Kanaan: Bitcoin Band Beats Any Growth Potential For Chips, For Now (NASDAQ:CAN)

Canaan (NASDAQ:CAN) is an interesting company when it comes to the AI ​​chip space, especially for the cryptocurrency mining sub-industry. They have made some good progress with their mining chips and have seen sales increase steadily over the past few years as they save them and their customers energy costs.

But there is a constant negative to all this – most of their business and long-term prospects are still closely tied to the price of Bitcoin (BTC-USD). There are a few parts to this, so let’s explore those before we get to and expand on my investment conclusion.

More Negatives with Bitcoin Bands

The first negative is that the appetite for the company’s chips, and the price they can charge for these chips is almost directly tied to the price of Bitcoin. The CEO and CFO both acknowledged that when the price of Bitcoin falls, the price at which they can sell their products falls and they lose the ability to generate meaningful profits.

The other part of this is that the company have several expenses that are not linked to the price of Bitcoin as the price of energy that they use to mine their own Bitcoin. This is also true with Wafer prices, meaning that when the price of Bitcoin is down, the hit to their profits will be significantly higher than the hit to their earnings.

Higher energy prices are also negative for the company’s own mining operations of Bitcoin, which the company makes quite a bit of. As of their last report, the company only held onto 347 Bitcoins, valued today at around $6.9 million. This is also the other negative for the company’s valuation and balance sheet when it comes to the price of Bitcoin – the value of these 347 Bitcoins was about $17.5 million about a year ago, but has now more than halved. This volatility, as the price of Bitcoin is expected to remain under pressure, could create problems for the company’s balance sheet and valuation.

Here is the summary made by the CFO in his latest earnings call:

As the Bitcoin price declined further in the second quarter, we responsively lowered the product price for spot sales to bear the pressure with our customers. On the other hand, the wafer price remains high on the cost front. We therefore expect the gross margin to drop dramatically in the second half of this year. Looking ahead to the coming quarters, we see a tougher market environment from the lower Bitcoin price level, overall increased energy price and various pandemic and geopolitical uncertainties globally…

Let’s expand on these a bit

Estimates of the cryptocurrency mining market have shrunk in recent months as the prices of Bitcoin and other cryptocurrencies have fallen from their highs. Now, analysts and market experts expect the cryptocurrency mining market to grow at a CAGR (compound annual growth rate) of just 2.8% through 2028.

When it comes to the company’s costs, it is their existence that causes these price increases. Even as the chip shortage resolves and supply chain constraints ease, companies that make the Wafers used to make these mining chips are raising their prices by around 20% to accommodate the increased demand from cryptocurrency miners.

The price of energy in the People’s Republic of China is also expected to remain high. Although the world’s soon-to-be largest economy is transitioning to renewable energy, they still consume most of it from gas and the cost generation that electricity is expected to rise through 2024.

There are positives

The company has a bunch of positives going for it, with the main one being that there is still demand for their products around the world as they work with their headquarters in Singapore to expand their business internationally to other East Asian nations in order to avoid some of the borders from People’s Republic of China for cryptocurrency mining.

The company grew its revenue quite a bit on a year-over-year basis, but there is a factor of comparisons going on here as their main base was locked down during the 2021 COVID-19 peak in the People’s Republic of China. Still, compared to the 2020 period, the company saw a big increase in revenue and is expected to report $724 million in sales this year.

This number is then expected to grow by over 31% to $954 million in 2023 and then another 6.4% to just over $1 billion by 2024. While I don’t think these estimates will be met, it shows that the company’s products are good and that current demand is strong.

Valuation is not possible, but the future is unstable

I don’t think that given the fact that the company’s core growth is so dependent on the price of an external and sporadic cryptocurrency, a fair value is even possible to fine. As a result, I look at the company from a risk-to-reward standpoint rather than a specific price point.

Overall, there are many good points that could generate meaningful growth for the company, and they currently have about $394 million in cash and equivalents to fund operations and international expansion, which in turn will boost the top line.

But the sensitivity of their sales margins to the price of Bitcoin has me very skeptical of their ability to generate real long-term value. Even when the price of Bitcoin shot through the roof, the company’s fundamentals didn’t improve much, except for the value as they owned a certain number of those Bitcoins.

Conclusion – Avoid still

Although there are several positive factors in the company’s long-term outlook, the uncertainty surrounding the price of cryptocurrencies in general and the price of Bitcoin in particular makes Canaan’s technology and sales path more susceptible to fluctuations that can sour an investment.

As a result, I continue to avoid the company’s stock and will focus on other chipmakers that have a more diverse business until the company can demonstrate a sustainable ability to generate consistent sales and profits.