Summary With the Bitcoin halving event which will cut miners' rewards in half looming in April, it is important to assess whether Marathon is in a position of strength. At the same time, the industry is consolidating because of the competition while some are diversifying into other industry verticals. Marathon's strategy to scale while reducing operating costs is positive, while the value of the Bitcoins it is HODLing seems not to have been fully priced in its Price-to-Sales multiple. After addressing this discrepancy, this is a buy. However, higher BTC prices increase mining difficulty which can in turn lead to volatility risks. Trading at $29.4 at the time of writing Marathon ( MARA ) is far below its 2021 peak of $75. Now, historical developments like the regulatory approval of the first Bitcoin ( BTC-USD ) spot ETF last month and the halving event to take place around April 19 are determining the miner's performance, especially given it holds a large number of coins in its treasury compared to peers. Data by YCharts This means a position of strength, but my objective with this thesis is to justify a bullish case based on the number of coins produced per month given the increasing mining difficulty, and operating costs since this is a loss-making company while also considering the competitive landscape. I first check why production fell by 42% in January relative to December, a significant decline. Looking Closer at Bitcoin Production for January Three other miners suffered from a reduction from December to January as summarized below. Table built using data from (seekingalpha.com) The reason for the common decrease seems to be related to the energy situation in the state of Texas where they have extreme heat in the summer followed by cold weather in the winter months. At that time, to favor domestic usage, miners are asked to curtail their activities, resulting in reduced Bitcoin output. Therefore, the reduction was pretty much across the board. However, the degree to which Marathon has suffered, or 42% compared to 20% or less by peers, suggests some reasons specific to the miner. According to a press release , there were temporary disruptions in the form of equipment failures which affected production thereby partly contributing to the hash rate dropping to 19.3 exahash per second (EH/s) in January, or by 14% compared to December. Another factor that comes into play here is the network fees-to-rewards ratio. This is the miner's revenue (or transaction fees) divided by the reward obtained for adding a block to the blockchain. This ratio declined in January, by 11% , while it had increased by 22% in December, making it more of an exceptional month with a production of 1,853 Bitcoins. This compares to only 1,084 in January. For a fairer comparison, I used November's production of 1,187 which was more of a normal month and whose fees-to-reward ratio was more or less equal to January according to bitinfocharts.com. Hence, relative to November, the effective decline for January was only around 8.68% which is far less than the 42% decline. This implies that after accounting for the seasonality and transaction fees, Marathon-specific outages are not meaningful, especially after performing a peer comparison with the table below. Table built using data from (seekingalpha.com) This shows that except for RIOT, which managed to keep January production the same as November, the other miners also experienced drops, even more than Marathon, which, it must be mentioned, is expanding capacity aggressively. Thus, it has added hash rate in Abu Dhabi, and Paraguay without forgetting about 0.9 EH/s in the newly acquired Granbury data center in Texas. Acquisitions also included Kearney in Nebraska, and, noteworthily, both these two U.S sites were operated by another miner Hut 8 Mining ( HUT ) whose contract was terminated by the new owner, Marathon. Competition, Consolidation, and Diversification This termination illustrates the competition in the mining industry, also characterized by consolidation as big miners like Marathon acquire new sites and energize new Bitcoin miners to boost the hash rate. Furthermore, both the high amount of energy consumed by mining rigs and the increasing mining difficulty caused by new computing machines constantly being added by miners and competing with each other to earn rewards, make things harder. As a solution, sites with access to low-cost energy sources are being favored with Marathon's expanding into Paraguay and Bitfarms ( BITF ) into Argentina . Moreover, due to the rapid depreciation of mining assets, a lot of capital has to be spent on state-of-the-art mining rigs which are more power-efficient. Still, renewal of the mining infrastructure has been going on for years despite the Bitcoin price dropping from its all-time high of nearly $69K in 2021 and a lot of uncertainty in 2022 because of the FTX crypto exchange collapse which caused others like Genesis to crash in its wake. The reason for continuing is that BTC mining is highly revenue-generating, and contrarily to gold mining, does not require physical vaults to store the product. As per the table below, the four miners produced between $6.2 million and $54.2 million worth of coins in January, whose dollar value per day is at least $200K for the smallest one. Table built using data from (seekingalpha.com) Looking further, in addition to diversifying across geographies, miners are also venturing into new industry verticals in the face of intense competition. Hence, Hive Digital Technologies ( HIVE ) is offering high-performance computing services to the artificial intelligence market to reduce reliance on mining while Riot Platforms ( RIOT ) is using its power credits to sell energy in addition to producing Bitcoin. In this way, it generated $13.5 million in energy reduction credits during the second quarter of 2023, compared to $49.7 million from BTC production. Therefore, energy-derived revenues can provide some insulation in case of crypto volatility. Marathon's Strategy to Reduce Costs Still, Marathon's gross profit margins exceed RIOT's considerably showing that its strategy to scale operations to spread its fixed costs over a wider revenue base is functioning. For this matter, RIOT's production for January was only about half of Marathon's as shown in the above table. Diving deeper into profitability, Marathon prioritizes direct ownership of production sites which not only reduces operating fees but also allows it to manage the way it uses energy more effectively, for example by using its technology rather than being dependent on what is provided by default. This strategy seems to be working when looking at the operating expense to revenues ratio, which from around 1000% in mid-2022, has considerably decreased to the 40%-55% range during the last three quarters as shown in the chart below. For investors, the 1000% spike was caused by exceptionally higher depreciation and amortization costs as the company decommissioned older rigs to make way for newer machines to optimize its energy footprint while increasing the hash rate. Charts built using data from (www.seekingalpha.com) On top, the company's HODLing strategy is positive going into the halving event which will see rewards reduced by 50%, or from 6.25 BTC to 3.75 BTC, which implies that only miners who are profitable and have strong balance sheets are likely to survive. Moreover, considering only 21 million Bitcoins can be mined in total, it will become scarcer and more valuable. From this perspective, Marathon's treasury of 15,741 BTCs as of the end of January becomes a key asset, which at a market price of $50K is worth $787 million. On the other hand, RIOT held 7,648 which amounts to $382 million. Deserves Better Based on Peer Comparison Now, with its treasury of BTCs worth two times more than RIOT in case these are sold and converted into revenues, Marathon's stock trailing Price-to-Sales ratio should trade at least two times RIOT's ratio of 10.45x , or 20.9x. Next, valuing Marathon using a multiple of 20.9x, I obtained a target of $37.3 or (20.9/16.5) x 29.41 based on its current P/S of 16.5x and share price of $29.41. Comparison of key metrics (seekingalpha.com) Now, some will argue that RIOT disposes of more cash or that it has relatively less debt as shown above, but Bitcoin mining's financial dynamics are somewhat similar to metal mining, where the net value of the company also depends on the commodities held. As for Marathon, it not only opted to HODL (or not to sell) any Bitcoin in January but, also purchased an additional 183.5 coins while RIOT chose to sell 212 BTCs. This explains why the latter disposes of more cash but this may be at the expense of its HODLing strategy consisting of becoming "one of the largest holders of Bitcoin". Applying some moderation, in the frenzy of Bitcoin crossing the $50K mark, it is important not to forget that this remains a highly volatile asset class. First, on February 12, it plunged from $50K to $48.5K within a day in reaction to core inflation figures for January not going down as expected . This implies that rates staying higher for longer can cause volatility risks. Second, while most people tend to focus on the hash rate going up in tandem with BTC prices, it is also important to watch out for network (mining) difficulty. Beware of Volatility because of Mining Difficulty This is illustrated in the chart below and shows that as BTC prices have moved up (in orange), the average mining difficulty has also risen to more than double, from around 37 in February 2023 to 77.56 currently. Data by YCharts This signifies that as miners increase production, it also becomes difficult or more time-consuming to solve mathematical equations under the PoW (Proof of Work) mechanism underlying Bitcoin which impacts the monthly production. This is one reason why miners, including RIOT , are constantly increasing hash rates. Extrapolating further, the current rally in BTC will only serve to heighten difficulty as shown in the above chart resulting in Bitcoin volatility. Two such volatility episodes occurred at the end of December and mid-January each time with BTC losing around $1,500, or 3% based on $50K per BTC. Therefore, any such volatility should reverberate on Marathon's stock and to a higher degree as illustrated by the fluctuations in orange being even wilder than those in blue. Data by YCharts Therefore, it will likely not be a smooth ride to the halving event, and the $37.3 estimate for the stock depends on Marathon's 13,700 mining rigs that were energized in January to contribute 1.6 EH/s as planned, because of mining difficulty. Still, I am bullish on the stock due to its war chest of Bitcoin, and as it scales operations while also reducing operating costs which puts it in a position of strength going into halving. Moreover, this event which aims " to control the supply of new Bitcoin entering circulation" is favorable to higher prices. Hence, in case, BTC reaches $65K, Marathon's treasury of 15,741 coins would be worth over $1 billion excluding those mined in February and March. Finally, the price action chart below is now in favor of the miner who had underperformed since new ETFs including the iShares Bitcoin Trust ETF ( IBIT ) were issued on January 10. At that time, the price action was largely determined by outflows from the Grayscale Bitcoin Trust ETF ( GBTC ) making their way into IBIT and peers as I explained in a recent thesis. However, the situation seems to have now normalized which explains why Marathon's orange chart has been surging higher since February 5 as shown below. Comparing the returns (seekingalpha.com)
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