HIVE: Pivoting To AI?

Summary HIVE Blockchain is one of the largest publicly traded crypto miners with assets in Canada, Sweden, and Iceland. As expected, HIVE closed out calendar 2022 on a whimper with the crash in digital currency prices and a huge write-off in mining equipment. Looking forward, HIVE is hyping up a pivot to use its GPUs in 'AI' applications. I remain skeptical until we see more financial details. Where to begin? In November, I penned an article suggesting that HIVE Blockchain Technologies Ltd. ( HIVE ) could potentially be mining bitcoin at a negative margin. I was also cautious because HIVE had continued to invest heavily towards Ethereum mining equipment, right up until the Proof-of-Stake ("POS") merge , so there was potential for a large asset writedown. Unfortunately, both of my worries came to fruition in the months since my article. Financials Going From Bad To Worse As digital currencies collapsed in the second half of 2022 due to a myriad of scandals and bankruptcies, including the bankruptcy of FTX, one of the largest crypto exchanges in the world, HIVE's fortunes went from bad to worse. As we can see from figure 1 below, HIVE went from a 3% gross margin in fiscal Q1/2023 (June 30, 2022), to -28% gross margin in Q2/2023 (September 30, 2022), to -117% gross margin in Q3/2023 (December 31, 2022)! Figure 1 - HIVE financial summary (HIVE Q3/23 MD&A) The revenues HIVE brought in from crypto-mining in Q3/23, $14.3 million, barely covered the electricity costs to run the mining equipment, let alone cover the depreciation of the mining equipment and G&A expenses of the company. Furthermore, as I highlighted in my prior article, HIVE faced obsolescence costs on its Ethereum mining equipment as Ethereum switched from Proof-of-Work ("POW") to Proof-of-Stake ("POS"). In fact, in Q2 and Q3/2023, HIVE took a combined $87.7 million impairment charge to mining equipment and equipment deposits. Crypto Mining Is A Terrible Business Is crypto mining a terrible business? HIVE's cumulative financials since going public suggest so. HIVE has the dubious distinction of having lost a cumulative $284 million since the company went public, despite the company having recorded $441 million in cumulative revenues from mining crypto currencies (Figure 2). Figure 2 - HIVE has lost money since IPO (Author created with data from tikr.com) Even ignoring asset writedowns and impairments, HIVE has generated cumulative operating loss of $68 million since going public, as electricity, SG&A, and mining equipment depreciation has eaten up more than 100% of revenues. Bitcoin Prices Have Bounced, Is Hive's Future Looking Bright? Since the end of 2022, bitcoin prices have staged an impressive 50% bounce, from ~$16k in December to ~$24k recently, does this mean HIVE's future looks bright? While bitcoin prices have rallied significantly, bitcoin network difficulty have also climbed ~20% since year-end, so HIVE may not see the full benefit of the rally in bitcoin prices (Figure 3). Figure 3 - Bitcoin prices and difficulty have climbed since end of 2022 (blockchain.com) In fact, in January, HIVE reportedly produced only 260 BTC, a decrease from 264 BTC in January 2022, despite bitcoin mining capacity increasing from 1.87 Exahash in January 2022 to 2.68 Exahash at January 31, 2023. Due to the constant increase in mining difficulty, bitcoin mining is like running on a treadmill, miners have to spend millions in capital just to stand still. Late Filing Adds Confusion To The Mix On February 14th, 2023, shareholders also got a Valentine's Day surprise when HIVE reported that due to a tax notice for one of its European subsidiaries, HIVE would not be able to file its interim financial statements by the regulatory deadline of February 14th, 2023. Fortunately, the company was able to release its financial results on February 21, 2023. However, reading the notes to the financial statements, we can see that the tax dispute on input VAT against equipment and other charges of SEK 338 million ($32 million) has not been resolved. While the company has filed formal appeals to the Swedish Tax Authority, there can be no guarantees that HIVE will prevail in recovering the VAT taxes. Altogether, the disputed VAT tax amounts to $4.6 million that the company currently includes in accounts receivables (Figure 4). Figure 4 - HIVE has $4.6 million in disputed VAT tax receivables (HIVE Q3/23 Financial Statements) Furthermore, if the ruling goes against HIVE, the company could be liable for the full amount plus other items such as penalties and interest. Why No Earnings Conference Call? In an age of transparency and accountability, it is notable that HIVE decided not to host a conference call after it released its Q3/2023 earnings report on February 21. This is especially galling as the company reported a huge $1.09 / share quarterly loss and shareholders were no doubt looking to management for direction and guidance towards future results. Perhaps the lack of an earnings conference call was to prevent analysts and investors from asking management tough questions? Pivot To 'AI' A New Source Of Growth? One interesting positive development in the quarter was the introduction in the earnings press release of language pertaining to 'high performance compute' ("HPC") and 'AI' (author highlighted): Frank Holmes, HIVE’s Executive Chairman, stated “We wish to again thank our loyal shareholders for believing in our vision to mine both Ethereum and Bitcoin. We are sad to see the higher margin from mining Ethereum gone however our HPC strategy which has taken longer to roll out is now growing rapidly on a month over month basis. We are happy to share that our robust growth is scalable and could potentially increase 10x fold over the next year as the demand for our high quality chips due to the huge global demand for Ai projects like GPT CHAT, medical research, machine learning and rendering . Further, HIVE was the first to use our software to help balance the electrical grid and resell back energy whenever there is spike in demand. This strategy has been good for the community and HIVE. Even with a challenging quarter for the global digital asset ecosystem, where we saw the capitulation of crypto prices due to the implosion of FTX and the related contagion with other exchanges, lenders and hedge funds. Strategically, we have not borrowed expensive debt against our mining equipment or pledged our Bitcoins for costly loans, thus our balance sheet remains healthy to weather this storm. We believe our low coupon fixed debt; attractive green renewable energy prices and high performing energy efficient ASIC and GPU chips will help us navigate through this crypto winter. The most recent unexpected challenge has been in Sweden which we cover in greater detail in our interim filings.” As many investors are aware, 'AI' has been the hot topic in the past few months due to introduction of Chat GPT , a generative AI chatbot that has taken the public's imagination by storm (author's note, Hive appears to have mixed up Chat GPT's name in its press release above). The mere mention of 'AI' or 'Chat GPT' can cause small cap speculative stocks like C3.ai ( AI ) to rally 10-40% in a day, so it is not surprising that HIVE wants to be associated with the AI movement. However, it remains to be seen how applicable HIVE's GPU farms are towards real-world AI applications. According to the press release, HIVE will launch 'HIVE Performance Cloud' in calendar Q2 2023. Prior to the full-scale launch of HIVE Cloud, Hive's proof-of-concept test of its GPU fleet was able to produce annualized revenues of over $1 million doing high performance computing workloads. At current market conditions, HIVE estimates HPC is approximately 25x more profitable than mining bitcoin, on a dollar per MWHR basis. Enlisting approximately 450 GPUs, HIVE was able to produce $3,500 in revenue per day with 80 kW of power consumption. By comparison, 80 kW of Bitcoin ASIC miners would only produce approximately $175 per day of BTC. While those are gaudy numbers, investors are cautioned against counting their chickens before they hatch. In the HPC realm, HIVE will be competing against industry giants like Amazon's AWS, Microsoft's Azure, and Google's Cloud, not to mention dozens of dedicated competitors. It is unclear what advantage HIVE's GPUs have besides being idle. Let's wait until we see actual operational results from 'HIVE Cloud' before assigning any additional value to the GPU fleet. Risks To Bearish View Obviously, the biggest risk to being bearish HIVE is that even if one gets the fundamentals correct, one can still lose money. For example, even though the company has performed operationally exactly as I imagined in my November article, its stock price trajectory has been a different story. HIVE's stock first dropped from ~$2.50 to ~$1.40, then tripling to $4.20 in early January, before finally trading back to $2.50 in recent days (Figure 5). Figure 5 - HIVE is an extremely volatile stock (stockcharts.com) This is because HIVE trades much more on investors' sentiment towards bitcoin and risk appetite in general, rather than fundamentals. For traders who can time the markets, HIVE could be a great trading vehicle. However, for investors who want to invest in strong fundamentals, I would suggest they look elsewhere. Conclusion In summary, HIVE delivered exceptionally poor financial performance to close out calendar year 2022, as I had expected. Gross margins, which includes depreciation for mining equipment, fell to -117% in Q3/F23. HIVE also took $88 million in writedowns against its obsolete GPUs. Looking forward, I think HIVE's financials will see a relief bounce in Q4/F23, as bitcoin prices have rebounded in the past few months. However, investors should bear in mind bitcoin mining difficulty have increased, so the financial benefits may be less than what bitcoin prices suggest. One ray of hope for HIVE is its recent pivot towards 'high performance compute', which HIVE describes as being 25x more profitable than mining bitcoin. However, until we see some real financial results, I think investors should remain on the sidelines.