they plan to address these issues going forwards:

In early 2018, we anticipated strong market growth for cryptocurrency mining hardware in 2018 due to the upward trend of cryptocurrencies price since the fourth quarter of 2017, and we placed a large amount of orders with our production partners in response to the anticipated significant sales growth. However, there had been significant market volatility in the market price of cryptocurrencies in the first half of 2018. As a result of such volatility, the expected economic return from cryptocurrency mining had been adversely affected and the sales of our mining hardware slowed down, which in turn caused an increase in our inventories level and a decrease in advances received from our customers in the first half of 2018. Going forward, We will actively balance our business growth strategy, inventories and cryptocurrencies assets levels to ensure a sustainable business growth and a healthy cash flow position, and we will adjust our procurement and production plan to maintain an appropriate liquidity level. (Source: Bitmain IPO prospectus, BitMEX Research)

Cash injections

The balance sheet position improved significantly in Q2 2018, mainly due to new cash injections from new investors. The net cash balance improved from US$104.9m to US$343m in Q2. Investors essentially rescued the company as it neared a cash crisis. As the table below shows, Bitmain raised even more money in Q3, which is likely to improve the cash position even further going forward.

Bitmain issuances of shares

Date Amount raised August 2017 US$50.0m June 2018 US$292.7m August 2018 US$442.0m Total US$784.7m

(Source: Bitmain IPO prospectus, BitMEX Research)

Inventory

The inventory balance fell to $887.2m in Q2, compared to the $1,243.8m in Q1 2018. This reduction is likely to be primarily driven by impairments. In H1 2018 Bitmain suffered an inventory write-down of US$391.3m. Therefore a significant proportion of the pain related to the overproduction could have already occurred.

Pre-payment to TSMC & the current mining industry outlook

Worryingly the TSMC pre-payment situation has not materially improved as a drain on working capital, with the balance as at Q2 being US$652.9m, only down slightly from US$666.0m in Q1. This could relate to Bitmain’s new 7nm mining product, which was recently announced. The fact that this was officially announced by the company is a positive, since the failed chips were not announced and therefore this product could finally be successful. This could rescue Bitmain from a difficult business enviroment. However, skeptics would point to the following:

This new 7nm project could also be a failure, the company is only announcing it as they are under more pressure (in our view this is unlikely)

Moving to 7nm is very challenging and it could take around 12 to 18 months until these devices are as reliable as the 14nm and 10nm products on the market

Producing at the 7nm level is too expensive and Bitmain’s rivals, Innosilicon, Ebang, Bitfury have out-smarted Bitmain by selecting the cheaper and larger wafer size in their new products, which have also all been announced in the last few weeks.

Impairments related to failed chips

As we mentioned in our previous piece, “Bitmain has tried to release at least three new more efficient Bitcoin mining chips, one at 16nm, one at 12nm and more recently 10nm in March 2018. Each of these releases failed, costing Bitmain hundreds of millions of dollars”. The disclosure in these documents may reveal that our assessment may have been accurate and the scale of the cost of these failures can now be determined.

Provisions for impairments related to TSMC prepayments & inventory write-downs



Period Value 2017 US$240.4m 2018 H1 US$252.7m Total US$493.1m

(Source: Bitmain IPO prospectus, BitMEX Research)

The above illustrates just how risky and potentially financially costly it is to produce new chips. Bitmain have paid a high price for some of the failures.

Bitcoin Cash & the crypto-currency holdings

The prospectus does not reveal any significant new information compared to our previous report, individual holdings by coin were not disclosed. The value of crypto-currency on the balance sheet fell to US$886.9m in Q2, compared to US$1,172.4m in Q1. This is likely to be driven by a fall in value in Bitcoin Cash and the other coins. Bitmain disclosed an impairment of its crypto-currency holdings of US$102.7m in Q2, which is likely to have accelerated further into Q3.

Conclusion

The prospectus enables us to quantify the financial impact of mistakes we already suspected that Bitmain had made.

Bitmain lost US$0.5 billion on production costs associated with mining chips that failed (or other inventory write-downs)

The company was dependent on US$784.7m on new investment to retain a positive cash position

Bitmain incurred a net loss of almost US$400m in the most recent quarter, due to having too much inventory and needing to lower sales prices

Obviously many of these mistakes could have been avoided, but all they really show is that Bitmain take risks. If Bitmain didn’t take such risks the company would not have built $1,617m of shareholder equity in the last few years and Bitmain would not have been the largest and most profitable mining company in 2017.

We now know the IPO is close and could occur within a few months. This could provide Bitmain a substantial cash war chest. Although Bitmain’s rivals have very recently successfully began releasing a wave of new more efficient mining products, Bitmain’s new large cash reserves is something they should worry about. Even though Bitmain obtained this money from investors, rather than generating it from free cash flow.

(The timeline of the IPO or number of shares which will be sold has not been disclosed in the filling)