A report by Marcus Aurelius Value, an analysis organization, argues that the Nasdaq-listed ASIC manufacturer Canaan (NASDAQ: CAN) misrepresented its potential revenue for 2020. At least one of its clients is an alleged related party who is unable to honor the $150 million purchase contract.

Aurelius Value also considers Canaan’s AvalonMiner series to be uncompetitive within the ASIC market, noting that the manufacturer’s R&D budget is vastly inferior to competitors like Bitmain.

Following the Feb. 20 report, the analysts have deemed the company’s stock to be uninvestable and revealed that they have entered into short positions.

Canaan representatives responded to some of the claims after multiple Cointelegraph inquiries. Aurelius Value, in turn, did not respond to Cointelegraph’s inquiries on methodology — but we nonetheless found that some of the analysts’ conclusions are not entirely correct.

Alleged client irregularities

The analysts’ core argument against Canaan lies in what it claims to be a highly irregular transaction pertaining to its Nov. 27 initial public offering.

One month before the IPO, a “strategic partnership” was struck with Hong Kong Exchange-listed company Grandshores (HK 1647), which would have the company purchase up to $150 million worth of equipment.

This transaction presents several irregularities, according to Aurelius Value. That one order would represent almost the entirety of Canaan’s revenue in the past twelve months, which amounted to $177 million. Furthermore, they argue that Grandshores has no way of honoring the agreement, citing its $50 million market cap and $16 million cash balance.

Most notably, Grandshores appears to be a related party to Canaan. Hong Kong Stock Exchange filings list Yao Yongjie as its chairman, while Canaan’s Securities and Exchange Commission filings disclose that Yao Yongjie is a partner at a company that owns 9.7% of Canaan shares. A Reuters profile further mentions Yongjie as an angel investor in Canaan.

Canaan’s sales director Chen Feng held a livestream shortly before the deal was struck, promising that Canaan had letters of intent for more than 500,000 units, which led him to expect revenues of more than $1 billion in 2020.

The analysts concluded their argument:

“We therefore wonder if the giant Grandshores letter of intent, which we view as largely bogus, was used by CAN as a device to hype its financial prospects to investors.”

From a regulatory perspective, if the analysts’ conclusion is accurate, the failure to include this as a related party transaction in Canaan’s IPO filings dated after Oct. 27 could also have consequences. Companies are required by law to report dealings with entities with which its shareholders or executives have relationships in quarterly and annual filings with the SEC.

Canaan representatives responded to Cointelegraph’s request for comment on this transaction. They maintained that Yao Yongjie is not the owner of the stakeholder company mentioned in the filings and that he owns less than 1% of Canaan shares.

They also emphasized that the Grandshores contract is not a formal sales contract. The representatives explained:

“It is a framework agreement between two parties which Canaan granted Grandshores as a distributor and permit him to resale no more than $150 million of miners.”

The allegedly informal nature of the contract was also cited as the reason for not including it in the SEC prospectus, reportedly to “avoid misleading and to protect our IPO investors,” the representatives said.

Cointelegraph reached out to the law firm entrusted with conducting the IPO for further clarifications, but did not receive a response.

Canaan’s clients mentioned in Canaan’s previous public listing attempts in 2016 and 2017 also showed multiple irregularities, according to the analysts.

Poor product and business model

Aurelius Value concluded its analysis by reporting perceived flaws with Canaan’s business model and product line. According to SEC filings, the company began offering credit sales as the market dropped in 2018, which it says “caused our customers who purchased our Bitcoin mining products on credit to be less willing to make payment.” In addition, Canaan was involved in a lawsuit for failed payment of a $1.7 million invoice. The analysts noted:

“At minimum, we believe the plunge in Bitcoin prices that began in late 2017 has had a devastating impact on CAN’s business.”

Aurelius Value also argued that Canaan miners are entirely uncompetitive in the market, reporting data from the website asicminervalue.com. They maintain that Canaan’s business model is “upside down” as all its miners simply generate revenue at a loss.

However, this conclusion was reached by using default settings on the aggregator website, which put electricity price at $0.12 per kilowatt-hour (KWh). Few mining operations would ever be profitable at these rates — most of the activity is concentrated in specific regions where cheap electricity can be found. One such example is Quebec, where rates can go as low as 0.05 Candian dollars ($0.037).

Under these conditions, Canaan miners can be profitable, though they are generally less efficient in terms of hashes per watt ratio. While the lower efficiency could eventually make them obsolete, Canaan miners are often much cheaper than similar offerings from Bitmain.

For example, using electricity prices of $0.04, Canaan’s AvalonMiner 1066 generates an estimated $1,600 yearly profit, while it costs approximately $1,500. Bitmain’s S17+ would bring about $3,000 in profit at current rates, but its average price is around $2,850. The two miners would thus take a similar amount of time to pay themselves off.

While Aurelius Value raises important questions regarding the profitability of Canaan ASICs, the miners are still competitive under at least some circumstances. Nevertheless, the ASIC mining industry more broadly faces tremendous pressure from the Bitcoin (BTC) halving. Bitmain reportedly laid off 50% of its staff in preparation for the abrupt mining revenue dip.

Unclear sales practices and the nature of the mining industry may point to a higher investment risk than traditional markets would be accustomed to accepting.