Argo Blockchain: Stay safe and warm this crypto winter with high yield baby bonds

Crypto winter is here. At a recent price of $20,444, Bitcoin (BTC-USD) is trading for less than 1/3 of its 52-week high. Bitcoin miners have faced lower margins due to the combination of low Bitcoin prices and high energy prices. On a recent price of $4.55, Argo Blockchain (NASDAQ:NASDAQ:ARBK) is trading for less than 25% of its 52-week high. This article looks at the Argo Blockchain PLC 8.75% Senior Notes due 2026 (NASDAQ:NASDAQ:ARBKL). The ARBKL baby bonds are now yielding 12.2% and trading at just 72 cents on the dollar. This article makes a positive case for why income investors should consider ARBKL and also provides a discussion of the biggest risks.

What is ARBKL?

ARBKL is an unsecured par $25 baby bond with a generous 8.75% coupon due 11/30/2026. Quarterly interest payments of 54.7 cents are payable on 1/31, 4/30, 7/31 and 10/31 to holders of record on 1/15, 4/15, 7/15 and 10/15. ARBK is headquartered in England and trades in London and on NASDAQ. For US investors, there is no withholding tax on ARBKL interest payments

ARBKL is callable at par $25 as of and including 11/30/2025 and matures on 11/30/2026. See prospectus for further details. At a recent price of $18.10, ARBKL is trading at a cash yield of 12.2% and a 28% discount to par. ARBKL is a small issue with only 1.6 million shares outstanding ($40 million par value). Average daily trading volume is only around 3K shares. Use limit orders and patience when trading.

1. Strong liquidity

Strong liquidity is always an important factor for high-return investors. This is especially true given the recent volatility in the broad markets as well as the price of Bitcoin. As of its Q2 2022 earnings report, ARBK had total current assets of $167 million compared to current debt of just $65 million for a very healthy debt ratio of 2.6X. Current assets included cash of $9 million and holdings of Bitcoin and other digital currencies valued at $28 million.

2. Debt is well covered by assets

As of Q2 2022, ARBK had total capital of $304 million compared to total liabilities of only $139 million. ARBKL and other debts are well covered by assets.

3. 1.6X interest coverage

The interest rates were fully covered even with very low Bitcoin prices. Adjusted Q2 2022 EBIDTA was $3.2 million compared to interest expense of $2.0 million. Note that interest costs will fall significantly in the 3rd quarter. Debt temporarily increased in Q2 2022 due to a new loan to finance the purchase of mining equipment:

Received up to $70.6m (£56.3m) in additional funding from NYDIG secured by certain Bitmain S19J Pro machines at Helio.

Bitcoin sales (including a large reduction in long-term Bitcoin holdings) were used to reduce the debt. That NYDIG debt was reduced to $22 million at the end of Q2 with a further reduction to just $6.7 million by the end of July.

4. Access to capital

Even with recent weakness in ARBK’s common stock, ARBK’s stock market value is still around $200 million. Additional capital can be easily raised by selling equity if necessary. An equity capital increase will reduce the risk for the debt holders. For the 6 months ending 30/06/2022, share sales generated only 116,000 cash. Stock sales can at times be an important source of cash. Share sales generated $50 million for the 6 months ending 06/30/2021.

5. Excellent green credentials

Including carbon credits, ARBK had negative net carbon dioxide emissions in 2021. Their Bitcoin mining sites in Quebec use electricity produced from hydropower. Their new Texas location is primarily powered by surplus wind power. See their 2021 sustainability report for details. ARBK is a member of the UNFCCC Climate Neutral Now Initiative and claims to be the first climate positive crypto miner. This is an important consideration for all investors given the recent regulatory focus on reducing the climate impact of Bitcoin mining.

6. Low electrical costs

ARBKL has low electric costs in Quebec (mainly hydro) of around 4 cents per kwh and targets long-term electric costs in Texas (primarily wind) of around 3 cents per kwh. Having multiple mining locations in different regions helps reduce risk. Spot electric prices can rise at times even in locations selected for historically low electric prices. The August 2022 Operations Update showed that mining margins were squeezed in Texas due to unusually high electric rates:

In August 2022, spot power prices in West Texas averaged nearly $0.09 per kWh, which is nearly three times the average price in the month of August last year.

7. Technology manager

ARBK is the technology leader. They use state-of-the-art submersible cooling systems to reduce power costs and equipment wear and tear. ARBK distributes new Intel® BlockscaleTM ASIC chips in custom proprietary machine designs. ARBK recently received a contract to host equipment for another Bitcoin miner in exchange for 25% of their mining profits. This type of contract award illustrates the value of their new Helios Texas facility.

8. Hedging reduces risk

The price of Bitcoin has been very volatile. Fortunately, ARBK has succeeded in securing itself to reduce risk. As mentioned in the results report for the 2nd quarter:

In response to the challenging market environment, we have adjusted our financial management strategy. Throughout the period, we have sold Bitcoin steadily, using derivatives to achieve a higher realized price than simply selling into the market. In Q2 2022, we sold Bitcoin at an average realized price of approximately $28,500, realizing hedging gains of over $1,500 per Bitcoin.

9. Experienced management team

See the company’s September investor presentation for more details. ARBK has grown significantly since it went public in 2018 as a Bitcoin mining company. The management has grown the company with a focus on low costs, technical leadership and a strong balance sheet. ARBK has also been a leader in the movement towards sustainable Bitcoin mining.

10. 2.1X interest coverage even under adverse conditions

ARBK is an investor-friendly company that provides monthly operating updates. The August 2022 update reported that ARBK mined 235 Bitcoin in August and generated mining revenue of $5.23 million. Mining margins fell from 37% in July to just 20% in August due to high electric costs in Texas (see point #6). Remember that the mining margin excludes non-cash costs such as depreciation costs for mining equipment.

Even with this very tough combination of low Bitcoin prices and unusually high electrical appliance spot prices, ARBKL interest payments are still covered. If these tough conditions in August persisted for a full quarter, the quarterly operating margin would be ($5.23 million X 3 X 20%) = $3.1 million. Given the recent debt reduction (see point #3), quarterly interest expense should be around $1.5 million going forward for 2.1X coverage.

But what happens if the margins are temporarily pushed further? Fortunately, ARBK has strong liquidity (see point #1) and access to capital (see point #4). ARBK would survive a period of even tighter mining margins based on their hedging, current liquidity and ability to sell equity and/or other assets.

What are the biggest risks?

See page 120 of the ARBK annual report for a more detailed discussion of risk. I have briefly highlighted some of the biggest risks here. Even with a strong balance sheet and hedging, ARBK would be hurt if Bitcoin dropped significantly in price over an extended period of time. As mentioned in point 9 above, ARBK would not fully cover interest costs with $10,000 of Bitcoin. While ARBK is already a leader in sustainable Bitcoin mining, it may still be affected by new US or Canadian regulations in this area. Ethereum is migrating from a “Proof-of-Work” system to a “Proof-of-Stake” system. Such a transition seems highly unlikely for Bitcoin, but would have a negative impact on ARBK and other Bitcoin miners should it happen.

Conclusions

Despite the recent volatility in the crypto sector, high yield investors should consider ARBKL for its 12.2% yield and potential capital gains. The ARBKL baby bonds have less risk and volatility than shares such as ARBK ordinary shares. ARBK is well established as a Bitcoin miner. They stand out due to low mining costs, advanced technology and leadership in ESG issues.