The current economic surge revived the fortunes of many previously struggling companies. Crypto is one such category. As a result, Riot Blockchain (NASDAQ:RIOT) stock has soared from $4 to $50 since November.
During the pandemic, trader interest in Bitcoin (CCC:BTC-USD), Ethereum (CCC:ETH-USD) and other cryptocurrency dipped. As a result, shares in publicly traded crypto companies slumped. However, all the stimulus spending has sparked inflation fears, and that’s caused crypto to roar back.
At first glance, this seems to make perfect sense. After all, the price of Bitcoin is up 5x in recent months. Why shouldn’t a mining company like Riot be up even more, given its more levered exposure to the price of Bitcoin?
However, as you’ll see, there are some serious valuation concerns around RIOT stock. Before we get to the bad news, however, let’s give Riot credit where it is due.
Business Is Accelerating
The biggest positive for Riot Blockchain is that it is picking up steam. For the first two months of 2021, Riot produced 304 Bitcoins, or 157 per month on average. That’s up sharply from its 100-coin monthly average in the fourth quarter of 2020. This is perhaps inverse of what you might have expected.
With the price of Bitcoin soaring, the difficult of mining new Bitcoins hit record highs in early 2021. This means that a mining firm needs to devote more computing power simply to generate the same amount of Bitcoins as it did previously.
Given the rise of competition, more computing resources are chasing the same number of resources, leading to a decline in efficiency.
That notwithstanding, Riot is on pace to generate significantly more coins this quarter than it did at the end of 2020. That’s a great sign. Riot’s growth strategy is working as the company intended. This also puts Riot significantly ahead of other mining rivals such as Marathon Digital (NASDAQ:MARA) that have taken longer to scale up their operations.
Stock Price Is Far Ahead of Fundamentals
Riot is doing better than many of its bitcoin-mining peers. That said, this advantage is not nearly enough to justify RIOT’s current stock price.
Think about it this way. The company is now mining 150 or so new Bitcoins every month. At a price of $50,000 each, that’s worth $7.5 million per month. Let’s call it a $100 million annual revenue run rate assuming production bumps up a bit more or the price of Bitcoin further increases.
The company’s profit will be much less than this, of course. In addition to normal corporate costs, Riot has to pay for its additional mining gear, along with maintenance, electricity and other items. Generating $100 million or so in annual revenues and a small fraction of that in profits is not an especially large business.
Yet, the market is currently valuing Riot at more than $3 billion. At current operational levels, it’d take Riot 30 years or more to earn back its current market cap, even if it earned a 100% profit margin on its revenues, which is obviously unrealistic.
Now sure, Riot can grow more, but that will likely require further share dilution. Or it could earn more money from a higher selling price for its Bitcoin. But if you want to bet on that, you can always buy Bitcoin outright rather than a high-priced mining firm.
RIOT Stock Verdict
The best thing I can say about Riot is that it’s a better Bitcoin operation than Marathon Digital and some of the other smaller rivals. If you’re looking for an above-average company in the field, Riot probably fits the bill.
Here’s the thing, though. It’s unclear if any of these mining companies – at least the ones based out of North America – will ever make large sums of money. This is a brutally competitive field where rivals elsewhere can compete with really cheap electricity costs. Riot has some operating scale, at least compared to Marathon, and that’s an edge.
However, this business will earn thin profit margins even in the best of times. As such, it’s hard to justify a price-sales multiple of more than a couple times for this sort of business. Instead, speculators are paying a nosebleed valuation for Riot. It’s true that the company’s prospects have gotten much better recently. But it’s not nearly enough to back up a 2,000% move in the stock price.
This is an emerging industry and perhaps it will see its economics get way better at some point. So far, however, there’s no evidence that this is going to be a long-term winner. If you want a trade on the price of Bitcoin going up, you could simply buy bitcoin.
RIOT stock seems like a bad choice by comparison.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.
